On the Way to Carbon Neutrality : the EU Energy Landscape by 2030

Two weeks ago, July 17th through 21st, the European Council met to discuss COVID-19 economic recovery strategy. After extensive discussions, the council announced an overall climate target of 30% of the total expenditure pledged for recovery, that is 570 billion euros pledged for the European Green Deal.

The European Green Deal is the new European Commission’s roadmap for making the EU's economy more sustainable. The aim of this set of policy initiatives is to render the EU climate neutral in 2050.

What does it mean to be “Climate neutral”?

At the global level, it is akin to reaching net-zero emissions in order to limit warming to 1.5°C[1]. In other words, we will need to reduce human caused GHG emissions and balance out the remaining ones through carbon removal techniques such as direct air capture and storage.

At EU level, this means reducing net emissions by 55% compared to 1990 levels as soon as 2030, down from a “mere” 20% reduction so far.

This note explores the expected EU energy infrastructure landscape by 2030:

• Which technologies can be leveraged for massive decarbonization in electricity supply, industry, transport and residential and commercial sectors in the next decade?

• How can such massive acceleration in decarbonization be triggered?

• How can risks associated with such a shift be managed?

The extent of emissions reduction targeted by 2030 in the EU means that efforts need to be done on all fronts, from energy supply to industry, transport and residential and commercial uses.

The extent of emissions reduction targeted by 2030 in the EU means that efforts need to be done on all fronts, from energy supply to industry, transport and residential and commercial uses.

What technologies can be leveraged to achieve significant results in the next ten years ?

The International Energy Agency estimates that CO2 emissions reductions will mostly stem from efficiency, renewables, fuel switching, nuclear and CCUS (carbon capture, utilization and storage) technologies.

These technologies have to be at an advanced maturity level as of 2020. This includes technologies that are already in use and need to be further scaled up: PV including rooftop, on-shore and off-shore wind, nuclear, hydroelectric storage, electric vehicles, building retrofits and energy circularity (where “energy waste” generated by an industrial site is used as an energy source for another process or for heating). It also includes technologies that are already deployed for specific use but need to become more efficient before generalization: green (from renewables) and blue (from natural gas) hydrogen, electrochemical storage, CCUS and biofuels.

In electricity supply

Achieving emissions’ reduction target in the electricity supply sector requires further scale-up of renewable energies, and increased share of nuclear electricity if mass storage is not efficient enough.

Further integration of renewable energies poses the question of network and storage costs. Indeed, although there still is some untapped small hydro potential, the largest potential is in off-shore and on-shore wind and solar

First, because of their intermittency, on-shore wind and solar PV lead to high network costs and overall higher costs to the electricity system than traditional generation assets of similar capacity. If storage remains expensive, intermittent renewables would eventually reach a plateau at about 50% of the EU mix, a level which will hamper the carbon neutral policy.

EU initiatives to manage costs imposed to the network by intermittent renewables include:

• For rooftop solar, moving away from net metering and feed-in tariffs towards lower tariffs for grid exports. This creates a localization signal: the economics of rooftop solar are thus linked to the amount of electricity that can be consumed locally

• The promotion of local energy communities (LECs). The concept of LECs was introduced in the revised Renewable Energy Directive (RED II) of 2018. LECs comprise consumers cooperating for the satisfaction of their energy needs using local production sources. Although not designed to operate in an island mode, the local exchange between producers and consumers should reduce overall burden of renewables on the grid (particularly when coupled with adequate incentives)

• Combining PV, Wind and battery storage in a single injection point. This is promoted by the new Spanish renewables law and is expected to enhance the use of existing networks to inject energy from renewables

• Firming requirements in auction programs might also be considered.

Second, when utilities were vertically integrated, the location of generation assets was selected to minimize overall costs to the system, including grid costs. However, renewables developed in a different regulatory environment and little to no geo-localization signals were given to project developers. As a result, supply developed where resources were abundant, with no regard to grid impacts.

Massive grid reinforcements are thus needed to better integrate renewables and reduce curtailment, but are always expensive and more and more difficult to achieve due to social and environmental constraints.

Considering the costs of such massive grid reinforcements, the EU energy policy makers might consider cost-reflective, real-time local tariffs or nodal markets. Under such schemes, local tariffs change dynamically depending on the grid congestions. This is the gold standard of efficient economic signal and will be instrumental in maximizing the speed of the transition toward decarbonized electricity. While seeming overly ambitious, such schemes already exist since the 2000’s in the USA.

