Understanding Demand Development of Hydrogen in Europe: Pointing policy towards capex support in consumption

As the emotion of the energy market advises the sovereigns to deploy capital and create stop losses for development of hydrogen infrastructure, one must understand this would create cues to the market to direct development towards pipelines and import terminals which can serve as the veins of the industrialization of tomorrow. As most of the funds allocated by the sovereigns point towards the supporting the supply side and ensuring easy availability, one must realize that there is no free lunch in this world. Any infrastructure development effort fueled by sovereign support with protection from the market forces can create a situation where there is relatively low consequeses of deploying towards building and hoping they will come. Considering the deployment and allocation of funds, the cycle of emotion for supporting the supply side of the hydrogen market is atleast one whole cycle ahead supporting the demand side of the market.

Before we jump into a time machine and try speculating on how demand for hydrogen may develop in Europe, let's start by understanding how the demand for hydrogen currently stands in Europe:

Refinary Demand ⬇️: In almost all countries of Europe, refinaries have been the primary end users of hydrogen for past few years with exception being Austria, Lithuania and Norway. The subsidization tail wind currently seems to be in favour of supporting the effort of expansion of production assets of Ammonia and Methanol in Germany, Poland and Netherlands. Upto publicly available information about deployed subsidies and grants upto March 2024, it seems only a small portion of the earmarked funds have actually been released and if the current allocation of subsidies and grants are to be considered at their notional value, and thankfully the government has been careful in deployment. As economies slow down or stagnate, it creates political incentives for any government to jump start an economy by deployment in infrastructure which may seem great on the first glance but if the investments does not yield under the discipline of the market forces, they can prove to be macro difficulties. Refinary production estimates are generally in line with demand expectations and this being an age old industry is fairly efficient. In the coming few years as the standard oil refining industries in the developed nations of the world face some tailwinds both due to demand expectations and nudges of the governments. It would be difficult to convince shareholders to invest in expansion of refining capacity unless supported by the public exchequer which has second order implications on demand for hydrogen consumption in Europe. In comparison with refinary consumption levels for hydrogen has been fairly flattish with increase in demand of around 6.36% over last two-three years.

Ammonia Demand ⬇️:

Going into this decade the prices of ammonia had a very unsustainable price increase primary driven by supply side constraints. Even though the supply issues have eased to an extent, demand has not supported the price of ammonia from 2023-2024. Though ammonia is a fairly illquid commodity and any assessment of price is only as good as available information of trades. Going into 2024-2025, it does not seem that consumption of ammonia would have short term support in Europe. Considering the fact that cost of capital may remain higher for longer, the retooling necessary for using ammonia for industrial heating applications may not prove to be it's best use atleast for a few years in the future. It can also be seen that through 2023, the margin for producers in Europe has been low and even one of the largest producers (Yara) has been running in 1/5th of capacity. The margin for producers and even for importers does not seem to have significantly recovered in 2024 yet.

Methanol and Chemicals Demand ⬆️: This is one sector that seems to have a combination of both head and tailwinds in Europe but my overall expectation would be that driven by regulations the mathanol and speciality chemical demand would overall increase over the coming years. One of the problems for this sector in Europe is that a number of base chemical producers are shifting a portion of their production assets to US in the developed markets and to some emerging market nations to reduce cost. There are some sectors in commercial as well as recreational shipping in which there are ambitious plans to use methanol. The key to unlocking the use of methanol in the shipping lies in understanding of capex and not opex. The operational expense side of the puzzle has adequate sovereign support both in terms of regulatory push as well as subsidies for production but the retooling effort has relatively low incentives. The cost of retooling a traditional heavy fuel oil ship engine to a methanol or a mixed use engine can range from 250 to 650 EUR/kW. Methanol happens to be a lot lower flash point fuel in comparison to heavy fuel oil, as such the fuel distribution system would need to be reinforced and nitrogen purge may need retooling. At the current cost of EU ETS which stands at 73.26 EUR/MT, considering a cost of capital of 7%, it would be diffcult to justify the cost of retooling a heavy fuel oil ship unless the regulatory burden is increased. LNG ships on the other hand can make a commerically viable case for retooling towards mixed usage.

The basic retooling necessary to transform a standard heavy fuel oil consuming tanker to a methanol or mixed fuel usage tanker can be understood from the above table.

The retooling effort is generally focused on double walling the pipes for fuel pumps and double walling any storage parts to accomodate for a lower flashpoint fuel. Any large scale adaption of methanol or even mixed use of methanol would require significant capex to be spent on majority of the fleet of most carriers which currently does not have active soverign incentives to allow for longer amortization of the cost or partial subsidization of the effort. The phase out process of the heavy fuel oils would enable the usage of more methanol in subsequent years but atleast for now the retooling efforts are just getting started. The recreational vessels have actively taken up the initiave to start the process. Elasticity of demand and how would the cost be distributed to start the process are the primary variables that would deterimine the future of the engine retooling efforts. This is a sector which would have second order effects to the methanol producers making purchase decisions and setting production targets. The methanol and specialty chemicals industry is rather concentrated with a few players but as demand increases, concentration of marketing efforts in this direction can yield results.

Industrial Heating ⬆️:

This is one sector that may result in relatively the best commerically viable use of hydrogen for would be for industrial heating as the capex requirement has the possiblity to consume lower portions of the margin and the opex benefits has the potential to kick-in relatively sooner than other applications. The primary cost of retooling can come from boiler refittings but mixed usage of hydorgen for heating can start from readying the pipes and pumps which comes at a relatively lower cost. The primary benefit here is that the commercial benefits of using hydrogen would be seen relatively sooner considering the spread of capex and opex, considering amortization with it. The primary problem of developing demand in this sector is expectation of industrial output from the most industrially productive nations of Europe, which currently is still waiting for a healthy growth climbing out of macro shadows.

The metal refining and second stage of the metals value chain has started testing the possibility of using hydrogen for furnaces but we must note that these efforts are only for testing readiness and large scale retrofitting has not actively started yet.

According to studies from 2020, a basic assumption of retrofitting unit costs in Europe understood as above. The numbers are a bit in the wild as the samples that participated in all publically available sources are rather low and in most cases the retrofitting efforts and studies are being done on standalone basis. Thus though this area of the hydrogen readniness may have the most commerically valid uses, it might require some time to get across the early stages of understading the cost.

What's Next?

As hydrogen production and distribution infrastructure in Europe gains momentum, the soverign must also start supporting the consumption side and one of the best ways to do that would be to work on blend turbines for hydrogen co-firing for power generation. It is economically feasible and politically sustainable as well. Stay tuned for a deep dive into blend turbines in Europe !