EU Policy and Market Updates on RED III and CBAM: What are the Impacts on Hydrogen?

I. Renewable Energy Directive (RED) III

RED III was formally adopted on October 9, 2023 [see EUR-Lex – 32023L2413 – EN – EUR-Lex (europa.eu)]. It was published in the Official Journal of the European Union on October 31, and will enter into force 20 days after that date. Some key aspects of RED III are:

Member States will have 18 months after the directive’s entry into force to transpose it into national legislation.
RED III raises the share of renewable energy in the European Union’s overall energy consumption to 42.5% by 2030, with an additional 2.5% indicative top-up to allow the target of 45% to be achieved.
RED III establishes ambitious sector-specific targets in transport, industry, buildings, and district heating and cooling, some of which will positively impact the hydrogen industry.

A. Context

- The Renewable Energy Directive (RED) is the legal framework for the development of clean energy across all sectors of the EU economy.
- RED was adopted in 2009 to deliver a minimum 20% share of renewable energy sources (RES) in EU final energy consumption by 2020.
- RED was revised (recast) in 2018 to deliver the EU objective of a minimum 32% share of RES in final energy consumption by 2030 (RED II) and became legally binding in June 2021.
- On July 14, 2021, the EU Commission presented the “Fit for 55” package, to align the European Union’s climate and energy legislative framework with its 2050 climate neutrality objective and with its objective of reducing net greenhouse gas emissions at least 55% by 2030, compared to 1990. This package included a significant revision to RED II.
- On May 18, 2022, the European Union launched REPowerEU in response to the hardships and global energy market disruption caused by Russia's invasion of Ukraine.
  - The main goals of REPowerEU are energy savings, diversification of energy supplies, and an accelerated roll-out of renewable energy to replace fossil fuels in homes, industry, and power generation.
- Discussions for the RED II revision were made by the Commission, the European Parliament, and the Council of the European Union; a provisional agreement to reinforce RED was reached between the Parliament and Council on March 30, 2023.
- On October 9, 2023, the Council adopted a new Renewables Energy Directive (RED III).

B. Policy and market implications for hydrogen projects

- RED III will boost the development of hydrogen projects by establishing policies for Member States to reach certain targets regarding renewable energy in different economic sectors:
  - For the transport sector, Member States will have the option between:

1) a binding target of a 14.5% reduction in greenhouse gas intensity in transport from the
use of renewables by 2030; or

2) a binding share of at least 29% of renewables within the final consumption of energy in
the sector by 2030.

For industry, Member States will need to increase the use of renewable energy by 1.6% annually.

These sectors will have increased demand for advanced biofuels and renewable fuels of non-biological origin (RFNBOs), including hydrogen and hydrogen-based synthetic fuels, which will positively impact hydrogen projects and market players in the field:
- For transport, the directive establishes a combined sub-target of 5.5% for advanced fuels and RFNBOs in the share of renewable energies supplied to the transport sector.
- Within this target, there is a minimum requirement of 1% of RFNBOs in the share of renewable energies supplied to the transport sector in 2030.
- For industry, Member States agreed that 42% of the hydrogen used in industry should come from RFNBOs by 2030 and 60% by 2035.
- Member States will be able to discount the contribution of RFNBOs in industry use by 20% under two conditions:

1) if the Member States’ national contribution to the binding overall EU target meets their
expected contribution; and

2) the share of hydrogen from fossil fuels consumed in the Member State is not more 23%
in 2030, and 20% in 2035.

- Regulatory changes will expedite the permitting procedure for renewable projects, which may reduce regulatory burden on certain renewable hydrogen projects in the European Union:
  - Member States will design renewables acceleration areas where renewable energy projects will undergo simplified and faster permit-granting processes.
  - Renewable energy deployment will also be presumed to be of “overriding public interest,” to limit the grounds of legal objections to new installations.