Third, large scale offshore wind farms require the development of an equally large scale offshore electricity grid. One such initiative did emerge as far back as 2009: The North Seas Countries’ Offshore Grid Initiative (NSCOGI), which is an initiative grouping Belgium, Denmark, France, Germany, Ireland, Netherlands, Norway and Sweden among others. It is however not clear whether this initiative is still on the books.

Fourth, solar energy is abundant in the Southern Mediterranean, with generation costs going as low as 2,4 $cts/kWh (Tunisia’s 500 MW 2019 Solar tender). Already, two interconnectors link Morocco and Spain, with a third underway. And a Tunisia-Italy interconnector is under assessment.

Meanwhile, Nuclear electricity is regaining ground in the EU. In France, which derives a majority of its electricity from nuclear, President Macron asked EDF to prepare proposals to build new reactors. Opponents of nuclear put forth safety hazards and the uncertain construction costs of new nuclear. Its proponents put forward its high availability, the energy independence it provides and its low land use ratios compared to other low carbon technologies.

In electricity supply, massive grid reinforcements are needed to enable decarbonization at the required scale. Network costs might however be lowered through adequate market design strategies.

In industry

Carbon reduction potential lays in: efficient use of material, energy efficiency, circularity and fuel switching. Innovations in business models and financing are needed to unlock the significant stock of emissions’ reduction potential available with mature technologies.

The European Commission recently finalized a public consultation on the Renewed Sustainable Finance Strategy. The strategy aims to provide the policy tools to ensure the financial system genuinely supports the transition of the industry towards sustainability in a context of recovery.

Great potential can also be found in newer technologies. Green hydrogen can be used both as energy storage vehicle, source for industrial heat production or feedstock for different industrial processes. The EU aims to deploy as much as 40 gigawatts of renewable hydrogen by 2030, a significant increase from the existing one gigawatt.

CCUS technologies, which consist in capturing CO2 at industrial emission sites and either reusing CO2 or storing it in underground storage is also a promising development, with many initiatives underway in Europe. Taxation of emissions at an appropriate level will be necessary for scalable business models to emerge.

In industry, the absence of scalable business models is hindering the deployment of decarbonization technologies. Europe is expected to reinforce its carrot and stick approach through adequate regulations of industries and of the financial sector, enhanced emissions' taxation, and targeted subsidies.

In Transport

The transport sector covers different realities: personal transport, public transport (rail and road), and logistics.

In personal transport, expansion of electric vehicles (EVs) purchase support will be needed until EVs reach price parity with internal combustion engines, which is expected by the mid-2020s, or until policies displace the latter. Scaling-up charging infrastructure is also needed to incentivize massive adoption of EVs: 240 million charging points are targeted for deployment by 2040 in the EU and one million as soon as 2025.

In logistics and public transport, hydrogen is showing good promise. Bloomberg estimates that hydrogen will achieve price parity with gas by 2050. Green hydrogen, which relies on electrolyzers powered by renewables will benefit from the constant decline in renewable energy prices. Adequate pricing of carbon emissions will also give a strong boost to hydrogen use in long distance transport.

As a technology, the use of hydrogen in road transport is mature. However, massive adoption depends on the development of the ecosystem: green hydrogen production, distribution logistics, charging infrastructure, and hydrogen fleet. Hydrogen ecosystems are being considered in remote mining areas. However, large scale developments in continental EU is at a different scale and business models are yet to be found.

Shipping and aviation have different constraints altogether. Energy to volume constraints mean that hydrogen is not currently considered as a directly usable form of fuel. Decarbonization technologies under consideration include nevertheless the use of hydrogen combined with captured carbon to create hydrocarbon fuels: methanol for shipping and e-kerosene for aviation. Biofuels have also been tested in aviation over a decade ago. They are however far from achieving price parity.

In the next decade, electric vehicles, hydrogen, soft mobility, and, to a lesser extent, biofuels, are expected to be the strongest contributors to the transport sector decarbonization. Again, a mix of subsidies, public sector investments or PPP schemes and more stringent regulations will be needed to trigger the required level of transformation.

In the residential and commercial sectors

Here, decarbonization is synonymous with building efficiency and green renovation. Scale-up potential of mature solutions is still important and may be unlocked through programs to renovate public buildings and business models that align incentives between building owners and their users.

Future developments include development of carbon sink materials to be used in construction and furnishing. Significant deployment of such technologies is however not expected in the next decade.

How can such massive acceleration in decarbonization be triggered?

