"Green" hydrogen portends progress on climate, with government help

The prospect that “green” hydrogen can become a commercially viable low-carbon energy carrier has engaged advocates of combating climate change for many years. Until now, however, green hydrogen production has been beyond commercial reach without sizeable government support and, over time, significant cost reductions. That could change with large new hydrogen production tax credits offered in the US Inflation Reduction Act (IRA) of 2022. In Europe, the combination of an “emissions trading system” (ETS) that effectively raises the price of fossil fuels and new hydrogen production subsidies could also make “green” hydrogen competitive.

Hydrogen has long been used as a feedstock in the energy and chemical industries, and in some niche applications as a fuel. But its traditional production from natural gas emits carbon dioxide and therefore contributes to climate change. So-called green hydrogen from electrolysis of water does not emit carbon dioxide in its production or end-use.

Recent policy developments can bring the long-sought prize of affordable green hydrogen within reach. The International Energy Agency (IEA) projects that, with policy support and increasing scale, its production costs would decline from the current range $3.2 to $7.7 per kilogram to $1.3 to $3.3 per kilogram in 2050. These cost declines are anticipated to arise from both the falling cost of electrolysers for use in producing green hydrogen and renewable electric power for their operation.

The IRA provides a $3 per kilogram tax credit for “green” hydrogen production over 10 years, and smaller credits for less clean types of hydrogen. The Congressional Budget Office projects the 10-year cost of the IRA hydrogen production subsidies at $13.2 billion.

Europe is pursuing a different policy path, using a combination carbon pricing and hydrogen production subsidies. The price of an allowance in the EU ETS, which covers industrial emissions, just breached the €100 per metric ton milestone. The United Kingdom has a similar ETS. In Europe, a purposeful EU emission allowance price emerged gradually from the 2020 EU ETS reforms, economic recovery from the COVID-19 pandemic, and recent easing the European energy crisis from Russia’s invasion of Ukraine. The EU and UK are also planning to further boost to green hydrogen through competitive allocations of production subsidies. The first EU auction planned for this year is to award €0.8 billion in subsidies.

But is the United States or Europe off to the better start in the race to shape the future energy role of hydrogen?

Hydrogen’s competitiveness with fossil fuels in energy markets

To see what’s going on in various energy markets in which green hydrogen can compete with fossil fuels, it is useful to express energy costs inclusive of carbon prices and fuel taxes in terms of a standardized energy unit—a gigajoule (GJ). Per capita energy use in Europe is about 120GJ per year across all energy types—mostly fossil fuels and electricity from renewable and nuclear resources—and in the United States is 280GJ.

Expressing the cost of different types of energy—liquid fuels like diesel, gaseous fuels like hydrogen and natural gas, and solid fuels like coal—in a uniform way makes it easier to compare energy costs. Comparing the cost of a kilogram of hydrogen with a litre of diesel, cubic metre of natural gas, or metric ton of coal is not particularly fruitful—like comparing apples and oranges. What matters is the energy in fuels (GJ), not their weight or volume.

Consider first the energy market for road transport and in particular heavy-duty trucks. European and US manufacturers are developing trucks with fuel-cell electric drive trains in place of conventional diesel engines and planning their market introductions in the next few years. The current retail price of diesel in Europe is around $48/GJ, including fuel taxes, and in the United States $30/GJ. The IEA puts the current cost of producing green hydrogen in the range $25/GJ to $59/GJ, with costs of electrolysers and renewable power on declining trends. So green hydrogen is already competitive with diesel as a fuel for heavy-duty road transport at current European and US retail diesel prices, assuming hydrogen does not attract the fuel taxes.

While fuel-cell electric-drive trains for trucks are more expensive than diesel ones, fuel-cell costs—like electrolyser costs—are declining (they are related technologies), and this electric-drive train is more energy efficient than the diesel one. So, a direction of travel in this energy market segment is already toward hydrogen.

In the United States, the IRA tax credit for green hydrogen production is equivalent to $23/GJ, which generously closes any fuel cost gap between hydrogen and diesel. A hydrogen production subsidy could be used to kickstart its role in this US market segment because of the relatively high cost of fuel-cell electric trucks, but the IRA tax credits for the purchase of low-emission vehicles are better targeted to the vehicle cost difference. Both tax credits should be tapered as electrolyser, renewable power, and fuel cell costs decline.

In Europe, beyond exempting hydrogen from current fuel taxes, a green hydrogen production subsidy is less necessary in this energy market segment to close the fuel cost gap with diesel. However, policies to help close the fuel cell electric vehicle cost gap with diesel vehicles and develop infrastructure for hydrogen distribution remain necessary.

Now consider the energy market for heavy industry, which uses mostly coal and natural gas for fuel. Because these fossil fuels are significantly cheaper than diesel on an energy equivalent basis and attract lower carbon prices or fuel taxes, green hydrogen faces a much greater competitive challenge in the energy market for industry than for transport.

