As shown in Figure 4, the energy crisis transforms the financial case for green hydrogen. The cost of producing green hydrogen is driven by the degree to which a manufacturer can spread the fixed cost of the electrolyser over a large number of hours of operation (i.e. the load factor) as well as the cost of the main input - green power. In Europe, let’s assume a cost for large-scale renewable power at €30-€50 per MWh, combined with a load factor for the electrolyser of 20-40%. This gives a cost range of €3.50-€6.50 per kg of hydrogen.
Figure 4 shows how the cost of green hydrogen stacks up against grey hydrogen, depending on the price of natural gas on the wholesale market. At gas prices seen over the last decade, i.e. €20-€30 per MWh, grey hydrogen is more competitive. Once gas prices reach the €60-€70 per MWh range, green hydrogen starts to become competitive for projects with exceptionally high load factors. With gas prices at €150 per MWh, as it is the current future market expectation for gas in Europe in 2023, even marginal green hydrogen projects become competitive. The EIB is actively working on a number of green hydrogen projects currently, including a 20MW electrolyser in Spain designed to produce green hydrogen for the fertilizer industry.
To conclude, a period of high fossil fuels prices transforms the economics of several low-carbon technologies, helping to strengthen the investment case. This section illustrates how different combinations of gas and electricity prices impacts the investment case for battery storage, heat pumps and green hydrogen. Although the examples are based on EU data, in the context of a global phenomenon of cheap renewable power and rising gas prices, the basic message of stronger project economics for many low-carbon technologies holds globally. Acceleration of investment is made all the more likely through the favourable policy context within which projects are being developed, including the Fit for 55 package in the European Union, augmented by REPowerEU; the Inflation Reduction Act in the US; as well as ambitious clean energy investment programmes in China and India.
Risk of a disorderly transition
A period of high fossil fuel prices helps accelerate investment in low-carbon alternatives. This is good news. Economists3 have long argued for a global carbon tax to send a strong credible price signal to households and businesses about the choice between high- and low-carbon alternatives, and to drive long-term investment. The current spike in the price of fossil fuels sends a similar signal, arguably more forcefully4 than that recommended by the carbon pricing literature.
We should not, however, get carried away.
Yes, price signals work. European consumers have demonstrated this by duly cutting gas demand thus far in 2022 by 7% compared to the average over the last three years – and by 23% in August (bruegel.org). But sudden, dramatic changes in energy prices come at a cost. First, there are strong distributional impacts – locally, nationally and globally –putting at risk the political consensus built up around the idea of a just transition. Second, increasing price volatility, particularly against a setting of regulatory uncertainty, is likely to increase the cost of capital and may lead investors to delay investment. In short, a disorderly transition.
We look at each argument in turn.
First, consider the distributional impact. Were the transition driven by price signals sent through high carbon taxes, governments would now be collecting substantial revenues. These could in turn be used to lower labour taxes, redistribute towards those most impacted by the transition, fund innovation or support international climate finance goals. Instead, today’s price signals are driven by the high cost to import fossil fuels. This price increase redistributes wealth from importing countries (i.e. consumers) to exporting countries (i.e. producers), via the balance sheets of an array of energy companies – primarily oil and gas companies, but also energy utilities –and dividend returns to their shareholders.
At the global level, the impact is most starkly felt by least-developed countries importing fossil fuels. The IEA estimates that 75 million people that have recently gained access to electricity may now lose the ability to pay for it, and around 100 million people with access to clean cooking may return to unhealthy cooking.
More generally, energy bills have become unaffordable for many citizens. To their credit, European governments have reacted. Bruegel estimates that €674 billion have been allocated to shield consumers and firms from the rising energy costs – with €264 billion earmarked in Germany alone. Note these aggregate results include general measures – such as reducing energy VAT or retail price regulation – as well as measures specifically targeted to vulnerable groups.
Support measures for the most vulnerable often tend to focus on income. Recent work by academic economists in the context of a just transition, however, stresses the need to consider ‘’horizontal’’ inequality, i.e. that even within groups with a broadly similar income level, the impacts of a rise in the price of fossil fuels may differ strongly. Consider workers needing to commute long distances by car, households owning or renting housing with poor energy-efficient standards, or indeed communities dependent on high-emitting industries.