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The economics of hydrogen in a carbon constrained world
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David Cunningham
Principal Investment Manager

The current COVID-19 crisis has placed a lens over the energy sector and how it responds to future requirements. Hydrogen has a role to play in a transitioning global energy model and could provide 20% of the world’s CO2 reduction needed by 2050, however, the scale of that role in tomorrow’s economy will depend on its economic viability.

Previously, my colleagues have been sharing insights on the potential of hydrogen and its contribution to the global energy transition. Alan Mortimer discussed its clean energy credentials, Omar Bedani shaped the challenges of scaling up hydrogen production, and then Adam Frew offered perspective on how it could compliment a more sustainable mix of fuels in the transportation sector.

Now I want to put an economic lens on the hype around hydrogen.

Hydrogen demand

Hydrogen is already a vital part of the global economic environment, primarily for use in either de-sulphuring natural gas or - more importantly - for the production of fertilisers.  Feeding the world’s growing population will therefore play a significant source of ongoing hydrogen demand in the years ahead.

Global food production is currently dependent upon Steam Methane Reforming (SMR) to produce hydrogen which is then combined with nitrogen to produce ammonia for fertilisers. However, SMR has a high carbon intensity and so consequently hydrogen production represents around 3% of global greenhouse gas emissions today.

Projected worldwide population growth of two billion people by 2050 will mean demand for ammonia could double by 2050 but global carbon reduction targets will mean that production methods will themselves have to be decarbonised.

hydrogen demand

Costs of green hydrogen

The cost of hydrogen solutions is projected to decrease by up to 50% by 2030, but it’s a complicated process to try and estimate the long-term price of green hydrogen – which is hydrogen produced without emissions via water electrolysis that can be powered by electricity from renewable sources. The market for green hydrogen today is characterised by a low rate of deployment, at less than 140 megawatts. However, small-scale projects are showing evidence of feasibility and could mitigate future carbon price changes that will impact on overall project costs in relation to carbon emissions.

If we assume electrolyser capacity can be scaled up, it’s likely ammonia could be produced from green hydrogen for at least twice the cost of ammonia from SMR. The burning of natural gas could still be competitive with the current cost of green hydrogen. SMR hydrogen production is scalable to very large capacities and presents a very competitive investment cost, but it is challenged by the disposal or use of the captured CO2. Clearly with innovation, economies of scale and learning rates the cost difference will compress with time.

If we also look at some fundamentals of the renewables market, prices continue to drop and power generation capacity is up; wind turbine manufacturing, solar (polysilicon) and battery storage (handheld devices) benefit from established supply chains which have been instrumental in rapidly reducing the cost of renewable power and battery storage systems. Unfortunately, electrolyser and fuel cell technologies do not benefit from similar developments. Consequently, it is likely the pace of hydrogen cost reduction will be slower by comparison.

Key addressable markets for green hydrogen

The initial focus for hydrogen production will be decarbonisation of ammonia for supply to the fertiliser market. There is very little evidence of substitute products to displace hydrogen for fertiliser at significant scale. Consequently, devoid of lower cost alternatives, ammonia for food production should outbid the price for electricity supply, transportation fuel or heating requirements. It is probable that green hydrogen will eventually supply the ammonia as a first market adopter.

Despite this, the role for clean hydrogen in energy applications is more positive in areas of the economy which are technically hard to decarbonise. Industrial heat processes represent around a fifth of global greenhouse gas emissions. Removal of these emissions is essential for 2050 net zero targets to be met.

hydrogen demand

Within the industrial heat sector, steel and cement require the highest temperatures for production. Virgin steel production from coal fed blast furnaces is approximately half the cost of steel production using renewable powered hydrogen plant. If we consider natural gas the difference narrows to around 35% versus green hydrogen.

As food, paper and aluminium demand lower temperatures, electric arc furnaces can be installed in place of fossil fuel fed systems for these sub-sectors. Electricity is passed through giant electrodes in the roof of an oven, creating an arc.  They tend to be more efficient and use electricity as their power source, while also side-stepping energy intensive electrolysis processes evident in water electrolysis to split water for hydrogen production.

To date, there is very little evidence of traded or transported liquified hydrogen approaching commercial viability. It is probable this market dynamic will remain for a number of decades as hydrogen production lends itself to regions with local production and the cost efficiencies that brings.

Is the power grid an addressable market? As the cost of renewable power undercuts traditional power generation across global markets, it is inevitable that increased levels of intermittent renewable energy will raise the cost of balancing the grid. In periods of demand where energy is needed by the grid, hydrogen could be used to ensure the correct amount of electricity is needed. This will depend on its competitiveness against a combination of other energy alternatives such as hydroelectric, thermal stores, electric vehicles, battery storage and inter-connectors (where energy flows between electricity and natural gas networks).

Hydrogen’s market opportunity will depend on its competitiveness with the renewable hydrogen market. The sectors which are hardest to decarbonise and which less sensitive to changes in price will be the key addressable markets for green hydrogen production in an increasingly carbon constrained global market. Initially, this may well favour the production of carbon-free ammonia to support food production for a growing population over the energy sector.

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