II. Carbon Border Adjustment Mechanism (CBAM)

On May, 16, 2023, the CBAM regulation was published in the EU’s Official Journal [see EUR-Lex – L:2023:130:TOC – EN – EUR-Lex (europa.eu)]. On August 17, 2023, its implementing regulation for the transitional phase—and accompanying guidance—were published in the Official Journal of the European Union.

The CBAM’s transitional phase began on October 1, 2023, with the permanent system entering into force on January 1, 2026. The CBAM aims to:

1) fix a fair price¹ on the carbon emitted during the production of carbon intensive goods entering
the European Union, and

2) incentivize cleaner industrial production in non-EU countries to support the decarbonization of
industry in the European Union.

The CBAM objective is to make the carbon price of imports to the European Union equivalent to the carbon price paid by EU domestic producers under the European Emission Trading System (ETS), to avoid the undermining of the European Union’s climate objectives. CBAM will have a direct impact on importers of goods that participate in the EU market.

A. Context

- Given that less stringent climate policies prevail in many non-EU countries, there is a risk of ‘carbon leakage’. Carbon leakage occurs when companies based in the European Union move carbon-intensive production abroad to countries with less stringent climate policies, or when EU products get replaced by more carbon-intensive imports.
- The CBAM transitional phase, from Oct 1, 2023 to December 31, 2025, provides a pilot and learning period for all stakeholders (importers, non-EU producers and authorities), with a predictable and proportionate transition period regarding CBAM for both EU and non-EU businesses and public authorities.
- During the transitional phase, importers of goods will only have to report direct and indirect GHG embedded in their imports, without making any financial payments or adjustments.
- The importers covered by the CBAM will need to register with national authorities of the Member State in which it is established to obtain a status as an authorized CBAM declarant. Registration will begin on December 31, 2024.
- From January 1, 2026 onwards, the importer will have to declare the emissions embedded in its imports and deliver a number of CBAM certificates each year.
- Also from January 1, 2026 onwards, an importer registered as an authorized CBAM declarant will have to purchase CBAM certificates through a common central platform managed by the Member State where it is established.
- If the importer can prove that it already paid its carbon price during the production of the imported goods, the paid amount may be deducted from the total number of CBAM certificates required for the imported goods.
- Throughout 2024, importers will have several methods of reporting, including default reference values (only until July 2024); starting in 2025, all importers must report their compliance with the methodology established by the European Union.

B. Policy and market implications for hydrogen projects

- Hydrogen is classified under the CBAM as a simple good, as the raw materials and fuels used in its manufacture are considered to have zero embedded emissions. As such, there are no relevant precursors to report for hydrogen.
- During the provisional period (until December 31, 2025) importers will have to report both direct and indirect emissions embedded in imported hydrogen.
- Importers will be asked to collect data as of October 1, 2023. Each quarterly report must contain data on total quantity of CBAM goods imposed during the preceding quarter, total embedded direct and indirect emissions, the carbon price due in the country of origin for the embedded emissions.
- Importers must submit their first report by the end of January 2024.
- Modification and correction of CBAM quarterly reports can be made within two months of the relevant reporting quarter, with a special derogation for the first two CBAM reports which may be modified until July 31, 2024.
- As of December 1, 2026, CBAM declarants will only have to account for—and cover by CBAM certificates—direct emissions embedded in imported hydrogen. This may change during the review of the CBAM Regulation to include indirect emissions, as well.
- Once the permanent system enters into force, importers must make annual declarations of the quantity of goods imported into the European Union during the preceding year along with the associated embedded GHG, and then surrender the appropriate number of CBAM certificates.
- The hydrogen market will be impacted by CBAM:
  - The transitional phase of CBAM will have a policy impact on hydrogen projects outside the European Union if the hydrogen is targeted for import into the European Union.
  - Hydrogen importers will be incentivized to develop cleaner hydrogen projects to be more competitive in the EU market starting from January 1, 2026 onwards.