Reducing emissions by 55% compared to 1990 level by 2030 requires a massive acceleration in decarbonization. Such massive acceleration cannot be achieved without public investments and policy adaptations.

The EU decarbonization roadmap targets a massive shift in the European economy. Such shift requires:

• massive investments in energy infrastructure, particularly networks,

• the creation of new ecosystems at scale

• enabling business models through: adequate pricing of externalities; regulatory adaptations to help mature green technologies achieve price parity with their brown competitors; unlocking banking sector participation to the green economy at scale, by rethinking banking sector regulations; and de-risking, through price or volume protection for example

• adapting the workforce to the needs of the green economy

Already, the European commission intends to adapt the carbon pricing scheme: Under the European Green Deal, the Commission intends to present an impact-assessed plan to increase the EU’s greenhouse gas emission reduction target in a responsible way, including for the EU ETS.

Government support schemes

Such mechanisms are also under assessment: auctions, feed-in premiums and contract for difference schemes are mechanisms that protect renewable energy investments from price risks.

Support schemes have been implemented in support of renewable electricity generation for decades. They were instrumental in the development of wind and solar technologies.

Today, the cost of support schemes to renewable electricity may have surpassed their benefits. At the same time, banks don’t shy away from financing merchant renewables anymore.

In France and in Germany, the cost of support to renewable electricity soared during confinement when electricity market prices were low, putting financing mechanisms and the electricity market under pressure. Buying renewable electricity at a higher price than the spot price has indeed exacerbated oversupply. A less distorting scheme could be to subsidize renewables with a lump sum, letting them exposed to electricity market price.

For the newer technologies, such support can be material in unlocking investments. Indeed, for these technologies, investors bear construction and technology risks. Price and off-take risks in yet to be developed markets may tip the scale in the wrong direction.

Funding the transformation

Funding required to achieve the targeted transformation in the next decade is massive. Public funds are needed to trigger private sector financing of the transformation. The green stimulus package goes towards achieving this goal.

Leveraging the carbon market to make the transformation happen is also on the books: the European Investment Bank, which is renamed the European Climate Bank, will be responsible for auctioning of allowances from the European Emissions Trading System. The proceeds will be used to support ten lower income EU member states in their transition by helping to modernize their energy systems and improve energy efficiency.

How can risks associated with such a shift be managed?

Some would argue that imposing decarbonization will reduce efficiency of the European economy.

According to Wood Mackenzie, the costs of decarbonisation of the sole US electric system is 35 k$ per household[3]. In one study, OECD estimates that reaching only 75% of renewables will double the cost of electricity. Decarbonizing other sectors (transport, industry, heating) will not be less expensive.

These ambitious targets can only be achieved through massive subsidies or other schemes that are economically equivalent : carbon emission trading, publicly funded infrastructures or regulated investments.

Much higher taxes or other compulsory levies will be needed. As a result, the additional deadweight loss of taxation [4] will slow down the European economy. Several policies need adjustment to ensure that the deadweight loss does not exceed the value of the positive externalities resulting from imposing decarbonization:

In the internal market

European tax policy needs a massive revamp. Instead of taxing transactions (VAT, income tax, corporate tax), member States might consider taxing natural resources (land value, minerals and fossil fuels). Transaction taxes slow down the economy[5] whereas natural resources taxes does not[6]. Shifting the tax base from transactions to natural resources might be the only way to fund decarbonization without sending the economy backward.

At European borders

A carbon border adjustment mechanism is expected to be announced in 2021. If designed right, it may compensate the higher cost of production of the European economy and trigger a global move towards decarbonization.

Indeed, according to the European parliament, Europe is the world’s largest exporter of manufactured goods and services, and is itself the biggest export market for around 80 countries. The EU’s trade in goods with the rest of the world was worth EUR 3 936 billion in 2018. This is roughly a quarter of world trade. The EU is also the world’s largest investor and a major recipient of others’ foreign direct investment (FDI).

A well-designed carbon border adjustment mechanism should offset the impact of the increased cost of carbon emissions on the European industries’ competitiveness, it should also generate demand in decarbonization technologies from main commercial partners of Europe. It needs to be well thought through in order not to impede economic growth.

With European People

Sustainability of the green economy requires also political acceptability, otherwise, the movement might be reversed in the next electoral cycle. Lessons must be learned from the Gilets Jaunes movement in France.

Those who stand to lose in this ambitious transformation process need to be accompanied, retrained or compensated.