Economist: Carbon trading is ‘a right first step’ to decarbonise buildings

Optimal solutions to decarbonise heating "very much depends on the individual circumstances – what type of building is considered, which geography, how is the relevant energy system designed, what are the relevant social aspects and people’s preferences," says David Bothe from Frontier Economics. [Zvone / Shutterstock]

This article is part of our special report Building decarbonisation.

Moving parts of the building sector under a separate carbon trading scheme, like the European Commission has proposed, “is a right first step” to address the complexity of the heating sector, which is spread across millions of buildings, diverging climates and local circumstances, David Bothe told EURACTIV.

However, any such move needs to be balanced by social considerations, warned Bothe, who cautions against making housing “a luxury good” as a result of decarbonisation efforts.

David Bothe is the director in Cologne for Frontier Economics, a microeconomic consultancy firm. He spoke to EURACTIV’s Frédéric Simon.

Disclaimer: Frontier Economics have worked for Viessmann in the past but the views expressed in this interview are Frontier’s independent perspective.


INTERVIEW HIGHLIGHTS:

  • The heterogeneity of the heating sector rules out ‘silver bullet’ solutions like electrification. Rather, a wide mix of technologies will be needed depending on the local circumstances.
  • A unique feature of the heating system is that it is temperature-driven, which requires scaling infrastructure to meet peak demand during exceptional cold periods that may occur once every 20 years.
  • In countries like Germany, the electric system hasn’t been built to supply heating applications in households. Moving to a higher share of electrification in heating therefore often requires costly extensions to the power system.
  • Electricity provided for heating currently falls under the EU ETS, while natural gas used in heating is not. Bringing both under a single umbrella would ensure a level playing field and allow more decentralised decision-making based on the merits of each solution at a local level.
  • One reason why heating is so difficult to de-fossilise is because it has a huge social component: access to housing is a basic human right and cannot become a luxury good.
  • Analysis by Frontier Economics shows that heating applications can form a valuable part of the future hydrogen demand and that electric heat pumps are not always the most optimal solution for every household.

Heating and cooling in the building sector represents 40% of carbon emissions in Europe and needs to be brought down to net-zero by 2050, under the EU’s climate law. According to your analysis, what are the different pathways to reach climate neutrality in that sector? And what must be done this decade in order to stay on the path to net zero?

Restructuring the heating sector certainly poses one of the biggest challenges in the energy transition, mainly for two reasons.

First of all, there is heterogeneity, even on a national level. Take a country like Germany, where you have a very diverse housing stock with very different energy efficiency standards and infrastructure connections of the premises. At the European level, the differences get even bigger because you have different climates and different energy systems.

So the heterogeneity certainly rules out aiming for a single ‘silver bullet’ technology – we will instead have to accept a wide mix of technologies, which has to be adapted to the individual, national, regional and even local circumstances.

A second specific challenge of the heating sector is more technical: it’s capacity requirements. Because heat demand is largely temperature-driven, we’re dealing with strongly correlated peak demands, during short or exceptional periods. For example, when we have a very cold winter, e.g. once in any 20 years, the system still has to be able to meet the capacity demand from all users simultaneously.

And this is unique to the heating sector compared to other sectors like mobility where you get stronger portfolio effects across larger groups, which smoothens demand.

So that is typically related to peak winter demand, right?

Yes. And not only regular winter demand, but also extreme scenario, like those 1 in 20 year occurrences. And providing capacities just for very seldom situations is from a commercial point of view often challenging.

That’s why we have capacity mechanisms in Europe – backup power plants, usually gas or coal-fired, are being remunerated for keeping on standby, just in case of a demand peak…

In a way. We could try and ration peak use via prices, but that might be politically unacceptable and therefore not credible in some countries. We also still lack the technology to manage peak demand most efficiently. And this applies to any part of the energy system, not only for energy generation but also for network capacities or for storage.

In terms of decarbonisation pathways then, what are the consequences of this? Does it mean a regional approach to heating decarbonisation is the optimal way forward?

Any pathway will have to include various components, a bit like building blocks.

