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Deep decarbonization – Green hydrogen, net zero and the future of the EU ETS

Responsible Investing

BNP Paribas Asset Management

Green hydrogen is set to be a key pillar of the EU’s sustainable development and emissions reduction plans. This has major implications for how carbon emissions are removed from the EU economy over the next 30 years and for how carbon pricing is used as a tool to achieve zero emissions, according to new research from BNP Paribas Asset Management.

According to the European Commission’s recent strategic vision for green hydrogen, there is a significant role for this clean and renewable energy source on the road to achieving its objective of net-zero emissions through decarbonization by 2050.

Lower product costs, greater incentive

For green hydrogen to be able to deliver on this promise, the price will need to fall to a level that incentivises its use over that of alternative fossil-fuel energy sources in buildings, transportation, and power generation. A likely drop in production costs – green hydrogen is produced using wind and solar-generated electricity – will contribute to the appeal of green hydrogen.

A further incentive comes through the pricing of European Emission Allowances (EUAs), which can be bought and sold on the EU Emissions Trading System (EU-ETS). These permits – each for a tonne of CO2 emitted – can be seen as the cost of pollution. That makes them a key instrument for cutting greenhouse gas emissions in the EU and ultimately achieving the net zero goal by 2050.

EUAs are currently mandatory for emitters in certain sectors and industries, first and foremost in power generation.

EUA pricing will need to rise to a level that encourages fuel switching – to green hydrogen and away from fossil-fuel energy sources such as natural gas and petroleum products as well as so-called grey hydrogen, for which the production process is very carbon-intensive.

The future of the EU-ETS

At the same time, the EU-ETS’s concept will need to change. We believe 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 as a first step to climate neutrality in the EU by 2050.

Accordingly, the research finds, EU-ETS pricing will need to shift from being based on coal-to-gas fuel switching in the power sector to being based on fuel switching in industry, whereby the cost of switching from grey hydrogen to green hydrogen becomes the key pricing parameter.

“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”, says Mark Lewis, Chief Sustainability Strategist and author of the research report.

Doing whatever it takes for green hydrogen to take off

Given the EU’s vision on the significant role of green hydrogen in CO2 reduction, it is likely that Brussels will do whatever it takes to create the conditions for EUA prices to reach levels at which it is attractive for green hydrogen to take the place of grey hydrogen.

Our research has found that this could ultimately lead to a near-doubling in the price of EU carbon allowances to a range of EUR 42 to EUR 55 a tonne from current levels.

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