How EU Contracts for Difference can support zero-emission fuels
The European Union (EU) is introducing new regulation to reduce GHG intensity and emissions from the shipping industry under the ‘Fit for 55’ package to achieve the decarbonization goals set out in the European Green Deal.
May 09 2022
A previous Insight Brief recommends that ‘Fit for 55’ should be designed and implemented with a target of having commercially viable zero-emission vessels operating along deep-sea trade routes by 2030, with at least five per cent scalable zero-emission fuels (SZEFs) in international shipping, in line with the messages of the Call to Action for Shipping Decarbonization launched in the lead up to COP26.
A key barrier to achieving these targets is the significant competitiveness gap that exists between fossil fuels and zero-emission fuels (shown in Figure 1 below). The inclusion of shipping in the EU Emissions Trading System (ETS) will result in a reduction to the cost gap between SZEFs and fossil fuels. However, the expected ETS prices will be insufficient to create price parity with traditional fuels, which means that a significant cost gap will remain due to SZEF production technologies still being in their emergence phase. SZEFs are currently produced at low volumes and high costs, whereas fossil fuels have well-established technologies, supply chains and economies of scale which allow for low-cost production at high volumes.
Source: Mærsk Mc-Kinney Møller Center for Zero Carbon Shipping, Industry Transition Strategy
Therefore, in addition to putting a price on emissions from fossil fuels, the EU ETS should be complemented by support mechanisms that will reinvest a portion of shipping related ETS revenues into incentives for the production and use of SZEFs. This will drive down the cost of SZEFs, in a similar way to programs that supported renewable electricity such as wind and solar as explained by University of Oxford researchers in a June 2021 report.
This Insight Brief outlines how the EU could use a portion of shipping related ETS revenues to fund a program of targeted Contracts for Difference (CfDs) to incentivize private investment into the production and use of SZEFs. A CfD program that supports at least five per cent SZEFs in EU shipping would cost an estimated 1.2 billion euro annually. This can comfortably be funded using shipping related ETS revenues which are estimated at 5 to 9 billion euro annually depending on the ETS price. This strategy of carbon pricing combined with the reinvestment of revenues through CfDs could also provide a useful template for other regions and for eventual global action through the International Maritime Organization (IMO).
A CfD program should target different SZEFs in separation from each other to account for the fact that different fuels are at different stages of their development cycles. For example, hydrogen derived fuels currently have a cost disadvantage but have long-term scale advantages which are likely to make them the cheapest in the long-term. Moreover, upscaling hydrogen infrastructure may have benefits outside of the shipping sector which could improve energy security and ensure diversity of supply. Higher availability and lower costs for green hydrogen can also accelerate the decarbonization of other harder-to-abate sectors such as steel and aviation.
Other CfD programs provide useful templates for overcoming the challenge of how to support technologies at different development stages. CfD programs often separate funding incentives into targeted groups of ‘established’ and ‘less-established’ technologies.
