A lot of hot air? Part 2
Looking at the cost of hydrogen powered electricity and why we could be solving for the wrong thing
If you or your firm are looking for advice on how to optimise your energy mix, optimise profit in a dynamic regulatory landscape, ensure energy security for your firm, or looking for policy advice at a higher level that is devoid of the absolutism of rhetoric and rooted in pragmatism, please see MCOE Consultants.
MCOE Consultants is an independent firm, one that is not guided by any vested interests or stakeholders that need appeasement. We will solve for that only thing that matters. Yourself and your goals.
If you haven’t read Part 1 of this series then I suggest you take a look at it first. It analyses the key differences and hurdles in converting the grid to hydrogen, looking at the quantitative costs as well as the more qualitative issues that need to be addressed. I left it on a bit of a cliff-hanger, as I hadn’t looked at the cost of hydrogen powered energy. Given this is the raison d’etre of this substack, it’s a fairly gaping hole. So, let’s go, it’s numbers time.
Well, just one more thing
I’m conscious of sticking to facts and not becoming bogged down in political discourse, however this week saw a speech by Nigel Farage on energy costs. This was both pilloried and lauded, depending on which side of the debate you sit on. The speech talked of abandoning net zero and reindustrialising the UK. Proponents of this view, point to flagging GDP and flagging industry amid rising energy costs.
There are elements truth in this, and the use of renewables is somewhat to blame for this. However, the proposed solution is simplistic, and I think misses the vital point that we should be striving to do better, rather than just arrest a decline. It’s easy to say no but trying to come up with better solutions is the real goal (fossil fuels really are finite in supply). Any policy for the future needs to have a plan for how we improve things and direct resource appropriately, rather than just turning back the clock. If nostalgia was a plan would the industrial revolution have happened? Over the course of these pieces I aim to present a pathway that is positive for growth, rather than just arresting decline.
Anyway, the backlash was immediate. However, the assertions by certain talking heads on Radio 5 live and Ed Miliband, that more wind would solve our issues also misses the point. As per my piece on CFD contracts, the current structure ensures prices are high now and can only increase over time. It’s also not even the cheapest if you take the average strike of CFD contracts:
The benchmark is also skewed. Gas powered electricity incorporates carbon allowances costs, which added ~£20/mwh last year (I’ll come to this in a later piece). Finally, it increases the risks in the winter months, given its intermittent nature as previously highlighted. Given winter has a disproportionate impact on the overall price we pay, just adding wind would not help. The key is to think about the system as a whole and what you do to smooth out the winter months.
The marginal cost of producing hydrogen
Firstly, hydrogen is not pumped out of the earth, it is created by electrolysis (assuming you don’t use gas, which is self-defeating if you’re trying to reduce emissions). This means you need an input energy source to create the hydrogen that you then burn later to create electricity. It’s worth remembering the laws of thermodynamics (to which I’m grateful as they are the reason why the marginal cost of everything has its focus and formed the core of the initial research that inspired me). Energy can neither be created nor destroyed, but in the conversion of one form into another (potential energy in the case of hydrogen), energy is lost. Think of your battery getting hot in your phone as you charge it. Not all the electricity you use goes into charging your phone, some is lost as heat.
Weights and measures
Helpfully, the research on hydrogen looks at weight rather than volume, which is slightly daft given the convention for gas is volume. Anyway, regardless of your definitions, I will only ever compare to the one thing that matters, the price per mwh. Try not to get lost when I mention weight, I will bring it all back to price and it should hopefully make sense.
Currently, to make a Kilogram of hydrogen, requires 50kwh of input energy. The heating value of 1kg of hydrogen is 33.3kwh. Your hydrogen fuel cell (how you burn it to make electricity) is not 100% efficient either, indeed the output electrical energy is more like 16-23kwh per kg of hydrogen you created. So, you put in 50kwh and get between 16 and 23kwh back. To get the same amount of energy as the input, you need to use between 2.1 and 3.1 times as much hydrogen as you would the input energy source.
Think of it like a baker selling cakes, versus someone selling just the sugar, selling to someone satisfying a sugar fix. They buy the flour, eggs, sugar etc, buy a cake tin, put in the oven then put it in a box. Clearly if the price of the cake you then sell is less than the cost of the inputs you lose money and your business goes under. So, the cost will be higher than if you stuck your spoon in the sugar jar. The extra cost is like the loss of useful energy in thermodynamics. This is why hydrogen must by virtue be more expensive than whatever its input energy source is.
Now this isn’t the full story. Like solar, hydrogen electrolysis is a young industry, improvements are being made all the time (in addition to economies of scale which would bring down the cost of the equipment)1. Industry forecasts put the required input energy at closer to 39.4kwh by 2050. The eagle eyed will still note this is higher than the 16-23 kwh you ultimately produce, those pesky laws of thermodynamics.