Current European prices for natural gas and coal are $15/GJ and coal $5/GJ, respectively. The EU ETS emission allowance price adds about $6/GJ to the cost of natural gas use and $9/GJ to that of coal, assuming carbon emissions from their use are not captured and stored. Current US prices for natural gas and coal are $3/GJ and $5/GJ, respectively. There is, of course, no US carbon price to add to the cost of natural gas and coal use.

So, in Europe, the current fuel cost difference, including the cost of carbon emissions, between green hydrogen and natural gas is $10/GJ to $44/GJ. The cost difference with coal is slightly greater. In the United States, the fuel cost difference with natural gas is $22/GJ to $56/GJ. The cost difference with coal is slightly less. These energy cost comparisons show that in both Europe and the United States green hydrogen now needs an economic boost to compete in heavy industry with natural gas and coal. 

Differing European and US policies to boost hydrogen’s competitiveness

In Europe, purposeful carbon pricing and relatively high natural gas price from the pivot away from Russian pipeline supplies provide part of the boost. But more needs to be done to close the current fuel cost difference if green hydrogen is to compete in energy markets.  The planned launch this autumn by the EU Innovation Fund of competitive auctions for a fixed premium per kilogram of green hydrogen produced for 10 years should provide the rest of the boost in EU member states. The UK government hydrogen production business model offers similar support.

The award of hydrogen production subsidies through competitive allocations aims to drive cost effectiveness, as did auctioning of feed-in tariffs for renewable power. At the same time, the carbon pricing schemes and progressive tightening of emission allowance caps for industry in line with net-zero emission goals provide a clear long-run signal to industrial energy users to switch their production process away from fossil fuels to green hydrogen or other low-carbon alternatives. The expected cost declines in green hydrogen and tightening of allowance caps also create a market exit from the hydrogen production subsidies.  

In the United States, the boost takes the form of an administratively set tax credit of $25/GJ for green hydrogen production. This closes much of the fuel cost gap with natural gas. US policy risks are that the hydrogen production subsidies are not competitively allocated, and they stand alone. Competitive subsidy allocations add pressure to cut production costs for green hydrogen. Moreover, to develop the market for green hydrogen, it is necessary to foster both supply and demand, and the demand side of the market is somewhat neglected by a focus on hydrogen production subsidies.  

The IEA projections for green hydrogen costs in 2050, which range from $13/GJ to $25/GJ, would unlikely be competitive with abundant and low-cost US natural gas and coal. So, some form of carbon pricing in the industrial sector is necessary to secure a long-run role for green hydrogen and other low-carbon alternatives. The sooner this aspect of US decarbonization policy is clarified, the stronger is the incentive for industrial energy users to convert their production processes to green hydrogen or another low-carbon alternative.  

So, the hydrogen race is underway. US policymakers appear to be running a fast sprint and those in Europe a slower paced marathon.

Importance of aligning European and US policies

The United States has certainly sent the hydrogen hares running with its large, fixed tax credit for green hydrogen production. But there many potential rabbit holes on the pathways to net-zero emissions, including stronger incentives to produce green hydrogen than for potential industrial users to invest in its use.

To strengthen incentives to convert industrial processes to hydrogen or other low carbon alternatives, US investors would benefit from greater clarity on how policies will in the long run align market prices with the goal of net-zero emission in industry. A perpetual tax credit for green hydrogen production is not a credible policy, and it would eventually advantage green hydrogen relative to other low-carbon alternatives. Establishing a purposeful carbon price is more challenging than implementing a low-carbon subsidy, but the advance of green hydrogen as a low-carbon alternative to natural gas and coal will over time make carbon pricing easier. A timely commitment to carbon pricing would send a clear signal to investors.  

The EU and UK started the hydrogen race some time ago by laying the groundwork for a purposeful carbon price on industrial emissions with the 2020 EU ETS reforms. The planned competitive allocations of hydrogen production subsidies, moreover, provide their necessary fillip cost effectively as the pace of the hydrogen race quickens. For example, the EU has an €800 million budget for the first pilot auction of hydrogen production subsidies, and it is to be followed by further auctions. Moreover, Europe’s well established carbon pricing in industry will also help steer hydrogen towards its most cost-effective uses in a net-zero emission economy.

So, while the hydrogen race is in its early stages, it would be fair to say that Europe is probably off to the better start as it has already done what most countries have found hard to do—put a purposeful carbon price on industrial emissions. But both Europe and the United States have much more policy work to do. Europe needs to set out its medium-term funding arrangements for hydrogen production subsidies to foster a robust project pipeline. The United States needs to clarify its long run policy framework for industrial decarbonization, including carbon pricing, to encourage industrial users to invest in technologies that use hydrogen or other low-carbon alternatives to fossil fuels.

But the much more important point is the importance of aligning European and US industrial decarbonization policies. This would be good policy from their respective domestic perspectives, and it would align policies to create a “carbon club” of large markets in which industrial firms can compete internationally and fairly and succeed in their net-zero ambitions. That is how a fast, long-distance decarbonization race is best run.