Talking with…

Prof. Machiel Mulder 

For more than a year now, NortH2 has been working in multidisciplinary teams so that we can continue to add depth to our vision of the usefulness and necessity of large-scale green hydrogen. Over the coming months we will be inviting a variety of independent thinkers to challenge our narrative in a public conversation. In this series of articles you will read their personal views on the role of hydrogen in the energy transition. We emphasise that these perspectives are not necessarily shared by NortH2. Prof. Machiel Mulder is Professor of Energy Economics at the University of Groningen.

“We should be talking about cutting carbon emissions, not pushing one technique or another!”

Let’s start where we left off in a conversation with your colleague David Smeulders: the role of the government in the energy transition.

It would seem to be plain common sense that, when it comes to the energy transition, the government should take the lead in redesigning the market. That’s not how I see it at all. The central question in my way of looking at it is: what will go wrong in the energy market or the energy system if the government doesn’t intervene? It’s obvious that the government has a major role to play in bringing about the energy transition, but the question is whether the energy market should be organised differently. Governments should intervene only when the market fails—that is, when the market is unable to achieve socially desirable outcomes.

The general view is that our energy mix will continue to need molecules decades from now. Is that your vision too?

Absolutely. Today, about 80% of the energy we use consists of molecules. In the future, we can safely assume that the proportion of electrons will increase significantly. But we will certainly not manage with electricity alone. We will continue to need molecules because of their energy density, but also as industrial feedstock and for heating.

I don’t put much stock in studies that tell us that the split between electricity and gas will be around fifty-fifty by 2060. I used to come up with scenarios like that myself, at CPB Netherlands Bureau for Economic Policy Analysis. These are storylines. I mean, they’re very useful for thinking about the future, but they’re certainly not predictions. 2060 is a world away, so no one can predict what the energy system will look like then.

Nevertheless, developing a sustainable energy vision means playing the long game. So you have to have a go at extrapolating into the future?

As an exploration of the future, yes, but not to make predictions.  We’ve had a liberalised energy market with decentralised decision-making for 20 years or so. This has brought us many benefits in the form of lower prices and more innovation. So I’m looking at this from an economic point of view. Before liberalisation, the energy system was centrally controlled. Not any more. Network operators, by the way, still play that kind of central role. They want to develop a vision of where things are heading and model the infrastructure accordingly. That’s good. But liberalisation has left much more to market parties, producers and consumers. Network operators are now only facilitators. They no longer have a leading role. To ensure the energy system’s decentral organisation mechanism works properly, the incentives must be strong, especially when it comes to price. And how energy systems will develop from that point on, nobody knows, because it’s impossible to predict future prices.

So it’s about setting those prices in the right way. And once again I ask: what’s so wrong with the energy system today that government intervention would be justified?

And what’s your answer?

My answer is the pricing of the climate effect. You have to get that one right. If we price carbon emissions in such a way that they are proportional to the damage caused to the climate, we’ll have made a lot of progress. Then you don’t have to do much more as a government.

And indeed, that pricing should be done centrally. Gas and electricity prices are derived from the international energy markets. Those prices are endogenous—the result of supply and demand. Nobody decides what the price should be: it’s determined by the market. For CO₂, though, there was no market. Economists call this a market failure. So you have to do something collectively as a government. And for that, here in Europe we’ve developed the Emissions Trading System (ETS). The resulting carbon prices are the outcome of market processes. They are determined on the one hand by the emissions ceiling set by the government and, on the other, by the costs that market players incur in order to cut their emissions. The most important thing the government has to do is set the emissions ceiling correctly—that is, in such a way that the climate targets are achieved.

Is carbon pricing, then, the only government tool available that can help us reach our climate goals?

Well it’s certainly an important tool. But there are several possible market failures that could justify intervention. The development of infrastructure, for example, where it is not created by the market, if only because of the uncertainty of how it will be used in the future. Private parties are sometimes unable to properly address the uncertainties surrounding this.

With heat, for example, a lot of factors are intertwined. The key thing there, too, is that we price carbon emissions properly. And if it turns out that the infrastructure between, for example, the port of Rotterdam and the Westland area can be built on the basis of a good carbon price, you can conclude that it is socially desirable and economically viable. If private parties do not take it up in spite of this, you shouldn’t immediately go looking for grants, but should ask why the market doesn’t dare to take it on. This may have to do with purchasing uncertainty, for example, or uncertainty about future government policy. And so you have to address that. If we then designate a network operator to build that infrastructure and open the network to other producers, an efficient heat market can be created.

