1. Rise of the RFNBOs

Direct use of electricity from renewable or other zero carbon sources may be the ideal way to decarbonise, but if you turn zero-carbon electricity into a liquid or gaseous energy source, you can decarbonise some hard-to-abate applications faster, particularly in the transport and heavy industry sectors. This is one of the attractions of making hydrogen with renewable electricity, and the key selling point of electrofuels or “e-fuels” that combine low carbon hydrogen (or its derivates, such as ammonia) with recycled or sustainably produced carbon molecules to provide “drop-in” replacements for conventional petroleum-derived fuels.

The significance of e-fuels in the energy transition has been underpinned by the carbon reduction regulatory regime that has emerged from the EU. In particular:

a) the Renewable Energy Directive1 (RED) set targets for the use of renewable energy in each member state (each a National Target) and mandated that 20% of the EU’s collective gross final energy consumption should come from renewable sources (EU Target) by 2020. More than one member state has been helped to meet its National Target by requiring the blending of a certain proportion of bioethanol, for example, into transport fuels;

b) the Revised Renewable Energy Directive (RED II)2 raised the EU Target to 32% to be achieved by 2030 and refined the framework for each member state to develop support schemes to encourage the development of renewable energy sources. RED II specifies that renewable liquid and gaseous transport fuels of non-biological origin (RTFNBOs) would be “important to increase the share of renewable energy in sectors that are expected to rely on liquid fuels in the long term”;3 and

c) Fit for 55 (a 2021 package of proposals to reduce EU greenhouse gas emissions by 55% by 2030) includes amendments to RED II, aiming, amongst other things, at stronger promotion of renewable fuels of RFNBOs, in particular hydrogen, through new targets and other measures. It is proposed that RTFNBOs would no longer be thought of as limited to the transport sector (therefore becoming RFNBOs), recognising their wider relevance to achieving decarbonisation targets. It would increase the EU 2030 renewables target from 32% to 40% and targets for the proportion of RFNBOs to be used in the transport sector and as hydrogen in industry. Other elements of the package create further demand for RFNBOs by setting targets to reduce the carbon intensity of the maritime sector and requiring fuel suppliers to distribute sustainable aviation fuels to decarbonise the aviation industry.4

In light of the above, much focus has been placed on understanding what is required for an e-fuel to qualify as an RFNBO in order to be sold as such in the EU and count towards achieving the carbon reduction targets.

Within the wider EU regulatory framework, there are a number of pieces or groups of legislation that those developing renewable hydrogen or e-fuel projects will want to bear in mind:

(i) RED II and the RFNBO-specific regulations made under it (see further below);

(ii) the proposed hydrogen and decarbonised gas market package – covering the integration of renewable and low-carbon gases into the existing gas network;

(iii) the EU Taxonomy – defining environmentally sustainable activities for the purpose of sustainable investments;5 and

(iv) the EU Carbon Border Adjustment Mechanism, which extends carbon pricing based on what EU-based producers of some potentially emissions-intensive products (such as steel, hydrogen and ammonia) pay under the EU Emissions Trading System to importers into the EU of the same products manufactured elsewhere.6

To date, the primary focus of RFNBO producers and buyers seeking to sell into Europe has been satisfying the criteria under RED II, given (i) the mandatory National Targets set down by RED II and (ii) that fuels qualifying as “renewable” under RED II will benefit from the various types of public support at both EU and national levels, such as the European Hydrogen Bank, with a pot of €800 million to provide production subsidies of up to €4.5/kg from the ETS Innovation Fund.

