EU weighs design of 'market maker' hydrogen funding auctions

European hydrogen developers are gearing up for the region's first-ever funding auction later in 2023, in a process that is billed as a learning curve and a small step toward achieving ambitious production targets by the end of the decade.

The European Commission is channeling the auction system through its newly minted European Hydrogen Bank, established to help it reach 10 million metric tons of domestic green hydrogen per year by 2030, as well as another 10 MMt/y of imports.

The bank is designed to bridge and lower the cost gap between renewable hydrogen and fossil fuels for early projects, with producers competing for a fixed price per kilogram of hydrogen for a maximum of 10 years.

A first auction, backed by €800 million from the EU and its member states, is slated for the end of 2023 — but it will have to be backed up by much larger competitions if the EU's hydrogen targets are to be met, according to analysts.

Still, the bank is seen as a "market maker" in bridging future supply and demand, said Olivia Breese, senior vice president and head of power-to-X at Danish renewables giant Ørsted A/S. Power-to-X refers to a range of technologies that convert electricity into other energy carriers, such as hydrogen.

"It's got the benefit [that] it's going to channel projects toward the highest willingness to pay on the demand side because if you already get those revenues ... and you top it up, you're definitely much more competitive than if you went to a certain industry with a lower demand or lower willingness to pay," said Sopna Sury, COO of hydrogen at Germany's RWE AG.

The scheme will also benefit projects which have a favorable cost position already, Sury said in an interview at Aurora Energy Research's annual conference in Oxford, England, in March. "This is not equally allocated throughout Europe. Iberia ... is in a very good position because of the lower cost of electricity production," the executive added.

Concern about auction volume

The design of the first pilot auctions is being decided, with final economic terms and conditions set to be published in late summer. Companies will then be able to prepare their bids in time for the launch of the process in December.

Bidders will need to comply with the commission's definition of green hydrogen, laid out in a February Delegated Act.

The timeline between award and construction is still being finalized, but successful bidders will have already worked out their business models, started conversations with permitting authorities and potentially acquired a site.

Funding from the auction will go furthest if winning bids only require a small top-up to their existing business cases, and even then, the awarded funding will be a fraction of the financing required to enable the scale envisaged by the EU.

The proposed ceiling price is €4 per kilogram. Assuming subsidies of €1/kg of hydrogen and €3/kg of hydrogen, the European Hydrogen Bank would provide revenue support to 80,000 metric tons per year or 26,667 t/y of production, respectively, over the 10-year period that the funding will be made available, according to Matthew Hodgkinson, hydrogen analyst at S&P Global Commodity Insights.

"This volume is far below the European Union's target of [10 MMt/y] of production in 2030," Hodgkinson said in an email.

To achieve its 2030 target, the commission estimates that total investment should be between €335 billion and €471 billion, including between €200 billion and €300 billion for additional renewable energy production. While the vast majority of this will come from private funding, the EU hopes to create an incentive with the subsidy support.

While price-only auctions like this are effective at fostering competition, the industry lacks visibility on future auction rounds, which are an important market signal, Breese said.

'Learning process'

For bidders and public authorities alike, the hydrogen auctions will provide lessons in bid structuring and scrutiny of prequalification documents, according to Ana Quelhas, managing director for hydrogen at Portuguese utility EDP - Energias de Portugal SA.

"We expect this to be a learning process that will spread through the first auctions," Quelhas said in an email.

Robust selection criteria based on technology, regulation and project economics will be key to ensuring projects that win support are delivered, Quelhas added.

Meanwhile, the first group of auction winners will have to grapple with supply chains and offtake infrastructure ramping up in parallel. "As such, the delivery risk is very significantly higher than for classic renewables," Breese said in an email.

Quelhas sees the auction as a key tool in unlocking investments for European hydrogen production, as well as a discovery tool for policymakers that will pinpoint funding gaps.

"It is important to integrate this mechanism within the wider policy and funding support mechanisms that have already been implemented across Europe, allowing projects to accumulate different funding mechanisms," Quelhas said.

Policymakers are keen to limit the risk of uneven playing fields between EU member states caused by state aid being combined with the auction awards. They have proposed auction rules that limit additional state support to parts of the hydrogen value chain outside of the project itself — such as the electrolyzer, grid connection or power supply.

Bidders will also need to ensure that their offtakers do not receive operational expenditure state aid support for the hydrogen, according to the proposed rules.

"It may actually turn out to be challenging for the industry to find sufficient suitable first-mover projects that are on the one hand mature enough to fit the qualification criteria while on the other hand have not proven that maturity already in previous funding schemes," Breese said.

The auction design process is taking place against the backdrop of generous support funding in the US, where the Inflation Reduction Act is set to encourage the ramp-up of the hydrogen market.

"While we try to come up with 'the perfect' scheme in EU — and deliberately exclude the most matured projects from bidding if they have received other funding — the US and other regions are setting up simple and very predictable schemes," Breese said.

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