The Institute for Energy Economics and Financial Analysis has released a report titled “Russia Sanctions and Gas Price Crisis Reveal Danger of Investing in “Blue” Hydrogen” in May 2022. REGlobal provides a brief extract from the report…
Key findings:
- Elevated gas prices and a future tight market means blue hydrogen is no longer a low-cost solution; IEEFA estimates that blue hydrogen costs published by the UK government last year are now 36% higher, calling into question continued policy support for development of the technology.
- Blue hydrogen is an extension of the gas value chain and does not make sense as an investment during a gas price crisis.
- The UK will need to import 10% more natural gas to produce blue hydrogen than if the gas was used directly for heat. This would raise demand for gas at a time when Europe is seeking to reduce its dependence on the fossil fuel.
- Reducing the demand for gas needed for grey hydrogen production could help ease issues with gas price, security of supply and energy transition. According to BNEF, just replacing current grey hydrogen demand with green hydrogen for oil refining and fertilizer production could reduce the European Union’s gas demand by 12%.
- Blue hydrogen projects are high risk and likely to become stranded assets.
- Twenty-six green hydrogen projects are expected to start construction around the world this year; no blue hydrogen projects are slated, demonstrating that its financial risks are already playing out in the global market.
The Economics of Hydrogen Production
Hydrogen production requires various fixed and variable costs. Levelized cost of hydrogen (LCOH) is a calculated metric that enables different production methods to be compared on a similar basis. It estimates all the capital and operating costs of producing hydrogen over the lifetime of a project and discounts future costs to the present. As with all such measures, it is completely dependent on the assumptions used and subject to uncertainty. However, it does reveal the major cost components of each production route and when considered within the context of energy market trends, can indicate relative risks as well as likely potential for future cost reduction.
The largest cost component for blue and grey forms of hydrogen is the cost of gas used as feedstock and fuel for the SMR or ATR process. The cost of production is highly sensitive to assumptions about the current and future price of gas, with longer-term pricing carrying less weight due to discounting. As well as the price of gas, blue hydrogen is sensitive to factors such as the project capital expense (capex), efficiency and timeline for the plant, the price of carbon and proximity of the CCS storage site. For green hydrogen, the largest components are the cost of power needed to run the electrolysis process and the plant capex, which is primarily the cost of electrolysers. Green hydrogen is also sensitive to electrolyser utilisation (or load factor) and efficiency assumptions.
The global gas price crisis over the last two years and the Russian invasion of Ukraine have highlighted the danger of relying on globally priced fossil fuels. Record high gas prices and expectations of sustained tightness in global gas markets have all but destroyed the business case for blue (and grey) hydrogen in Europe. As gas prices skyrocketed last year, several research institutions published information on how this could affect production costs, claiming that gas-derived hydrogen had become more expensive to produce than renewable hydrogen, or that it would become more expensive years earlier than previously expected.
Global Longer Term LCOH Trajectories
Blue hydrogen was previously advertised as cheaper to produce than its green equivalent because the underlying coal or gas technology is commercially mature, even though CCS is not. It is hard to see a dramatic technology breakthrough that could reduce key costs for blue hydrogen, especially since CCS has already suffered decades of failed investments. Meanwhile, assuming there will be sufficient demand for hydrogen globally, the long-term price forecasts for green hydrogen are getting cheaper. In particular, the cost of electrolysers is expected to reduce rapidly in coming years as companies and governments around the world invest in projects, production capacity, and technology research & development. As a result, global green hydrogen costs are expected to plummet in the coming decade.
The Global CCS Institute reported last year that the cost of producing clean hydrogen from gas with CCS could vary significantly from place to place due to differences in fuel costs. In locations with cheap gas ($3/MMBtu), capex is the largest cost component, and the overall hydrogen cost was predicted at $1.50/kg. In locations with very expensive gas, gas is the largest cost component. Assuming a very high gas price ($11/ MMBtu), the organisation estimated the cost of blue hydrogen at $2.40/kg.
IRENA expects green hydrogen to undercut blue hydrogen on costs by 2030. It may do so even sooner in some countries, such as China, thanks to its cheap electrolysers, and Brazil and India, thanks to their inexpensive renewables and relatively high gas prices. Bloomberg New Energy Finance (BNEF) predicts the cost of producing hydrogen from renewable electricity should fall by up to 85% from today to 2050, leading to costs below $1/kg ($7.4/MMBtu) by 2050 in most international markets. As the price of electrolysers rapidly declines, BNEF predicts that green hydrogen will be cheaper to make than blue hydrogen by 2030.
Prior to the gas price crisis, KPMG estimated that the scale-up of green hydrogen projects and innovations would make green hydrogen cost-competitive with blue by 2050. By their estimates, water electrolysers account for about 45% to 75% of green hydrogen production costs. Rystad Energy reported that the production costs of the green gas hovered around $4/kg (particularly in the Iberian Peninsula), compared with $14/kg for blue hydrogen and $12/kg for grey hydrogen.40 Costs of blue and grey hydrogen had jumped about 70% since the Russian invasion began, with the price of conventional energy surging due to concerns about the future of Russian supply, typically a significant percentage of Europe’s coal and gas.
This latest calculation shows the fragility of the gas market and its influence in the cost of producing blue hydrogen. Blue hydrogen costs of $14/kg in March 2022 is almost six times more expensive than the cost of $2.40/kg predicted by the Global CCS institute when assuming a high cost of gas.
Subsidies
The European Climate Law cements Europe’s goal to become climate-neutral by 2050, in line with the objectives of the Paris agreement. G7 leaders pledged to phase out new direct investment support for international carbon-intensive fossil fuel energy as soon as possible, and reaffirmed existing commitments to eliminating inefficient fossil fuel subsidies. In December 2021, the European Commission released its “Hydrogen and Gas Market Decarbonisation package” (“gas package”). The package aims to facilitate the integration of renewable and low-carbon gases, including hydrogen into the existing gas network.
The European Commission has approved a €900 million German scheme to support investments in the production of renewable hydrogen in non-EU countries, which will be then imported and sold in the EU. The scheme, called “H2Global,” aims to meet the EU demand for renewable hydrogen that is expected to significantly increase in the coming years by supporting the development of the unexploited renewable resource potential outside the EU. The UK says it will finalise a plan to subsidise the production of low-carbon hydrogen by the end of this year, with the first support contracts for projects scheduled in 2023. The government’s Contracts for Difference (CfD) plan — being billed as a “variable premium price support model” — would offer a subsidy representing “the difference between a ‘strike price’ reflecting the cost of producing hydrogen and a ‘reference price’ reflecting the market value of hydrogen.”
Gas Price, Security of Supply and Energy Transition
Europe is facing difficulties trying to balance between three priorities: Reducing the gas price, offering a secured supply of energy and continuing with energy transition objectives. The only clear way to achieve all of this at once is by reducing gas demand. Reducing gas demand will also help reduce European dependency on Russian gas.
It is important to understand that blue hydrogen production is an extension of the natural gas value chain, affected by the same uncertainties of the gas industry. As a consequence, Europe will need to import more gas for blue hydrogen. This will increase prices, increase energy security risks and cause more greenhouse gas emissions.
The full report can be read here