Under RED II, RFNBO is defined as “liquid or gaseous fuels which are used in the transport sector other than biofuels or biogas, the energy content of which is derived from renewable sources other than biomass”. In addition, “the greenhouse gas emissions savings from the use of [RFNBOs] shall be at least 70%”.7

RED II delegated the establishment of the detail as to how the above-mentioned criteria could be achieved and such detail has now been published and adopted by the European Commission in the following RED II “Delegated Acts”:

a) the First Delegated Act8 which sets out the requirements for the electricity used in water-to-hydrogen electrolysis and other processes involved in RFNBO production to be considered fully renewable; and

b) the Second Delegated Act9 which provides a detailed methodology for RFNBO producers to calculate the greenhouse gas (GHG) emissions used in the entire production process and sets requirements for the overall GHG emissions savings to be achieved by an RFNBO.

2. Key requirements under the First Delegated Act

The terms of the First Delegated Act were subject to considerable back and forth between the various organs of the EU. Ultimately, a balance needed to be struck between the interests of industry, to broaden the scope of electricity considered renewable (and lower the production cost), and environmental considerations, seeking to ensure there is enough renewable energy for RFNBO production without cannibalising the renewable energy required to decarbonise the grid.

This First Delegated Act recognises three “production pathways” through which electricity used in RFNBO production can be considered fully renewable electricity (RE):

a) direct connection between RE generation source and the RFNBO production (an islanded, off-grid solution);

b) electricity from grid (using the average renewable electricity share methodology); or

c) electricity from grid sold under a PPA.

(i) Direct connection

RFNBOs made using RE transmitted directly from the source of generation to the electrolyser will be considered fully renewable provided that:

• the RE generator is not connected to the grid, or is connected to the grid but a smart metering system that measures all electricity flows from the grid shows that no electricity has been taken from the grid to produce RFNBO; and

• the RE generation plant (e.g., the wind farm or solar PV plant) came into operation10 no earlier than 36 months prior to the RFNBO production plant (i.e. the electrolyser).

However, for electrolysers that come into operation before 1 January 2028, the 36-month time requirement will not apply until 1 January 2038. For some projects, for instance those with access to renewable electricity generated by existing plants whose original RE subsidy has expired, and a strong route to market in the short term, this is a potentially significant grace period.11

(ii) Electricity from the grid

RFNBO producers using electricity from the grid shall be deemed to satisfy the use of renewable energy requirement if:

• the RFNBO producer is in a “bidding zone”12 where the average share of renewable electricity in the grid in the previous calendar year exceeds 90%; or

• if electricity is taken from the grid during a period where electricity generation was curtailed (re-dispatched) and production of the RFNBO reduced the need for curtailment.

The only European grids that currently have a sufficiently high penetration of low carbon energy in their electricity mix are in Sweden13 and France.14

(iii) Electricity from the grid (with PPA)

Where the grid does not satisfy the conditions above, power taken from the grid can nevertheless be considered renewable provided that certain conditions are met demonstrating the linkage between the RE generated and RFNBO produced.

In the first instance, the RFNBO producer must enter a power purchase agreement (PPA) with an RE generator (such as a wind farm),15 both of them being connected to the grid, but with no direct connection between them. The following additional criteria are required to be satisfied to correlate the RE with the RFNBO:

a) Additionality:

• As per the direct connection production pathway above, the RE source must not come into operation any earlier than 36 months prior to the electrolyser; and

• the RE generation source must not have received any state aid or investment aid (e.g., through feed-in tariffs). Note this does not apply to state aid provided to the RFNBO production plant (i.e. electrolyser).

b) Temporal correlation:

• Until 2030, the RFNBO must be produced within the same calendar month as the renewable electricity was generated (monthly matching).16

• From 1 January 2030, the temporal matching requirement will be tightened to require the power generated and RFNBO to be matched on an hourly basis.

• An RFNBO will always be counted as temporally correlated if produced during a one-hour period where the clearing price of electricity in the day-ahead market is lower or equal to €20 per MWh or lower than 0.36 times the price of an allowance to emit one tonne of carbon dioxide equivalent during the relevant period.

