Welcome back to Energy Source.
Fallout from the Silicon Valley Bank crisis continues to ricochet around global financial markets, and oil has been caught in the downdraft. Brent crude is down about 10 per cent since the start of this week and the US West Texas Intermediate benchmark has fallen below $70 a barrel for the first time since December 2021.
Oil markets are clearly spooked that the banking crisis could spread and trigger a broader economic slowdown, which would undermine energy demand.
But oil was also vulnerable to a souring macro environment. Weak demand over the mild winter has seen stocks swell in recent months. Analysts at Bernstein described a “staggering” rise in oil inventories in rich countries in January — a sign that “markets cannot ignore”.
Supply is expected to remain healthy. The International Energy Agency said yesterday that global crude output would “comfortably” outpace demand in the first half of the year. Soft fundamentals and a fear-driven macro environment are going to weigh on oil.
Looking at the immediate crisis, I have three big questions:
When will Opec intervene? If oil’s slide continues, the market will expect the Saudis to try to put some kind of floor under the market.
How does the banking crisis shape the Fed’s path on interest rates? If the Fed is forced to halt rate hikes, or even cut them as many now think, it could stoke inflation again, soften the dollar, and buoy energy prices.
Will the big comeback in Chinese crude demand materialise? Oil’s bull case for later this year has hinges on it.
I’m curious to hear what ES readers are seeing in the wake of the Silicon Valley Banking crisis and how you think it is going to play out across the energy landscape. Let me know at firstname.lastname@example.org.
On to today’s newsletter, where Amanda digs in to President Joe Biden’s big choice on hydrogen. How US tax authorities decide what counts as “green” hydrogen, and is thus eligible for the Inflation Reduction Act’s generous subsidies, could be make or break for the industry.
Thanks for reading — Justin
PS Join FT journalists, including Unhedged’s Rob Armstrong, and guests later today for a subscriber-only webinar on the collapse of Silicon Valley Bank and the fallout for the banking sector and tech innovation. Register here.
Biden’s billion-dollar question on hydrogen
A fight over how the US government should define green hydrogen is intensifying with billions of dollars at stake.
The Inflation Reduction Act provided historic subsidies for green hydrogen, including a production tax credit of up to $3/kg that would make the US among the most cost-competitive markets. Despite virtually no production of the fuel today, green hydrogen has been hailed as the “Swiss army knife” of the energy transition, with its promise to decarbonise hard-to-electrify sectors such as shipping and aviation.
But before companies can tap into the federal subsidies, Biden must make a tough choice over what counts as green.
More than 300 letters were submitted to the US Treasury during the tax credit’s comment period. At the centre of the debate is how to certify that green hydrogen, which is produced by splitting water via electrolysis, is being generated using renewable sources.
The US Treasury said it was engaging with a “wide range” of stakeholders and working to ensure the tax credit “advances the goal of increasing energy security and combatting climate change.”
It’s a trade-off between economics and decarbonisation. Here is a rundown of the main arguments.
Rigorous accounting is needed
Supporters of more stringent regulation argue that for green hydrogen to reduce emissions, its definition must rest on three pillars: “hourly matching”, “additionality” and “deliverability”.
All this jargon means that a project must ensure every hour of its production comes from a renewable energy source that is new (ie does not take away from existing supply) and connected to the local grid. Otherwise, projects would have to power down or invest in their own energy storage or off-grid renewable sources.
“Our business is based on the need to decarbonise,” said Raffi Garabedian, chief executive of Electric Hydrogen, an electrolyser manufacturer. “Taking advantage of the incentives that are provided without actually decarbonising . . . would be a travesty.”
The definition draws from a Princeton University study finding that without these rules, green hydrogen projects could sometimes draw from fossil fuel sources and be too dirty to qualify for the full production tax credit.
“Without any of those three [requirements], you end up in a situation where the emissions rate is guaranteed to be equivalent to just plugging directly into the grid using fossil power,” said Wilson Ricks, lead author of the study.
Looser accounting may still meet climate ambitions
Some producers, including NextEra, BP, and Invenergy, argue that these regulations would be too difficult and expensive to implement, and they risk stymying the industry’s growth before it can take off.
“If we’re hampered over too many regulations . . . it is just going to make it harder to develop projects,” said David Burns, vice-president of clean hydrogen at Linde, which sees a $30bn investment opportunity in the US from the IRA.
An analysis released this week by Wood Mackenzie found that loosening accounting measures for renewable electricity consumption from hourly to annually would make green hydrogen production more economically competitive and still reduce the carbon intensity of the grid.
“This annual match would be a way to encourage the project economics to develop, ensure at least a net zero form of hydrogen, and encourage some additional renewables into the grid,” said Kara McNutt, head of Wood Mackenzie’s Americas power and renewables team.
Ricks, however, argues that Wood Mackenzie’s analysis did not factor in clean electricity subsidies from the IRA for hourly accounting and that continuing to run on fossil fuels would impact long-run investment decisions on the electricity market.
Compromise is possible
A Rhodium Group report released today offers a middle ground.
The report draws from the EU’s approach, which includes a transition phase for meeting stricter renewable energy requirements. Producers, for example, will be allowed to account for their renewable sources monthly until 2030.
Rhodium Group found that annual matching in the short term for US green hydrogen would only increase emissions by 34-58mn tonnes in 2030, a 1 per cent increase in economy-wide emissions.
A framework like this appears the most practical. Like the EU, the US faces practical challenges for hourly accounting of renewable consumption — many markets don’t even offer it yet. And if the US wants to become an exporter to the EU, it would have to abide by the bloc’s standards anyway. Setting stricter targets would also keep emissions in check and guide industry while allowing it to grow in the early days.
“How we define [green hydrogen] directly relates to how much of it gets built,” said Ben King, one of the authors of the report. “If you want to give green hydrogen the opportunity to play a role in decarbonisation, you need to start building it.” (Amanda Chu)
After riding high for the past two years, energy investors are suddenly struggling. The S&P 500 Energy index is among the worst-performing sectors this year after trouncing the market for the past two years.
Oil and gas producers (which make up the bulk of the S&P 500 Energy index) are still set up for healthy profits this year. But headwinds for the sector are mounting, with oil and natural gas prices expected to remain under pressure until at least the second half of the year.
A recent Rystad Energy analysis, for instance, found that if US gas prices stay at current levels at about $2.50 per million British thermal units, it could wipe out shale gas producers’ free cash flow for the year. At the same time, companies are still facing rising costs for workers and rigs, undermining profitability. Are the struggles a blip in a larger bull run or is the best behind the sector for now?
Energy Source is written and edited by Derek Brower, Myles McCormick, Justin Jacobs, Amanda Chu and Emily Goldberg. Reach us at email@example.com and follow us on Twitter at @FTEnergy. Catch up on past editions of the newsletter here.