And it’s no different for hydrogen.

What we see happening with hydrogen is interesting. We see all kinds of players, in the Maasvlakte and the northern Netherlands, but also abroad, who would like to make hydrogen, but only on the condition that governments contribute financially. However, CO₂ is already priced at around 50 euros per tonne. So we have already internalised the climate problem in terms of price. Why should more money be provided?

Because the carbon price is still too low, or because the switch to green carriers wouldn’t be made otherwise?

The carbon price was definitely too low before. It hovered at around 15 euros per tonne for quite some time, went up to 20 euros in 2018, and now stands at around 40 euros per tonne. That’s a hefty price, which really hurts the production of energy from fossil fuels, but it is also an incentive for the energy transition. It is fairly easy to calculate what the final carbon price has to be in order for a given technology to be economically viable. After all, the companies themselves are doing that too. I once calculated that the price of CO₂ would have to be 45 euros per tonne to shut down coal-fired power stations. With a higher carbon price, production by coal-fired power stations becomes economically unviable.

So, economically speaking, it would be a strange model if the government tried to push coal-fired power stations out of the market via all sorts of means, while proper carbon pricing makes the market do the job itself. Then you also avoid all the hassle of compensation and so on. Now there’s a court case in which the shareholders of a coal-fired power station are asking for compensation because they have to close down, but this could have been avoided simply by using the carbon price as a policy instrument.

So in response to Mr Smeulders, who expressed regret, in your previous interview, that the government had not seized the opportunity of a merger with Swedish steelmakers to make Tata greener, I would say that, if such a greening project is not profitable, while the carbon price is right, we shouldn’t try to get the government to cover the loss with grants. If a company feels that responsibility, and if the market demand for green steel is there, such a steel company will take the risk itself. Market players are free to invest in what they want to invest in. That’s the essence of a decentralised market model. We’re now seeing, too, that investors are increasingly forcing companies to do this. The government must then, above all, ensure fair and appropriate rules, conditions and procedures. But if market players turn around and say, ‘We’ll invest only if the government also puts in money,’ then something’s gone awry. To come back to the question of green hydrogen: to make this technology profitable, you need a much higher carbon price than for many other emissions-reduction technologies. So a hefty subsidy would be needed.

The social problem with giving grants is that the money comes from citizens. Small-scale consumers are already paying about half of the collective costs of the energy transition. We like it when companies switch to green energy, but we don’t want to put too much of a burden on them either. The network connections to offshore wind farms, for example, are paid for out of the surcharge for sustainable energy (ODE). But most of the ODE is financed by small-scale consumers, even though they use less than a quarter of the electricity volume involved. The large-scale users, who consume about a third of it, pay only one per cent of the costs. So you can say that the small users bear the burden, while industry’s reaping the benefits. That’s why I have a problem with subsidising the switch by industry to green hydrogen: in that case, too, it’s citizens who foot the bill, and in the meantime industry has much cheaper options for reducing its emissions, but it underutilises them because the energy it gets is cheap. It recently emerged once again that Dutch industry is lagging behind other European countries in terms of energy savings.

So then: will carbon emissions remain at the current level, whether they’re generated here in the Netherlands or elsewhere?

I don’t think so. It’s not only because of cheap energy that industrial companies are located in the Netherlands. The advantages of being here are numerous. There are good seaports and airports close by, the quality of the labour is high, laws and regulations are robust, and there’s a good tax regime. Companies will not simply take off just because the energy tax here goes up.

So you’ll be pleased if market players such as NortH2 are serious about investing in offshore wind farms themselves, to make hydrogen from them?

Well now, even there I’d hesitate. The amount of green power is limited, not infinite. There are spatial restrictions. However, we need much more green power. Citizens want to and must drive electric vehicles, everything is electrifying, the demand for electricity is increasing. And that demand for power must be greened. If you then say, ‘We’re claiming that green electricity for the production of hydrogen,’ you need to ask yourself whether that’s the best solution for society.

But isn’t the claim actually that there should be more offshore wind sites, so that green electricity for hydrogen is added to the planned volume of green electricity? So there’s no displacement going on.