The run-up period to an hourly based temporal matching is key to help flatten the intermittency curve pending further advancements in battery technology, and reductions in production costs.

c) Geographic correlation:

• The RFNBO plant must be located within the same “bidding zone” as the RE source; or

• the RFNBO plant must be located within an interconnected bidding zone (including if that is in another EU member state), and the day-ahead market price in this zone must be equal or higher than where the RFNBO is produced.

(iv) Certification

As is common in EU single market legislation, after setting out all the detailed requirements from scratch, the First Delegated Act offers producers a short cut: find a body that has established a standard that the Commission recognises as incorporating all the criteria set out in the legislation, follow its rules, and get them to certify your output as compliant. There may be no substantive difference in the ultimate requirements, but this route can have practical and procedural advantages and will be explored further in our next post on this subject.

3. Key Requirements under the Second Delegated Act

a) GHG savings

The Second Delegated Act defines the thresholds for GHG emissions savings that must be made for the relevant e-fuel to qualify as an RFNBO. Although some aspects of its provisions are more obviously relevant to the carbon components of e-fuels (just as it is easy to focus on hydrogen electrolysis when considering the First Delegated Act), both delegated acts need to be taken into account in considering the hydrogen and carbon elements of an e-fuel production chain.

In short, the following need to be satisfied:

• the GHG savings from the use of RFNBOs must be at least 70% when compared to the fossil fuels which are being displaced; and

• the overall GHG emissions intensity of the RFNBO must be no greater than 3.4kg of CO2e per kg of H2 (in volumetric terms) or 28.2g CO2e per MJ (in energy terms).

In calculating the GHG emission savings, the Second Delegated Act provides guidance, which considers the full life cycle of the production process from the upstream feedstock supply (electricity and water), through to energy used in the production process and the downstream transportation to the end customer including the end customer’s use of the fuel (including combustion). This lifecycle scope is referred to as a “well-to-wheel” analysis, which should be calculated on at least a monthly basis. It is likely that there will be some ambiguities in how the guidance should be applied to the full lifecycle of a production process, for example how data collected over different time periods should be reconciled.

Any RE used in the process which satisfies the First Delegated Act will be attributed zero GHG emissions under the Second Delegated Act.

b) Carbon sources and carbon capture

The Second Delegated Act also examines the permitted sources of carbon for production of RFNBOs and recycled carbon fuels as well as the usage of carbon capture as a means of reducing the overall emissions intensity of the fuel. A Recital notes that capturing CO2 from emissions of non-sustainable fuel sources for the production of electricity is considered “avoided” until 2035, whilst captured emissions from uses of other non-sustainable fuels is considered “avoided” until 2040, at least for the moment.17

The long-term goal here is to prevent RFNBOs from dependence on carbon generated from non-sustainable feedstock and therefore reduce the combustion of non-sustainable fuels and any associated carbon capture.

c) Mixing

The Second Delegated Act recognises that RFNBOs can be produced using electricity, and through processes which use a mixture of fuels. Where this is the case, the above-mentioned rules will still apply i.e., if an electrolyser is fed with 50% electricity that counts as fully renewable and 50% electricity that is only 40% renewable, 70% of the total hydrogen produced will be renewable.

4. Conclusion: Key takeaways

Given the strict decarbonisation targets that apply to the EU member states, such countries are forecast to be significant developers and importers of e-fuels, in particular, hydrogen, and this creates significant opportunity for e-fuel producers around the world. The Delegated Acts discussed in this article therefore provide much needed and awaited clarity on what constitutes “renewable” or “green” fuel in the EU, a key target market for many of the first mover projects.

However, these fuels face a significant competitive disadvantage in displacing fossil-fuels from the energy mix as they are currently significantly more expensive, dissuading industries which are already operating on thin margins to “fuel-switch” to a cleaner alternative. On the other hand, compliance with the rules set out here is likely to be a pre-requisite for eligibility to receive any of the forms of financial assistance that are emerging for renewable hydrogen and e-fuels, whether made available by the EU or individual member states.