Anyway, let’s run the numbers. I’ve labelled Current (today) , 2050 and a high or low efficiency fuel cell (which is where the 16-23kwh number comes from). I’ve taken £65/mwh as the input energy price given this is the lowest average CFD strike as shown above.2
Assuming a best case of £65/mwh input, currently it’s at best £132.1 per mwh and at worst right now £198 per mwh. This would be lunacy to use given over the last 3 peak winter months the average is around £105. The absolute best case (by 2050), Is £104.1 per mwh. This is hardly striving to improve; this is striving to make things worse.
At what price does hydrogen make sense?
Goal seeking for something that makes potential sense, the breakeven looks to be around £52 per mwh. This is lower than all the CFD strikes, so cannot be used within the framework mandated by the CFD scheme. However, generators don’t activate the contract so prices could technically drop below £65 per mwh. In data going back to 2021 there have been 93 days where this has happened on a non-volume weighted basis. The number drops lower when volume weighted.
The crux of the issue is hydrogen only works if the price of renewable energy is sufficiently low and at a time when it would otherwise be wasted. It only works if there is an EXCESS OF ENERGY in the system, that is not locked in at a higher strike.
If we go back to Mr Miliband and his assertions on wind turbines. Hydrogen only makes sense when otherwise wasted excess wind energy is stored as hydrogen to use in the winter. When we think back to solar, the same logic applies here. This is fine though, this is the whole point of balancing the grid and building in security for the winter.
The concern is that you cannot create anywhere near the amount of hydrogen required (at an economic price) to power us in the winter, which means its use case becomes more limited. That doesn’t mean it cannot be part of the solution, but it just means that it cannot be relied on as the major means of smoothing out the winter fluctuations.
Is this just papering over the cracks of something else? (Zonal Pricing)
The whole crux of the hydrogen debate is using excess energy (from wind turbines offshore say) to create hydrogen, otherwise the cost is prohibitive. This is created by the inefficiency of having a one price grid and not being able to transport the energy effectively.
Zonal pricing has been in the news recently. In essence, you remove the single price of electricity across the UK and have different prices by region. Currently, that would be lower in North Scotland, near offshore wind and low energy demand, and potentially higher in metropolitan areas where they have more limited power generation and higher demand.
Zonal pricing would make Hydrogen largely redundant. Here, a competitive market (with more efficient price discovery), moves energy demand to where price is cheapest and crowd out the cheap energy you could use for hydrogen (i.e. they can use a higher price of energy then hydrogen production can). Think data centres and industry moving to Scotland and using energy there. By shifting demand (or inducing new demand), it allows them to take advantage of lower energy prices, but also smooth demand away from the usual pinch points, which could mean the upward bias is more limited in metropolitan areas.
Now of course, this is being pushed by the likes of Google, who are being self-interested. They want to make money. But overall, that doesn’t mean a bad outcome if their profits and associated industry profits are taxed in the UK. Furthermore, if this allows us to re-industrialise more broadly (see I promised solutions not just nostalgia) then surely this is a better outcome and one that is positive for growth overall.
It feels like hydrogen is optimising for an inefficient system, rather than tackling the source of the inefficiency. This is crucial. If offshore wind creates wastage, either stop building them or allow markets to respond and move industry to where the price is cheapest.
Now, utilities and generators don’t want it. It introduces uncertainty risk on the price they receive. This is a twofold revelation, firstly that they don’t intend to trigger the CFD contracts, as they believe they will get a much higher price in the secondary market (so please stop quoting those numbers as the cost of renewables!) Secondly, it shows they acknowledge that producing energy away from the point of demand is inefficient (otherwise there would be no price difference!) and so are happy with the current suboptimal outcomes we see.
Conclusion
The main stumbling point for hydrogen is the cost of producing it. It only adds up if you can use otherwise cheap wasted energy. That leaves its use on a broad scale questionable. That does not mean we shouldn’t use it as part of the mix, we just need something else to pull the bulk of the weight.
That aside though, it is optimising for an inefficiency rather than tackling the root cause. Zonal pricing could eradicate the cheap energy hydrogen is reliant on, but has the potential to trigger broader economic growth and prosperity. Isn’t that what we are meant to be solving for?
In part 3, I look at the other options for storage and therefore how we can reduce the cost of energy in the winter.
If you or your firm are looking for advice on how to optimise your energy mix, optimise profit in a dynamic regulatory landscape, ensure energy security for your firm, or looking for policy advice at a higher level that is devoid of the absolutism of rhetoric and rooted in pragmatism, please see MCOE Consultants.
MCOE Consultants is an independent firm, one that is not guided by any vested interests or stakeholders that need appeasement. We will solve for that only thing that matters. Yourself and your goals.
I don’t cover the cost of building an electrolysis plant in the analysis. This is a glaring gap, but I think as you’ll see later, it’s not necessary at this stage, there are more pressing issues to address. Also, by having a competitive CFD process you allow the market to determine the price, although maybe that is wishful thinking
There’s no point going lower as the government hypothetically makes up the difference below this, assuming generators actually sign up to the contract!