It will already be a major task to achieve the planned volumes, so it will certainly not be easy to create even more on top of that. Moreover, we have to realise that hydrogen producers are competing with other electricity users in an electricity market. It’s not right within a liberalised energy system to tell some customers they’re getting a grant for their electricity consumption, while others have to pay a levy for theirs, and a hefty one at that.

But if we large-scale parties continue to need as much green gas as possible and we see that there is infrastructure in place that allows us to balance our energy system and keep it affordable, do you think that’s an odd situation?

No, not necessarily. My point is, above all, that it should not be about promoting certain techniques, but about ensuring that CO₂ is properly priced. The market will then figure out which technology is the best. And that applies, too, to the network operators that are regulated by the government. Gasunie and TenneT receive efficiency incentives from the government.  If these two network operators say that, for efficiency’s sake, they need green hydrogen on a large scale, then there’s obviously a business case there. The benefits of producing hydrogen on the North Sea would then obviously outweigh the costs of developing the power infrastructure further.

So you see, I’m not anti-hydrogen, just as I’m not for or against other technologies. I think large-scale green hydrogen would be fantastic. It would be great if we could use it to green our industry and reduce emissions. My point is simply this: if the infrastructure operators and market players believe in that, it should come from their own (or rather, their joint) business cases—which is what Gasunie is doing now, by the way. But if someone then says that the market will not take that up on its own, then offshore green hydrogen obviously can’t be a solution, not even from a social standpoint, because CO₂ has already been priced.

If we have to move towards a mix of heat, electrification and green gases, and set political objectives and deadlines for this, will a market mechanism such as ETS be enough to achieve the turnaround we want in time? If we want to have a hydrogen supply chain in place by 2030, we have to start now.

This question perhaps goes to the heart of the problem. If you set targets for certain technologies (heat, electrification or hydrogen), a policy tool such as ETS, which has a quantitative target for carbon emissions, is not well suited to this. However, the ETS is the key tool of European climate policy. Everything else is subordinate to it. It is based on a quantitative emissions-reduction target, which in turn is linked to the Paris target on global warming. If you also set other quantitative targets, such as having a ‘green hydrogen supply chain’ by 2030, you have to ask yourself why you are doing that. After all, for society, it’s a matter not of having a hydrogen supply chain or setting up a heating industry, but of reducing carbon emissions. Any policy that complements the ETS but that affects the same sectors will impact only how we reduce emissions, not the scope of the emissions reductions themselves. You could also say that any further policy will mainly affect the distribution of the benefits and the burdens: who gains from climate policy, and who foots the bill for it. I fully understand that everyone would like to be the beneficiary and that they thus plead the case for a particular technique or industry, but that’s not necessarily efficient for society.

Does the expected earning capacity of the Netherlands as a hydrogen country factor into your business case?

Yes, but I remain sceptical about earning capacity until I see a solid business case. Hydrogen is not natural gas. We made a lot of money for the Netherlands with natural gas, because the product price was very low and the market price was high. It cost a couple of cents, and we sold it for 20 cents. Lucky for us. With hydrogen, however, the market price is below cost. So you have to partly finance it yourself, in the hope that you’ll recoup this money in the future. And in that case, what is our competitive advantage over other countries?

If Japan and, closer to home, Europe, invest heavily in hydrogen, a de facto market will be created. If we do nothing with our North Sea, our expertise, our storage facilities, our infrastructure and our large industrial clusters, aren’t we missing out on opportunities?

Let’s say the Netherlands is very competitive and can do it cheaper than its competitors. Even then, we will have to see whether we can get beyond just recovering costs. And even then, I don’t see the hard earnings. There will certainly not be the kind of income we’ve had with natural gas.

But indeed, if neighbouring countries invest massively in hydrogen and if they are willing to pay for greening their industries, and if we can produce and transport it in the Netherlands at competitive costs, then that may change the business case. We would then be benefiting from grants paid by neighbouring countries. For the Netherlands that would be positive, but the question is whether that would also be true of Europe as a whole.

Ultimately, the question is how we can reduce carbon emissions, because the climate problem is the biggest problem we’re facing today. From a social perspective, it should not be about promoting certain techniques, but about encouraging market players to look for the most efficient solutions to reduce emissions.