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Hydrogen production through electrolysis can offer flexibility to electricity markets, but its costs are much higher than its benefits (for now, at least)

Datum:18 oktober 2021

Many governments, including the EU, give a prominent role to hydrogen produced via Power-to-Gas (i.e., electrolysis) as a flexibility provider to balance mismatches between electricity supply and demand which may increase because of the increased penetration of renewable energy. When the electricity market is oversupplied, electrolysers may use low-priced electricity to produce hydrogen; when the electricity market is tight, the produced hydrogen can be used by fuel cells to generate electricity. In this way, hydrogen can provide flexibility to the power system. Moreover, it can also help to decarbonize industrial and transport sectors. The question now is whether the benefits of Power-to-Gas exceed its costs. In a new publication in Applied Energy, Xinyu Li and Machiel Mulder conclude that this is not the case yet, and that more research and development is needed to make electrolysis an efficient solution for reducing carbon emissions while also helping the electricity sector to deal with increasing shares of renewables.

When we increase renewable electricity from the current 10 GW to 60 GW installed capacity (which is consistent with the Dutch policy target for 2050), the electricity prices become much more volatile. When we add Power-to-Gas to this energy system, the price volatility will be reduced. However, even when the Power-to-Gas capacity is set at about 8 GW (which is way above the current Dutch ambition), the impact on prices is fairly modest. Given the high cost of Power-to-Gas, the overall welfare effect appears to be negative.

While the overall welfare effect of Power-to-Gas as a flexibility provider is negative, for some groups it may be beneficial, which gives them an incentive to promote Power-to-Gas. The groups who benefit from Power-to-Gas include the producers of renewable electricity (as they have less hours with low electricity prices), some consumers of electricity (as they have less hours of very high prices). The groups who suffer include the producers of gas-fired power plants (as they enjoy less hours of high prices) as well as the international traders (as there are less international price difference).

The above conclusions hold when we ignore the hydrogen demand outside the electricity sector. As known, governments are also promoting the use of hydrogen in industrial process and transport to reduce carbon emissions. When we take a large demand for hydrogen from outside the electricity sector into consideration, will the answer be different?

We find that when there is a large external hydrogen demand from industrial and transport sectors, the impact of Power-to-Gas on the reduction of electricity price volatility is smaller than before. The explanation for this is that the production of hydrogen through electrolysis may push the (low) electricity prices up while the produced hydrogen is more likely to be supplied to consumers outside the electricity sector rather than stored for electricity generation in hours of high prices. Hence, the presence of a large demand for hydrogen in industry or transport reduces the economic value of hydrogen as a provider of flexibility to the electricity sector.

Nevertheless, a high hydrogen demand by industrial and transport sectors has some positive welfare effects because electrolysis (Power-to-Gas) is able to provide less expensive hydrogen than hydrogen production based on natural gas and storage of carbon during hours when electricity prices are low. This is generally the argument used by governments to pursue this policy (EU hydrogen strategy, 2020).

Again, there are winners and losers. The winners are the producers of renewable electricity (as they experience less hours of low prices), the producers of hydrogen by electrolysis (as they realize higher volumes and higher prices) as well as hydrogen consumers (as they have to pay lower prices). One of the major losers consists of electricity consumers (as they have less hours of low prices). Hence, industrial users of hydrogen benefit at the expense of other electricity users.

The overall welfare effect is negative when we take the costs of Power-to-Gas into account. This negative effect even becomes larger when we control for the costs of creating the hydrogen demand. Under the current market conditions, when industries switch from natural gas to hydrogen, they are replacing a less expensive by a more expensive energy carrier. When we include these costs, the conclusion is that the overall welfare effects of introducing Power-to-Gas are negative. To neutralize this negative effect, the required carbon price is about 150 euro/ton for a low level of installation of electrolysis plants and about 700 euro/ton for a high level of installation. Since this carbon break-even price is much higher than the prevailing carbon price in the European Emissions Trading scheme, one must conclude that Power-to-Gas is currently not a profitable solution, seen from a social-welfare perspective, to provide flexibility to electricity systems with high shares of renewables and a high demand for hydrogen in industry or transport. The economic value of Power-to-Gas can be turned positive by significantly reducing the fixed costs and improving the efficiency of the Power-to-Gas installations. Hence, more research and development is needed to make electrolysis an efficient option to reduce carbon emisssions and to help electricity sectors to deal with increasing shares of renewables.

 Link for the article

Authors: Xinyu Li and Machiel Mulder at the University of Groningen