One component, certainly, will be energy efficiency – that is, reducing the overall heat demand. But you have to be aware that efficiency always comes as a cost as well – it requires investments, not only monetarily, but also in terms of embedded carbon emissions for the implementation of efficiency measures such as improved insulation.

Therefore more efficiency is not always better, but rather there is an optimal level for these efficiency measures, which generates the highest return on investment.

Another main component will be the de-fossilisation of the energy pathways which supply the heating applications. For gas applications, you could think about moving towards low carbon molecules like hydrogen, synthetic methane or biogas.

Similarly on the electricity side, we will have to move towards a system increasingly based on renewable electricity, including solutions to cover peak demand, because in the long term we can’t rely on fossil backup generation there.

So it will be a combination of efficiency measures and de-fossilisation of the energy sources. Where the balance lies very much depends on the individual circumstances – what type of building is considered, which geography, how is the relevant energy system designed, what are the relevant social aspects and people’s preferences.

As a consequence, we should keep as many technology options available as possible. The challenges in the heating sector are so huge, and we have to de-fossilise the sector so fast, that we cannot afford to have long debates on whether to rule out one or the other technology at the EU level.

We rather need to leave member states and ultimately consumers with all the options so they can work out what the best options are based on national and local circumstances, weighing up the different trade-offs.

Countries have different heating and cooling infrastructures in place: district heating systems are quite common in former communist countries, Northern European countries like Belgium and the Netherlands have gas, while others like France are more electrified. How can regulators at EU level approach such diversity – are there common features or standards that can apply to all?

In an ideal world, indeed, a single incentivisation mechanism across all these technologies could be established, which would allow for a fair technology competition.

Moving parts of the building sector under a second emissions trading scheme (ETS2), like the European Commission has proposed, is a right first step. Currently, we have a distorted playing field, for example because electricity provided for heating falls under the EU emission trading scheme, while natural gas used in heating is not part of a similar system but rather subject to the various national regimes. So unifying the various energy carriers in heating under one single ETS would be an important step forward.

That is the main argument in favour of the second ETS, I suppose – it would allow us to manage the diversity and the complexity of the heating system, which is distributed across millions of homes…

Yes, exactly. Because the heating sector is so diverse and complex, we can’t rely on central EU decision-making on a technology level – efficient technology choices will likely have to be a balance between individual and local or national considerations.

No central agency will have all the required information about the particular situation in a specific building, its connections to the energy grid, preferences of the occupants, etc. So we have to create a mechanism to coordinate all these decentralised decisions towards a common aim, which is de-fossilisation. And economic incentive structures, like the current ETS, have proven that they can ensure such coordination of complex heterogeneous systems across sectors.

There are a lot of potential pitfalls with regard to the practicalities and we don’t yet know the details how the ETS2 is going to be designed and implemented, but the general idea to incentivise decentralised decision-making, based on an overarching pricing system, is a step in the right direction.

The downside, of course, is the social aspect: a second ETS for buildings will automatically push up the cost of fossil-based heating fuels for those who can’t afford to switch to a clean heating system.

Indeed, one reason why heating is so important and so difficult to de-fossilise is that it has a huge social component. Access to housing is a basic human right and so we have to be very careful not to let it become a luxury good.

De-fossilisation essentially means switching from quite cheap and at least for the time being abundant fossil fuels to an energy system based on renewable fuels, which will imply additional costs. So everything else equal will make the de-fossilisation of heating more expensive.

Therefore, we have to find ways of mitigating the impact, for instance by applying redistribution mechanisms. I gather this is the intended role of the Commission’s proposed Social Climate Fund. Otherwise, we risk to lose the social acceptance of these measures and potentially the social support for the whole climate protection objectives.

In the European Union, there is an intense debate going on at the moment about the role of gas versus electric solutions like heat pumps in the transition to carbon neutral heating. What is your perspective on this as an economist?

From an economics perspective, it is important to always consider the whole system when comparing technologies. Energy supply is based on a complex system, which includes energy generation, transport, storage, distribution, and end applications like heating appliances.

Often in discussions, technologies are compared based on single parameters at a certain level in the value chain such as conversion losses, efficiency, energy costs, and so on. And even though all of these parameters are important, they must always be seen in the context of the wider energy system.

