GREEN HYDROGEN USE IN INDUSTRY PROMOTED BY REVISED RED II

On July 14, 2021, the European Commission released a raft of regulatory proposals and revisions to achieve the European Green Deal target of 55 percent net reduction in greenhouse gas emissions by 2030. Shearman & Sterling will be publishing a series of articles on these important developments. This article focuses on the growing importance of green hydrogen in the Commission’s vision for Europe’s energy and industrial future.

The Commission has proposed revisions to the Renewable Energy Directive (Recast) 2018 (RED II) which:

• extend the application of elements of RED II to industries such as metals, cement and chemicals production; and
• impose targets for “green” hydrogen use in hydrogen-consuming industries.

In addition to the reforms to RED II, the Commission’s package—referred to as the “Fit for 55” package—includes revisions to the EU’s Emission Trading System (the EU’s carbon market) and a proposal for a Carbon Border Adjustment Mechanism, both of which will have a significant impact on European industry and foreign industry exporting relevant goods into Europe. These developments will be covered in more detail in subsequent articles by Shearman & Sterling.

Key Takeaways

Key takeaways from the proposed revisions to RED II for industrial clients are as follows:

• RED II, which imposes strict limitations on the description of hydrogen as “green,” is proposed to apply to industrial sectors, including iron and steel, aluminum, chemicals, fertilizer (including ammonia) and cement, as well as the construction industry;
• member states to ensure that, by 2030, 50 percent of the hydrogen used by industry is green hydrogen (more specifically, a renewable fuel of non-biological origin (RFNBO) as defined in RED II);
• indicative (non-binding) target to increase the renewable energy use in industry by 1.1 percent per year from 2030;
• minimum target of 2.6 percent for RFNBO (green hydrogen) use in the transport sector by 2030;
• the previous restrictions on how and when renewable energy supply for green hydrogen production would satisfy the RED II sustainability criteria for production of RFNBOs remain and now also apply in relation to the targets for hydrogen use in industry (depending on the implementing measures by Member States, this may in practice significantly limit the industrial use of EU-produced hydrogen);
• companies marketing industrial products as “green” will need to publish the percentage of renewable energy and green hydrogen (i.e. RFNBOs) used in their entire lifecycle (raw materials, manufacturing and distribution); and
• significant opportunities for hydrogen exporters to Europe provided projects are structured appropriately.

What is an RFNBO?

The Commission’s proposal has expanded the scope of the RFNBO concept from the currently applicable RED II, which applied it exclusively to transport fuels. The concept is now proposed to apply also to hydrogen when used in industry.

The requirements for an RFNBO are that it must:

• be produced using renewable energy (which notably does not include biomass or nuclear energy); and

• achieve a greenhouse gas emissions intensity reduction of 70 percent from the applicable fossil-equivalent benchmark (although the details of this benchmark and the calculation methodology will be clarified in subsequent Delegated Acts from the Commission (see below)).

Importantly, though, in applying the first criteria above for determining whether renewable energy has been used in producing the hydrogen (and therefore the extent to which the hydrogen qualifies as an RFNBO), RED II looks through to how the electricity supply for the hydrogen production is structured. In particular, RED II contemplates three possible electricity supply scenarios:

• renewable electricity supplied through a direct connection to the hydrogen production from a source of supply that comes into operation after or at the same time as the hydrogen production facilities—this will be considered 100 percent renewable energy;
• electricity that has been transmitted through the grid but where it can be shown that the other applicable sustainability criteria have been met (including temporal and geographical correlation of supply and demand) and that (as above) the relevant source of supply has come into operation after or at the same time as the hydrogen production facilities—this will be considered 100 percent renewable energy, provided the conditions to be laid down in the Delegated Acts are satisfied; or
• electricity taken from the national grid—the share of renewable energy in the relevant national grid as a whole will be used to determine the share of such energy that will be considered renewable.

Implications for Current and Future Hydrogen Use in Industry

The Commission’s proposals will, of course, require that existing hydrogen use in industry, the majority of which is fossil-derived hydrogen (e.g. in ammonia production), be replaced with RFNBOs (green hydrogen). However, these requirements will also have a significant impact on future hydrogen uses in industry—such as in hydrogen-DRI steel manufacturing (i.e. “green” steel).

With the RED II requirements governing how green hydrogen is produced now applying to RFNBOs used in industry, industrial players with existing or potential future hydrogen use will need to carefully consider the implications of RED II and likely implement measures on the structuring of their projects, in particular how renewable energy supply should be structured to ensure compliance with the RFNBO targets.

This increased role for green hydrogen in industry and the strict sustainability requirements imposed may represent a significant opportunity for hydrogen producers in countries with favorable renewable energy resources for exporting into Europe, including available land and a political environment that facilitates swift development of additional renewable energy generation in excess of what the local grid requires. Indeed, increased demand for green hydrogen that will be seen as a result of the targets under RED II for both industry and the transport sector may generate export opportunities for hydrogen projects in the European neighborhood and the Middle East.

Further Clarification Expected from Delegated Acts

No further clarity has been provided on the long-awaited Delegated Acts expected from the Commission to elaborate on important aspects of the regulatory regime for RFNBOs and, specifically, the conditions green hydrogen must meet to qualify as such. In particular, these Delegated Acts (expected by the end of 2021) will clarify:

• the criteria for determining when electricity taken from the grid to power hydrogen production can be counted as fully renewable, which would allow the resulting hydrogen to qualify as a RFNBO. We expect this to be highly politically controversial given that, as above, without a relaxed requirement in this regard, European industry may be dependent on imported green hydrogen; and
• the real-world greenhouse gas emissions benchmarks and calculation methodology for assessing whether RFNBOs achieve the required 70 percent emissions reduction target.

In addition, the RED II proposals will now need to be debated and adopted by the European Parliament and the Council and then implemented by Member States. The current proposal provides for implementation by 2024.

About Shearman & Sterling

As part of our work on the world’s largest “green” and “blue” hydrogen / ammonia projects, we are at the forefront of the complex and evolving regulatory issues affecting the production and downstream uses of hydrogen, ammonia and other green energy projects, and we are happy to speak with you if you would like further information as these matters evolve.