Meanwhile, the fact that the additionality requirements under the RFNBO Delegated Act specify that, where there is no “direct connection”, the RE generation source must not have benefited from state or investment aid, could preclude, for example, hydrogen produced in the United States which has used, in its production, electricity from an asset that benefited from tax credits under the recent Inflation Reduction Act, from qualifying as an RFNBO for sale into the EU.

Such nuances of the European regulatory regime may ultimately make the European market too difficult and too expensive to sell into and producers, perhaps particularly those with an eye to international markets and looking to reach them by ship rather than by pipeline, may simply look to sell into other markets instead. This could leave the EU: (a) more dependent on those producers who have a direct connection between the RE source and the electrolyser; which requires vast amounts of land and funds; and (b) struggling to meet its decarbonisation targets as a result. It remains to be seen whether the European e-fuel/hydrogen market will sink or swim.

Footnotes:

  1. Directive 2009/28/EC. ↩︎
  2. Directive 2018/2001/EU. ↩︎
  3. See Recital 90 to RED II, which effectively provides an outline of the policy for what would become the First Delegated Act (see below). ↩︎
  4. This is not an exhaustive list of the policy proposals in the Fit for 55 package. ↩︎
  5. The EU Taxonomy is about designating what are sustainable businesses to finance. Investors will be looking for investments in green fuels that are aligned with the EU Taxonomy. The main Taxonomy Regulation (2020/852) sits at the head of a growing family of delegated acts including Regulation 2021/2139, which imposes Annex II, section 3.10, a broader range of production requirements than is set out in RED II or its delegated acts for the production of hydrogen to be considered sustainable (for example, as regards the use of water). ↩︎
  6. Regulation 2023/956: see further here. ↩︎
  7. Directive 2018/2001, Article 25(2). ↩︎
  8. Commission Delegated Regulation (EU) 2023/1184 of 10 February 2023 Supplementing Directive (EU) 2018/2001 of the European Parliament and of the Council by establishing a Union methodology setting out detailed rules for the production of renewable liquid and gaseous transport fuels of non-biological origin. ↩︎
  9. Commission Delegated Regulation (EU) 2023/1185 of 10 February 2023 Supplementing Directive (EU) 2018/2001 of the European Parliament and of the Council by establishing a minimum threshold for greenhouse gas emissions savings of recycled carbon fuels and by specifying a methodology for assessing greenhouse gas emissions savings from renewable liquid and gaseous transport fuels of non-biological origin and from recycled carbon fuels. ↩︎
  10. Coming into operation, for both the RE producer and the RFNBO producer, is interpreted as coming into commercial production for the first time (i.e. excluding production during testing or commissioning unless used for commercial purposes). ↩︎
  11. The Commission here acknowledges “the time needed for the planning and construction of installations generating renewable electricity and the lack of new installations generating renewable electricity that do not receive support” (Recital 17). ↩︎
  12. s defined in the Electricity Internal Market Regulation 2019/943 “or an equivalent concept for third countries”. A bidding zone is an area where a single wholesale market price applies. Currently, most bidding zones in the EEA are co-extensive with national boundaries (exceptions include Italy, Norway and Sweden, which have multiple bidding zones). ↩︎
  13. Sweden generates approximately 68% of its energy from renewable sources (predominantly hydropower) and approximately 30% from nuclear. ↩︎
  14. Nuclear energy is not considered a renewable fuel under RED II for the purpose of RFNBO classification. However, a concession was granted to France to allow hydrogen to be produced using nuclear energy. ↩︎
  15. The PPA must be entered with the plant producing the RE and not an intermediary/supplier which has procured the Guarantees of Origin. ↩︎
  16. EU member states will still have discretion to introduce stricter requirements for temporal correlation from 1 July 2027. ↩︎
  17. See Annex, paragraph A.10 and Recital 5: these dates may change depending on EU ETS evolution and other developments. ↩︎