For example, electric heat pumps on average have a very high energy efficiency, which can potentially massively contribute to the decarbonisation of the heating sector. But then we do not all live in average houses. More recent buildings are better suited for heat pumps than older less insulated buildings.

Moreover, in many countries like Germany, the electric system hasn’t been built to supply heating applications in households. Moving to a higher share of electrification in heating therefore often requires extensions to the power system – we need to build additional network infrastructure, additional storage facilities as well as additional energy generation capacity. And all of these components come at a cost, monetarily but also with regard to the carbon impact of building these new infrastructures.

So in order to make a fair comparison of various technologies, we also have to take into account where we can rely on existing infrastructure and where new infrastructure would be required. Such a system-wide analysis can lead to results whereby technologies that are physically less efficient because of higher conversion losses might still be more economically beneficial from a system perspective because they can rely on existing infrastructure.

In addition, we have to also consider the time dimension – we have less than three decades to de-fossilise heating entirely in order to meet our climate goals. We simply don’t have the time and resources to build an entirely new infrastructure and should focus on re-using what’s already there as much as possible. Otherwise, there is a significant risk that we will simply run out of time and be too late.

What are the implications of this in terms of peak demand management? Does that mean relying on gas for peak demand, and electricity for baseload?

That’s exactly one of these economic questions, which would need to be answered from a system perspective.

One could for instance envisage a dual fuel or hybrid heating system based on both, electric and gas supply. As an advantage, such hybrid applications might in average circumstances make use of the high efficiency of electric heat pumps, while in peak situations switch to gas and avoid expensive peak electricity demand.

The costs would nevertheless be also higher, not only because of higher investments in the end application itself but also because of the requirements to maintain two different networks connected to the premise. So while there might be situations where this is an optimal solution, the evaluation has to be done on a case by case basis and always taking into account the system-wide effects and costs.

Let me give another example: In Germany, the future power generation will more or less exclusively come from wind and solar, which means you have to implement a backup technology for dark winter periods. One option will be converting excess renewable electricity into hydrogen, storing it, and reconverting it to power when needed – that is Power-to-Gas and Gas-to-Power as an energy storage solution.

But from a system perspective you can ask: if we have this Power-to-Gas element in the system anyway, wouldn’t there be cases where some of this gas could then directly be shipped to the end application and used there and avoid the need to re-convert it to electricity? Our analysis in recent studies showed that such a mixed system, where some of the gas is directly used is more cost-efficient than a system with is based on 100% electrification.

Where the optimum is, that’s certainly an economic question that depends on what the costs are, what infrastructure is available and which technology options will be developed in the future.

So right now I doubt that we can make decisions, what the optimal solution will be in 10-20 years.

So you think there will be a case in some places for hydrogen-fuelled boilers?

I think that is certainly one of the options we should offer subject to a fair technology competition. We will then see how large the share of this technology will be in the end.

There are discussions going on at the EU level about mandating new gas boilers to accept a 20% blend of hydrogen and some even argue for boilers to be 100% hydrogen-ready. Would that make sense in your view? I mean, some people compare green hydrogen to champagne because it is so scarce and expensive. So would that make sense economically?

The champagne discussion – is hydrogen a premium fuel that should only be used in premium energy applications – is at the end of the day only a question of supply and demand.

I honestly find this debate quite strange – I think it’s the first time in history that we try to develop a new technology by particularly debating about where it should not go.

The hydrogen economy is at an infancy stage. It would be a shame to start this sector based on the assumption from the outset that it’s going to be a luxury product in the long run. Ideally, we will be able to make hydrogen ubiquitous and more like table water to everybody.

If it turns out to be scarce and more like champagne, then certainly it wouldn’t go to low-value applications, and some heating applications might be among them – but we should let markets decide this taking into account all system-wide effects.

If we really want to push the development of a hydrogen economy, additional demand seems to be helpful to incentivise investments in production and infrastructure from which ultimately the whole energy sector will benefit.

Our analysis shows that heating applications can form a valuable part of the future hydrogen demand and thereby might help to accelerate the build-up of this new sector.

