Green hydrogen is set to become a key pillar of the European Union’s (‘EU’) sustainable development and emissions reduction plans, with significant implications for both the decarbonisation pathway the EU will follow over the next three decades and for carbon pricing in the EU, according to a new research paper published today by BNP Paribas Asset Management (‘BNPP AM’).
The research, Deep Decarbonisation: Green Hydrogen, Net Zero and the Future of the EU-ETS, has been written by Mark Lewis, BNPP AM’s Chief Sustainability Strategist. It examines the pathway to achieving net zero emissions, the prospects for green hydrogen as a new source of energy and the future of the EU Emissions Trading System (EU-ETS), as well as the potential impact on the pricing of Carbon Emission Allowances (‘EUAs’).
The paper argues that there is no plausible pathway to net zero by 2050 without the scaling-up of green hydrogen such that it is commercially viable as an industrial feedstock by 2030, and as an energy source thereafter. To meet the target, therefore, the pricing paradigm for the EU-ETS will need to shift from being based on fuel-switching in the power sector to being based on fuel-switching in industry. In other words, the key pricing parameter over the next decade will become the cost of switching from grey hydrogen to green hydrogen.
This argument is based on three key premises:
- As the EU’s target for achieving net-zero emissions by 2050 is soon to be EU law, there is now a clear endgame for the EU-ETS, consisting of ensuring that EUA prices reach a level commensurate with achieving the net zero policy target by 2050.
- The European Commission’s recently-launched strategic vision for green hydrogen states that net zero 2050 cannot be achieved without green hydrogen contributing a significant part of the solution.
- The pre-requisite for making green hydrogen commercially viable as an energy source is to make it commercially viable as an industrial feedstock by 2030.
The paper projects a range of potential production costs for green hydrogen and natural gas in 2030, from which can be derived a range of implied theoretical fair values for carbon allowances, based on making green hydrogen competitive with grey hydrogen as a feedstock. It argues that the EU will have to engineer the conditions for prices to reach the level at which green hydrogen displaces grey hydrogen by 2030 in order to be on track to achieving net zero by 2050. Beyond 2030, the EU will then have to engineer the conditions for EUA prices to reach the level that incentivises the use of green hydrogen over fossil fuel energy sources in buildings, transportation and power generation.
Based on the assumptions made about gas prices and the cost of green hydrogen in 2030, the paper estimates that EU-ETS carbon allowances would have to trade in a range of EUR 79-103 per tonne by 2030 for the EU is to achieve its net-zero goal.
Given that today's EUA price should theoretically reflect today’s perception of the future price required to deliver the policy goal (adjusted for the time value of money), this 2030 range implies a theoretical fair-value range for EUAs today of EUR 42-55 per tonne (assuming a discount rate of 6%); in other words approximately double today’s price of EUR 26.93 (as at 30 September 2020).
Mark Lewis, Chief Sustainability Strategist at BNPP AM, comments:
“Any move to pricing EUAs based on the fuel-switching level for green hydrogen to replace grey hydrogen will depend on how seriously market participants view the EU’s commitment to its 2050 policy objective of net zero, and therefore its 2030 commitment to making green hydrogen competitive as an industrial feedstock.
“If the market thinks net zero is as serious a policy commitment as its soon-to-be legally binding status would imply, both compliance players and financial investors will at some point start to assume that the EU will do whatever it takes to engineer the conditions for prices to reach the appropriate level by 2030.”
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N.B. BNP Paribas Asset Management holds no EUAs in any portfolios.
Mark Lewis can be heard discussing the research in two podcasts:
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