The European Parliament has reached a political agreement with EU member states to water down proposed “horizontal unbundling” rules that would have prevented gas companies from using regulated profits (and in some cases, subsidies) from their distribution networks to finance H2 infrastructure.

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The “horizontal” unbundling rules — tabled by the European Commission as part of the Hydrogen and Decarbonised Gas directive — aimed to protect consumers by ring-fencing subsidies within the infrastructure for which they are intended. This would ensure that gas customers do not end up paying for the construction of hydrogen pipelines that they will never use.

The agreement, reached yesterday between the European Parliament and the Council of the EU on the Hydrogen and Gas Decarbonisation directive proposed by the European Commission in December 2021, will now only apply the proposed “horizontal unbundling” regulations to gas transmission system operators (TSOs) that operate large high-pressure, long-distance pipelines.

But distribution system operators (DSOs), in charge of smaller pipes delivering gas to homes and businesses, will be exempt.

The deal represents a compromise between the EU Parliament, which wanted to scrap horizontal unbundling altogether, and the Council, made up of senior government officials from member states, which had wanted to endorse the European Commission’s strict unbundling proposals.

The directive, now expected to be adopted by the EU, means that a DSO that wants to convert some of its pipelines to hydrogen will be able to do so without either selling the asset, or creating a new spin-off company that is operationally and financially independent from the gas network business.

And even TSOs will be eligible to apply for exemption from unbundling rules, by applying to the relevant member state.

“Member states will be able to grant derogations based on a positive cost-benefit analysis and subject to a positive assessment by the regulatory authority,” an EU official told Hydrogen Insight. “The derogations will be assessed every seven years.”

The fear among some EU member states, including France and the Netherlands, was that gas pipeline operators that benefit directly or indirectly from national subsidies for fossil gas, can use those subsidies to finance investment in hydrogen infrastructure — either building new lines or converting existing ones.

And, as hydrogen heating isn’t expected to be used widely, this would mean that households connected to the gas network would end up subsidising H2 infrastructure that they would never use.

This was acknowledged in a position paper put forward by the Council in March this year, that said “public service obligations in price setting should only concern the supply of natural gas, as households are not expected to use hydrogen for heating purposes on a wide scale. The hydrogen market will mostly concern industry, which do not require such public interventions”.

But it is not clear whether any specific measures to prevent cross-subsidisation have been included in the political agreement, which is not yet in the public domain, but Hydrogen Insight understands that the aim of the regulation is to prevent cross-subsidisation — and in any case the bloc wants to phase out gas subsidies altogether.

Regulated asset profits

“This agreement is a great achievement as it will boost the deployment of the emerging hydrogen sector, the transition of the gas sector towards renewable energy and it also sets rules for consumer protection and strengthens security of supply,” said Teresa Ribera Rodríguez, third vice-president of the Spanish government, which is currently leading the Council. “This is undoubtedly a big step closer to the EU’s goal of reaching climate neutrality in 2050, which we should all be proud of.”

However, agreement on the regulation on internal gas and hydrogen market structure could not be reached, with Parliament and the Council now intending to revisit it later.

The directive also allows profits from operating the distribution network, which are deemed “regulated assets” and are therefore granted guaranteed investment returns, to be used to finance upgrades to gas assets.

This means that gas consumers can end up indirectly financing upgrades to infrastructure they will never use, even if no subsidies are in place.

In the UK, concern is growing that gas companies are using the proposed hydrogen village heating trial to build a case to spend millions of pounds “upgrading” the gas network to run on hydrogen — therefore future-proofing returns regardless of whether hydrogen is ever deployed, or if fossil gas ceases to flow.

What is vertical unbundling?

The EU’s “vertical” unbundling rules, were first introduced in 2009 as part of the Third Energy Package. They mandate that gas and electricity transmission and storage infrastructure cannot be directly owned by producers.

The goal of vertical unbundling is to remove the incentive for infrastructure owners who are also producers to discriminate against competitors by charging them more to use essential infrastructure over which they have a monopoly, for example, or restricting access.