The hydrogen backbone: Broken from the beginning?

A key objective of the draft Directive on common rules for the internal markets in renewable and natural gases and in hydrogen ("D-GD"), published in December 2021 as part of the European Commission's Hydrogen and decarbonised gas market package, is the regulation of hydrogen ("H2") as an independent energy carrier transported via dedicated H2 networks. The EC thereby follows a rather strict approach by establishing rules on network access, tariffs and unbundling ex ante. Some of these rules are even stricter than those for the electricity and natural gas markets. But will this approach promote the development of a cross-border H2 network, which is crucial for the decarbonisation of European gas markets? Apart from that, the D-GD appears to be in breach of EU law.

Non-discriminatory access to H2 networks

Access to H2 networks should follow a system of regulated third-party access ("TPA") based on published tariffs. Hence, access to H2 networks mirrors the system for natural gas, except that, until 2030, Member States may choose to implement a system of negotiated TPA, where the conditions for access are negotiated between parties. The necessity of establishing a strict TPA regime from the beginning can be debated, because currently there are almost no H2 networks and they do not form natural monopolies. There are neither obstacles to competition nor other market disturbances in the hydrogen sector and it is unclear whether and when H2 networks will develop into natural monopolies.

According to the EU principle of subsidiarity, the need to regulate networks generally exists only to the extent that the network infrastructure forms a natural monopoly and therefore cannot and should not be substituted or duplicated, while also being necessary for the provision of services in the markets. A natural monopoly is thus only subject to ex ante regulation if and to the extent that the monopolist is not exposed to effective competition. Notably, according to the EC's own studies and impact assessments, there is considerable uncertainty as to whether these requirements will be met in the future. Therefore, it is questionable if the proposed ex ante regulation is in line with the principle of subsidiarity.

Unbundling of H2 networks

As with transmission system operators ("TSOs") for natural gas, H2 network operators must unbundle from production and supply activities. Hence, Member States must implement ownership unbundling ("OU") and may implement the independent system operator ("ISO") and/or independent transmission operator ("ITO") if the H2 network belonged to a vertically integrated company at the entry into force of the D-GD. However, the ITO model is limited until 2030, meaning that from 2031 only OU and ISO will be available for H2 networks. Therefore, TSOs that are currently unbundled under the ITO regime (almost 50 % of all TSOs in Europe) will need to implement the OU or ISO model. Both options are linked to substantial corporate and contractual restructuring measures and massively interfere with fundamental rights of the TSOs (e.g. expropriation of network assets).

The vertical unbundling of H2 networks is intended to avoid conflicts of interest between generators, suppliers and network operators. The EC justifies this by arguing that vertical structures should be prevented from the beginning, in order to avoid the market failures of the historical energy markets. However, the experience from the electricity and gas markets cannot be readily transferred to the hydrogen sector. Uniform network regulation (i.e. prohibition of discrimination, network access and tariff rules) was insufficient for the electricity and gas markets because, despite these measures, discriminatory behaviour and market disruptions continued. European energy markets had been characterised by state monopolies for decades and, even after liberalisation and the introduction of European network regulation, the incumbents tried to defend their dominance. This was the sole reason why unbundling rules were introduced in the first place and were later further tightened.

Sectoral differences

The hydrogen sector is different, as there are no vertically integrated structures. Conflicts of interest are therefore ruled out. Even if vertical structures were to form in the future, or if the hydrogen market were to take over the existing natural gas monopolies, a potential conflict of interest cannot automatically be assumed. The hydrogen market is a completely new market which does not develop out of a monopolistic structure, but rather from the outset within the framework of a free market economy. Therefore, there will be competition, or at least the possibility of competition, at both the upstream and downstream market levels of hydrogen networks. As a result, the potential for conflicts of interest tends to be lower but is in any case not higher than in the historical energy markets.

In addition, the planned unbundling regime violates the EU principle of proportionality, which limits the action of the EU legislator to the least restrictive measure. A more lenient approach would be to allow the ITO model, which interferes with the existing legal positions of market participants considerably less than the OU and ISO model. The unbundling regime would also violate the fundamental rights of entrepreneurial freedom and property of TSO, because the infringement of these rights is not proportional.

The unbundling regime for H2 networks conflicts with the TEU and the EU Charter of Fundamental Rights. If it were to come into force, it would be open to legal challenge by Member States and network operators. This would be detrimental to the goal of establishing a hydrogen infrastructure as quickly as possible. At the same time, this foreseeable development could simply be avoided by adopting the generally proven unbundling models known from the gas market for the hydrogen sector.

authors: Bernd Rajal