Interview: Florence School of Regulation - The architects of liberalisation turn to the hydrogen market [GasTransitions]
The Florence School of Regulation (FSR), founded in 2004, may not be a familiar name to many people, but it is the place where, in the first decade of the 20th century, the epoch-making regulation was designed that transformed European energy markets. The path-breaking regulatory reform launched by the European Commission, culminating in the Third Energy Package in 2009, which liberalised and unbundled EU gas and electricity markets, was guided by a small group of regulatory experts who met and exchanged views through the Florence School of Regulation.
“FSR is not an ordinary academic institution or business school,” explains Jean-Michel Glachant, the French professor who has been its Director since 2008, “it is a school for regulators.”
The liberalisation of EU energy markets was started in the early 2000s under the Spanish EU Energy Commissioner Loyola de Palacio, and brought to completion by her successor, the Latvian politician and diplomat Andris Piebalgs. They looked to their regulators to design the new market structure: people like Pippo Ranci, co-founder of the Council of European Energy Regulators (CEER) and former Chairman of the Italian Regulatory Authority, Jorge Vasconcelos, also co-founder, Portuguese regulator and former Chairman of CEER, and Ignacio Pérez-Arriaga, a professor at MIT and the University of Comillas in Spain and Commissioner at the Spanish Electricity Regulatory Commission.
“They had to do something that had not been done before, except in the UK,” says Glachant. “Build new national markets and a new EU market. These did not exist at the time. There were no markets in the EU member states nor at EU level. They concluded that they needed to create a school where they could come together and discuss what had to be done. That became the Florence School of Regulation.”
Working closely with the European Commission, the regulators managed, in a very short time, to break up the decades-old oligopolistic arrangements by which energy markets were controlled at the time. In the gas sector, this meant, among other things, that the long-term contracts between Gazprom and a handful of European energy suppliers that dominated the market gave way to competition and diversification. Suppliers had to give up ownership of gas pipelines, which became freely accessible to all.
The reform turned out to be quite successful: as recent research from Luca Franza of the Clingendael International Energy Programme (CIEP) shows, Europe saved between €3 and €6.8 billion per year thanks to the new pricing arrangements. At the same time, security of supply improved rather than deteriorated. “I think we can say that things worked out very well for European gas consumers,” says Andris Piebalgs, who has been involved with FSR since 2015 as Senior Fellow. “We have not yet entirely reached price convergence between Western and Eastern Europe, but we are moving in the right direction. I had expected more coal-to-gas switching earlier in the process, but that too is now happening.”
“I remember in 2004-2005, the idea of gas-to-gas competition was laughable,” notes Christopher Jones, who was Deputy Director-General in the EU Energy Directorate and Deputy Head of Cabinet under Piebalgs, and is now Part-time Professor at the FSR and Principal at Baker McKenzie. “Now it’s a fact. The market works.”
However, just when the gas industry may have thought regulatory stability had arrived, and they could turn to business-as-usual, the EU energy market is in for a major change again. The concern over climate change has become absolutely paramount in EU policy.
“All of EU energy policy is now predicated on decarbonisation,” says Jones. In the past, “energy policy was always based on the idea of the equilateral triangle: a balance between affordability, security of supply and sustainability. That can no longer be the case. Now the foundation is the Green Deal objectives: 55% emission reductions in 2030 and net zero emissions in 2050. Any energy policy has to be predicated on that.”
“The new energy policy has far more politics in it,” Piebalgs observes. “Things have changed rapidly and radically. Who could have thought two years ago that the ECB would scrutinise the energy investments of banks in relation to climate change?”
EU energy policy is now solidly grounded in the Green Deal, which has led to a flurry of new policies coming out of Brussels: the recently announced Energy Sector Integration and Hydrogen Strategies, and a number of other initiatives, such as the revision of the ETS, renewable and energy efficiency Directives, and a carbon border tax. Together these will lead to a radical overhaul of EU energy markets.
In a new report, the regulatory experts from FSR take stock of this new policy landscape. The main idea behind their research is apparent from the report title: the Cost-Effective Decarbonisation Study. “Although the Green Deal objectives are a given,” says Jones, “we believe it is still important to take into account the other two sides of the triangle: competitiveness and security of supply. We believe it is vital that the new policies are implemented in an objective manner based on the best available evidence in the most cost-effective manner.”
Jones says competitiveness and security of supply are important for three main reasons. “One, to protect our citizens. Two, to ensure that Europe remains competitive. Three, to retain public support for decarbonisation. On this basis we present policy conclusions that will make the triangle as equilateral as we can.”
Piebalgs likewise stresses the importance of an “objective” approach. “What we set out to do is try to ensure that hydrogen policy and other energy policies are adopted in the most objective way possible.” Given the FSR’s reputation for objectivity, there is good reason to believe their analysis will get plenty of traction in policymaking circles.
The “Cost-effective Decarbonisation Study”, which focuses in particular on renewable energy (solar PV and wind) and hydrogen, comes up with a number of important findings (see sidebar). For the gas industry, the most important finding is probably that “blue hydrogen”, based on steam methane reforming of natural gas in combination with CCS, will almost certainly need to play at least a “transition role in reducing greenhouse gas emissions in the medium term”. Natural gas will in any event be important in the run-up to 2050.”
Noteworthy also is the finding that so-called “turquoise hydrogen”, produced through pyrolysis of natural gas, “whilst currently at a low level of maturity, may well be a very important (and possibly the cheapest) zero-carbon option for the EU in the very long term and needs to be matured as quickly as possible.”