Do you believe a ban on fossil gas boilers would make sense?

First of all, these bans on technologies like boilers, or combustion engines, always puzzle me. Because ultimately it’s not the end application that creates a problem, it’s the fuel type.

A gas boiler, if it’s run on biogas or synthetic methane, doesn’t create the same negative climate impact as its fossil counterpart. So, from a climate protection perspective there is no reason to ban it. We have to take much more of a lifecycle view in these decisions: the installation of new boiler always come with a cost and additional emissions.

And in this regard, replacing workable end applications just because they don’t fit new building standards creates carbon emissions in itself because new heating appliances have to be manufactured, transported and installed.

So in my view, there is no need to ban any end application. If we want to de-fossilise the sector, we have to tackle the fuel and the fuel consumption. For me, pricing mechanisms and price signals based on scarcity are better instruments.

Because, with a hard ban, there will always be cases where consumers don’t really have any alternative right now. And for those consumers, the ban will come at a disproportionate cost to their budget, which might allow for much more greenhouse gas savings when invested in other areas.

Most people in the industry seem to agree that electric heat pumps will eventually form the backbone of the future heating system in Europe. Yet, the proportion of installed heat pumps in Europe is still tiny compared to fossil fuel solutions and the price is still extremely high compared to fossil fuel applications. How can regulators at the EU level accelerate the switch?

I’m not an engineer but my understanding is that heat pumps, in order to be most efficient, require an adjustment to the building in itself – with regards to insulation, temperature deltas, etc.

So, in this regard, the pickup rate of heat pumps might not particularly be constrained by the exchange of the heater itself, but rather the availability or the renovation of buildings, which would allow for an efficient application.

You mean an electric heat pump would not work efficiently in a building that is not well insulated?

The heating efficiency of heat pumps deteriorates a lot when there is a high temperature delta. For instance, the efficiency of air-water heat pumps is significantly below average during cold winter days, particularly if the insulation standard of the building does not allow for low flow temperature in the heating system.

The efficiency therefore depends a lot on the individual circumstances, which means the choice of the end application is best made by the people on the ground, in a decentralised manner. And the best incentive for decentralised decision-making is a fair and technology neutral standard.

As I already said, a common carbon pricing system like the ETS would be a good first step to encourage this.

Heat pumps are currently much more expensive than gas boilers. Do you expect the price difference to narrow at some point? When could price parity happen in your view and what would be the drivers to make this happen?

For a cost comparison of heating technologies, again we have to take a systemic view, and therefore not only have to look at the costs for the end applications like heat pumps. We also need to look at the associated costs in the wider energy system to reliably provide renewable energy to the end application. So: what’s the price of bringing renewable electricity to the heat pump, taking into account networks and generation, and what’s the price of bringing renewable hydrogen to the boiler, taking into account the system-wide effects as well.

We have shown in various studies that there are situations where the hydrogen boiler doesn’t perform worse than the electric heat pump. And others where the heat pump might have significant benefits, for instance in new buildings with high insulation.

But many of the relevant factors for such a meaningful comparison are still quite uncertain.

For instance, one important aspect for the system-cost analysis is the degree to which Europe will in the long run be dependent on imported renewable energy. It’s foreseeable that we won’t be 100% self-sufficient in terms of renewable energy supply and will therefore have to import some of it from abroad.

Very likely a lot of these imports will come in the form of molecules, for example, hydrogen. In such a situation, the system-wide cost of running a heating system on hydrogen might be lower than in a situation where all of the hydrogen would be produced domestically, based on scarce European wind power for example.

Therefore it is hard to make any final judgment today about what the optimum technology mix will be in the long run. This is the reason why it’s so important to be as technology-neutral as possible and keep options open.

There will be situations where hydrogen will be the most efficient solution, and there will be other circumstances where the electric heating system and the heat pump will be the much better performing option. But it’s close to impossible to make a reliable central decision about this, we should therefore leave these decision to the individual stakeholders and rather focus on establishing an unbiased incentive regime which allows for a fair technology competition.

[Edited by Zoran Radosavljevic]

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