Policy

ANALYSIS | Why the risks and potential rewards are both high for green hydrogen producers at the upcoming EU subsidy auction

While rules on development timelines and firm contracts have been watered down, bidders may have to price in extra risk — or find they are no longer competitive

Maroš Šefčovič has recently taken on responsibility for the European Hydrogen Bank.
Maroš Šefčovič has recently taken on responsibility for the European Hydrogen Bank.Photo: Kenzo Tribouillard/AFP via Getty Images
Analysts warn that the EU’s terms and conditions for the upcoming €800m ($856m) pilot auction under the European Hydrogen Bank could result in developers underbidding on the likely cost of their project’s H2 in an effort to secure payouts.

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The terms and conditions of the competitive auction offer up to €4.50 ($4.82) per kg for ten years from when the project starts production — potentially a higher subsidy per project than the $3/kg clean hydrogen production tax credit offered in the US.

But this is not indexed to inflation.

As such, over the five-year time limit that developers have to build their projects, the cost of equipment, logistics and labour could all ratchet up beyond what was estimated when they bid into the auction, without the subsidy rising to compensate for the increased expenses.

Since the main purpose of the auction is to fill the cost gap between green hydrogen and grey H2 (made from unabated fossil gas), industry voices have raised concerns that a lack of inflation indexing means that developers may win with extremely low bids, but those projects could end up not being competitive with fossil alternatives once they actually start up.

“The lack of indexation in the offshore wind sector means companies have not been able to mitigate rising material and construction costs, leading to companies cancelling multi-billion-euro projects,” said Jorgo Chatzimarkakis, CEO of industry association Hydrogen Europe.

“This same issue could be a dealbreaker for hydrogen and the whole European Green Deal. To fix this issue in the pilot auction would be an important signal for all clean technologies.”

However, the lack of inflation indexation could also mean that developers will simply have to calculate how much they are willing to gamble on future inflation and longer lead times for cheaper electrolysers, according to Adithya Bhashyam, associate at research firm Bloomberg New Energy Finance (BNEF).

“By the time you come on line, by 2029, your costs could be so high because of inflation that you’re not competitive, so you need to find a balance between timelines — what gets me the cheapest equipment, but what puts me in least risk,” he told Hydrogen Insight.

The recent increase in bid ceiling to €4.50/kg from €4/kg could be a subtle way for the European Commission to pass on risk management around inflation onto the developers.

“From a Commission point of view, if you index [inflation], you can’t give out as many subsidies, you can’t support as many projects — either way, the amount is larger but you’re just moving risk onto the developers,” Bhashyam said.

But while some developers may try to push risk further onto their offtakers, they may find that buyers are already reluctant to lock in long-term purchases of green H2 at potentially high prices, since future volumes are likely to drop in price due to scale — so an inflation indexation clause may receive major pushback.

“The question is who will be willing to sign an offtake agreement like that?” Bhashyam mused.

And because winning bids in the auction will not guarantee that a green hydrogen project can actually produce competitively priced volumes of H2, developers may continue to see the US as the most attractive market when it comes to subsidies — even if the payout is potentially lower.

“In the US, you know you’re going to get the tax credit, as long as you meet the lifecycle emissions criteria,” Bhashyam said, although this guidance has still not been finalised.

However, he is optimistic that the auctions will provide greater transparency on what green hydrogen costs are actually achievable — and whether current support is enough to stimulate the market.

Bhashyam estimates that between 239-717MW could receive subsidies from the pilot auction, assuming the average bid is between €1.5-4.5/kg and electrolysers are run at 45% utilisation.

BNEF figures currently anticipate that projects in Sweden and Spain will be able to enter the lowest bid prices for renewable hydrogen, based on their respective countries extremely low wind and solar costs.

Green hydrogen projects in Germany, Italy, France, the Netherlands and Poland are all also expected to require fixed premiums of less than €2/kg to produce volumes at cost parity with grey H2.

‘Inflated profits’

On the other side of the equation, environmental non-profit Bellona has raised concerns that a lack of clawback mechanism on the profits of green hydrogen producers could enable them to receive “inflated profits sponsored by public funding” due to a likely ramp-up in demand for renewable H2.

Since only a five-year pre-contract agreement is needed to bid into the auction, “there is a high likelihood that after a certain period of time, the strike price with offtakers will evolve”, the non-profit wrote in an analysis published yesterday (Thursday).

It highlighted that the EU is already gearing up to introduce mandates for the use of green hydrogen and its derivatives in industry and transport via its updated Renewable Energy Directive, FuelEU and RefuelEU programmes, which will inevitably increase demand.

The non-profit also warned that the recent loosening of the terms and conditions could mean it ultimately ends up doing more harm than good when it comes to reducing emissions.
“Given the enormous amount of electricity it takes to produce hydrogen, and the consequent high inefficiency of hydrogen to decarbonise most energy sectors, its use must be reserved for those sectors with no other decarbonisation pathways,” Bellona wrote in an analysis of the auction’s terms and conditions published yesterday (Thursday).

“However, despite the fact that the funding for the Hydrogen Bank comes from the Innovation Fund, which serves to finance the decarbonisation of the ETS [Emissions Trading System] sectors, under this auction no restriction on off-takers was included,” the non-profit added, noting that the necessity for the buyer to use hydrogen to reduce emissions has not been included in criteria to rank bids, nor even to break a tie.

Additionally, Bellona pointed out that while the initial draft terms and conditions required project developers to have at least a memorandum of understanding for a ten-year renewable power purchase agreement covering 100% of production, the final rules only need bidders to have pre-contracts for 60% of the project’s total electricity demand.

While this could be necessary due to the difficult of contracting renewable electricity five years out, Bellona warns that although only bid volumes that meet the criteria for renewable H2 set out in the Delegated Acts will be eligible for subsidy, this could still mean that an electrolyser could run on carbon-intensive electricity alongside its clean production.
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EuropeEUSubsidiesGreen H2
Published 8 September 2023, 07:36Updated 8 September 2023, 07:40