The authors stress, however, that the report does not come out “in favour of” blue hydrogen. “We are technology-neutral,” says Jones. “What we are saying is that policy should be colour-blind. Let the market decide what is the best way to reach the climate objectives.” In fact, Jones adds that “blue hydrogen will almost certainly have no role to play after 2050. We know that with CCS we can only capture 90% of the CO2 emissions, which is not enough in a zero-carbon world.”
If that sounds discouraging, Jones does strongly believe in the potential of pyrolysis, about which the report is very upbeat. “Producing 1 kg of zero-carbon hydrogen will in all likelihood require far less renewable electricityy when produced via pyrolysis than through electrolysis,” it notes, “due to the fact that the chemical reaction used for pyrolysis requires the equivalent of 13-26% of the energy needed by the reaction used in electrolysis.”
According to Piebalgs, the gas industry has lots of opportunities to be part of the future energy market. He says there are “huge challenges” for green, renewables-based hydrogen, in terms of costs, volumes and grid requirements. “If you see the projects that there are now for electrolysers, you see that there clearly is a gap.”
There are two things the gas industry should do, he notes. “Provide transparency on methane emissions and deliver low-carbon solutions. CCS and CCUS have hardly been used yet, but they do have many advantages. From our analysis, I conclude that it would be strange if the gas industry did not use this opportunity.” He is personally somewhat less certain about the potential of pyrolysis. “If it is such a good thing, why isn’t the gas industry jumping on it?”
Nevertheless, the question is what will be the economic drivers for blue hydrogen? “Ideally,” says Piebalgs, “we would have an ETS price that would make other policies superfluous, but unfortunately, we don’t think that can work in practice.” He notes that “for green hydrogen, there will be support schemes, including for the renewable energy part. But what support there will be for CCS is not clear.” He adds that “we have many complex regulations and many actors. To find the right drivers is difficult.”
According to Jones, “It is very important to have an objective viewpoint on natural gas, it being a relatively low-carbon fuel, and the quicker you achieve decarbonisation, the greater the impact. So it’s great if natural gas can do that. We have to ensure it has its correct role until 2050. That is the key point of our study: to take the correct decarbonisation steps at the correct time. If you push gas out too quickly, you make energy more expensive than it needs to be and you can even cause higher CO2 emissions.”
Piebalgs says that at this moment, “consumers get value for money in the gas market. No question about that. But gas is a fossil fuel, so unabated gas should move out. The question is under what conditions.”
The message for the gas industry is sobering but clear. Piebalgs: “Industry needs to deliver a product that meets the demands of society. The demand is for decarbonisation. That is not a niche concern, it’s a mainstream concern for society. It is something that the European gas industry has been slow to grasp.”
Some highlights from FSR’s Cost-effective Decarbonisation Study
One of the key conclusions of the Florence School of Regulation’s Cost-effective Decarbonisation Study is that “the lowering of technology costs through massive R&D and industrial demonstration support for all three low and zero-carbon hydrogen technologies should be considered to be the highest priority for the EU's hydrogen strategy. Support should be 'colour-blind' at this stage of the technology and decarbonisation cycle.”
The FSR authors note that between 2009 and 2020, €70 billion a year was spent on subsidies for renewable energy in the EU. Although this may have been justified in the case of renewables, where these subsidies helped the solar and wind industries to scale up and thereby bring costs down, they do not believe this will necessarily be true in the case of hydrogen. They argue that in the emerging hydrogen market, it makes more sense to first pursue a policy of “massive R&D and demonstration support”, and only turn to production subsidies later.
“Whilst manufacturing economies of scale are important for low and renewable hydrogen, and plant costs can be expected to reduce significantly with standardisation and improved technology, it is reasonable to expect that a very significant part of these economies can be captured through ambitious R&D and demonstration funding,” notes the report. “We will need hundreds of new hydrogen plants for the low and zero-carbon hydrogen market of the future, compared to the millions of PV panels and windmills required for the renewable electricity transition. Manufacturing economies of scale will therefore be less relevant than technology development in reducing future hydrogen costs, and it is questionable whether massive production subsidies are the right tool to catalyse them.”
In addition, whereas renewable electricity is a high CAPEX/low OPEX industry, hydrogen, by contrast, is a low CAPEX/high OPEX undertaking, since its production costs are mainly determined by the costs of its feedstock, either renewable power or natural gas. This means that production subsidies will have less effect on hydrogen production costs compared to renewable electricity.
The authors further argue that energy and climate policies should be based as much as possible on market mechanisms. “The Internal Energy Market, based on ETS prices and competition between green, blue and hydrogen turquoise hydrogen, ensuring that GHG content is reflected in pricing through objectively calculated lifecycle-based guarantees of origin, is likely to be the best manner to ensure the cost-effective development of the EU's future hydrogen market.”
They also note that “A key element to the development of a cost-effective future hydrogen system will be the existence of a hydrogen grid, which will be essential to lower the cost of hydrogen transportation and prevent the emergence of entrenched monopoly positions.”
The “foundations of the of the Internal Energy Market for networks, unbundling, TPA and regulated prices will need to apply to the EU's future hydrogen network and will no doubt figure in the Commission's legislative package scheduled for 2021,” they add.
They warn that “Considerable care is required before imposing low or zero-carbon hydrogen quotas on actual/potential consuming hydrogen industry. It will be challenging to expose these industries to the ETS even with a carbon border tax.”
Another interesting conclusion: Turquoise hydrogen represents an exciting potential zero-carbon option for the EU, but the technology needs to be matured.” According to the authors, turquoise hydrogen may be expected “to be one of the cheapest forms of zero-carbon hydrogen in the future, and potentially the cheapest, appreciably so. However, it should be noted that this technology is at a lower level of technological maturity, which needs to be developed quickly to confirm these findings; it is not possible to guarantee today that these low figures will be confirmed.”