September 15, 2022

A Step Towards Removing the Red-Tape For Europe’s Green Hydrogen Sector

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A STEP TOWARDS REMOVING THE RED-TAPE FOR EUROPE’S GREEN HYDROGEN SECTOR

On September 14, 2022, the European Parliament (the Parliament) adopted its position on revised amendments to the Renewable Energy Directive (Recast) 2018 (RED II), amongst other things, proposing requirements for renewable fuels of non-biological origin (RFNBO) production (including green hydrogen and green ammonia, amongst other fuels) that are more lenient than those proposed by the European Commission in its draft Delegated Act on renewable energy supply (published in May 2022). The Parliament’s text proposed amendments to the draft amendments to RED II proposed by the European Commission (the “Commission”) in July 2021 as part of the Fit for 55 package.

Key Takeaways

Key proposals from the Parliament’s adopted text are as follows:

  • there would be no requirement that renewable energy sources (RES) used for RFNBO production be “new” (whether such RES are directly connected or transmitted through the grid);
  • the 2030 quotas for use of RFNBO in the transport sector would be increased (from 2.6 percent to 5.7 percent);
  • the quotas applying to the industrial sector requiring that by 2030 50 percent of hydrogen used be RFNBO are maintained and such quota would increase to 70 percent by 2035;
  • the temporal correlation window for balancing RES generation and consumption for grid-transmitted electricity would be widened to be quarterly periods (pre-2030) and either monthly, quarterly or yearly thereafter;
  • the delegated authority to the Commission under RED II to pass delegated acts to clarify the requirements for RFNBO production would be taken away and replaced by the criteria proposed in the Parliament’s text (which would, if adopted, become itself primary European legislation).

Key Implications

  • The Parliament’s text is just one step in the legislative process that remains ongoing to clarify the European requirements for green hydrogen and green ammonia production (both in Europe and in countries seeking to export to Europe). However, it is clear from this step that the trajectory in Europe is towards greater regulatory flexibility, in part perhaps a result of global competition for investment in the sector spurred on by the recent announcements of generous tax incentives for U.S. green hydrogen producers under the IRA.
  • If the Parliament’s proposals were to be adopted, thereby establishing the requirements for RFNBO production into primary legislation rather than the Commission passing the Delegated Act on RES supply, this would greatly improve legal certainty for investors in the green hydrogen sector. Not only are the Parliament’s proposals simpler and less stringent than those proposed by the Commission, being adopted as primary legislation would remove the risk for investors that the Delegated Act on RES supply might be challenged as being outside the Commission’s powers to pass delegated legislation by proponents of more environmentally strict production requirements for RFNBOs (as has been foreshadowed by a number of the public responses to the Commission’s consultation on the draft Delegated Acts in May 2022). Both of these factors would be a significant boost for the European hydrogen sector.

RFNBO Production Under the Commission’s Delegated Act

RFNBO is a concept applying to transport fuels as well as hydrogen used in the transport sector and 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 (GHG) intensity reduction of 70 percent from the applicable fossil-equivalent benchmark.

Under the existing text of RED II, in order to claim that the electricity used for the production of RFNBO is fully renewable, the electricity has to be either (1) supplied though a direct connection to the RFNBO production facility; or (2) transmitted through the grid with additional sustainability criteria being satisfied. RED II currently delegates power to the Commission through a Delegated Act to define what those additional sustainability criteria are and how to satisfy them. The other Delegated Act will define the GHG calculation methodology.

The consultation drafts of the Delegated Acts, published in May 2022, were controversial and proposed strict regulatory requirements that RFNBO producers had to meet. Amongst other things, these include the requirement that RES used to produce the RFNBO had to be new (part of the so-called additionality principle) and that RES generation and consumption had to be matched within an hourly window (the temporal correlation period).

The strict requirements under the Delegated Act risk pushing production of Europe’s RFNBO to offshore territories with smaller grids, more land and renewable generation capability, which would lead to higher prices and less RFNBO available for European consumption. The strict regulatory requirements defeated the intention of creating a “hydrogen economy” in Europe (based on cheap zero-carbon energy with the security of supply) and would structurally prolong Europe’s dependency on foreign sources of energy. Various parties have expressed concern that Europe’s strict RFNBO regulations will put the EU at a disadvantage in global competition for investor money, if funding continues to be limited to “dark green” RFNBO and the regulatory requirements are not loosened. For example, these requirements published by the Commission were in stark contrast with the recently developed flexible, technology-neutral, purely emission-focused regulatory requirements in the U.S. under the IRA tax incentives.

The Parliament’s Proposed Amendments

Strict principle of “additionality” removed. The requirement that RES used for RFNBO production must be “new” has been removed. This has been replaced by a much more economically sound principle requiring RFNBO producers to demonstrate the use of RES through PPAs, thereby letting (sensibly) the market dynamics of supply and demand operate unimpeded, which will logically lead to more RES capacity coming online to meet the increase in demand.

Geographical proximity principle clarified. The proposed amendments clarify restrictions on the geographical proximity of the RES and the RFNBO production facility and make them more easily transposable into non-European countries of production (which do not have the same concept as in Europe of the electricity market “bidding zone”), requiring that the RES and RFNBO facilities be in the same or neighbouring countries.

Temporal correlation window widened. The time period within which the RES generation and the RFNBO production must occur would be widened to a quarterly basis, and from 1 January 2030, on a monthly, quarterly or yearly basis (to be decided by the Commission). This is a significantly more flexible period compared to the Commission’s proposal for a monthly, and from 1 January 2027, hourly, balancing period.

Increase in the mandatory quotas increased. The mandatory quota for RFNBO use in the transport sector is increased to at least 2.6 percent in 2028 and 5.7 percent in 2030, compared to the previous proposal by the Commission of 2.6 percent by 2030, effectively doubling the quota. The quota for 50 percent of hydrogen used by industry to be RFNBO by 2030 is maintained and an additional quota is added for at least 70 percent of hydrogen used in industry to be RFNBO by 2035. This position is consistent with the Commission’s messaging in REPowerEU.

Implications and Final Remarks

These developments indicate that Europe may be on a trajectory towards reduced red tape and a more flexible and business-friendly regulatory environment for the green hydrogen sector. Whilst the Parliament’s proposal is just one step in the legislative procedure (and will be followed by negotiations with the Commission and the European Council as part of the trilogue procedure) the trend is positive for green hydrogen and green ammonia producers in Europe and those seeking to export into Europe.

Even if the Parliament’s text does not survive the trilogue negotiations, it sends a message to the Commission with a clear message that the Commission needs to remove red tape from the green hydrogen sector. Should the Parliament’s text be adopted as a formal amendment to RED II, this would give significant legal certainty that would boost the green hydrogen sector in Europe and in exporting countries. Even before then, the direction of travel in Europe is looking much more positive for business.

Shearman & Sterling is actively advising clients on some of the largest and most complex green hydrogen and green ammonia projects around the world. Please contact us if you would like to discuss any aspect of these developments.

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