INSIGHT

MARCH, 2020

The climate neutrality

conundrum for heavy duty
transportation
The climate neutrality conundrum for heavy duty transportation

Executive Summary
The European Green Deal has set a new trajectory for climate change policy in the European Union. The European Climate
Law will ensure that this political commitment will become a legal obligation, setting Europe on a course to achieve net zero
climate emissions by 2050.

Member states have only recently published their National Energy and Climate Plans (NECPs) for 2021 to 2030, setting out to
achieve a 40% reduction in carbon emissions. However, this commitment has now been superseded by the European Green
Deal, which increases the 2030 target to at least 50%. Moreover, the 2050 target is now focusing on net zero emissions,
compared to a previous 80% reduction in this time frame.

The European Commission had indicated that it would set out a plan for achieving this higher reduction by mid-2020. However,
the recent escalation of the Covid-19 virus and associated containment measures now in place across much of Europe could
delay this proposed timetable. Member states were due to then have until 2023 to propose new NECPs that make this target
happen. However, the financing measures which will need to be developed to underpin the European Green Deal, could also be
impacted as Europe grapples with impact of Covid-19 on public finances.

The focus on net zero emissions by 2050 has resulted in a step change in sentiment around climate policy. While an electrified
powertrain is now a viable means of decarbonising light duty and short distance travel, climate neutrality poses a much greater
challenge for heavy duty and longer distance travel.

This insight explores some of the emerging technologies for transport decarbonisation, which could play a role as Europe seeks
to implement its net zero carbon policy. This analysis builds on Wood Mackenzie’s extensive in-house expertise on Energy
Transition as well as discussions with industry representatives.

Key points include:

• The use of hydrogen as a road transport fuel starts to gain traction

• Series hybrid technologies are a key development for ICE investment

• While biofuels from waste are difficult to scale up, capturing biomethane from sewage and food waste must be a core priority

• Synthetic fuels will remain a very expensive option, but synthetic methanol for shipping shows some promise

The use of hydrogen as a transport fuel starts to gain traction

Hydrogen fuel cells are gaining momentum as a credible solution for a variety of transport applications, with a ramp up in
automotive investment and the development of near market ready solutions.

Most global hydrogen production is currently from fossil fuels. Over 70% is produced from steam methane reformation (SMR),
known as grey hydrogen, while most of the rest is produced from the gasification of coal or lignite, known as brown hydrogen.

Blue hydrogen is derived from methane with integrated Carbon Capture and Storage (CCS), while green hydrogen is derived
from water electrolysis using renewable electricity. While green hydrogen is very energy intensive, the process produces very
pure hydrogen with zero carbon emissions.

OEMs have invested over a billion dollars in hydrogen technologies in the last 18 months, while companies with a focus on
hydrogen technologies have seen a considerable uptick in their share value since the beginning of this year. This includes
companies such as Plug Power and ITM Power, which is leading on electrolyser development at retail forecourts.

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Two key factors are driving this recent focus on hydrogen. Firstly, there is now a growing consensus in the automotive sector
that net zero carbon emissions cannot be achieved without hydrogen. Secondly, industrial and other stationary applications of
hydrogen are now becoming the main pull for the hydrogen economy, rather than transport. The injection of hydrogen into the
gas network, and the use of hydrogen in industrial applications such as refineries and steel plants, represent nearly 60% of all
green hydrogen projects. This is then followed by the use of green hydrogen for road transport applications, amounting to 16%.
Moreover, this means transport applications are able to gain from this momentum in the industrial sector, as the hydrogen
supply chain starts to develop.

While there is currently only 258 MW of green hydrogen installed capacity, the pipeline of new projects is expanding rapidly. It
exceeded 3.2 GW in October 2019, and accelerated rapidly to 8.2 GW by March 2020. This ramp up is explored in a recent
insight published in March 2020 “Green hydrogen pipeline more than doubles in five months”.

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The climate neutrality conundrum for heavy duty transportation

However, green hydrogen is currently substantially more expensive than blue hydrogen, due to the high amounts of energy
required for water electrolysis. Carbon pricing will be a key factor. We estimate a carbon price of US$40/tonne in 2030 could get
green hydrogen on a level with SMR-produced hydrogen paired with CCS.

Hydrogen is particularly attractive for trains operating on parts of the rail network that are hard to electrify. With a commitment in
many EU countries to phase out diesel on all train routes by 2040, this has become a viable option for consideration. There is
presently only one operational hydrogen passenger train, which serves a 62-mile route in northern Germany, while the East
Japan Railway Company plans on launching a hydrogen powered train by 2024. However, this market currently accounts for
just 40 kb/d of diesel consumption across the whole of Europe, compared to over 3 million b/d for heavy duty road fuels. With
this in mind, if hydrogen is able to become a viable option for long distance road freight, the market potential is far greater.

We estimate that renewable hydrogen, produced in the UK from dedicated offshore wind electricity, can cost around $4.5 per kg
today. After including the capital costs of trucking, refuelling and production infrastructure, it would cost $1.9 per km for a fuel
cell truck powered by renewable hydrogen, as opposed to $1.4 per km for diesel trucking, excluding taxes. An additional carbon
charge of around $180 per ton would be required to close this gap. This is assessed in more detail in a recently published
insight “Hydrogen as a renewable road freight transport fuel – a UK case study”.

We expect capex costs for green hydrogen to fall by one-third over the next decade, driven by the automation of the
manufacturing process for electrolysers, combined with improvements in electrolyser efficiency and a reduction in feedstock
costs. If and when, capex costs for green hydrogen fall by 50%, this could start to make it competitive in the heavy-duty road
freight market. Nevertheless, building up a hydrogen re-fuelling infrastructure is a much greater challenge than with EV
charging, as there is no network currently in place. However, a focus on a fleet-based approach that relies on centralised
depots, makes this more achievable than aiming for hydrogen availability at the full network of retail service stations.

Series hybrid technologies are a key development for ICE investment

Most plug-in hybrid vehicles launched to date have been based on parallel hybrid technology, whereby the ICE engine can
directly drive the vehicle powertrain. A series hybrid, otherwise known as a range extender, still has an ICE engine, but this
powers a generator, to recharge the electric battery. While consumers want a high driving range, they tend not to use this range
very often, so there is a need for the right sizing of the battery for the specific application, particularly in urban locations.

In a series hybrid, the ICE engine operates over a more limited range, so it can operate at a much higher rate of efficiency. Most
of the current focus is on enhancing thermodynamic efficiency, which is currently below 50% for ICE engines. In contrast, all
other types of efficiency including combustion, gas exchange and mechanical efficiencies, are now close to 100% in ICE
powertrains. Due to the more limited operating range in a series hybrid, it is possible to focus on operating at a higher
compression ratio to improve thermodynamic efficiency.

Series hybrids are now generating more interest among OEMs, with a focus on both improving thermal efficiency as well as
minimising vehicle costs compared to conventional ICEs. A series hybrid can therefore have a very efficient ICE engine, and
can support the increased range of EVs, while ensuring that the battery size is not too large. As is well documented, large
batteries have many downsides for the performance of the vehicle, and the sourcing of battery raw materials can be very carbon
intensive.

With a simple ICE in a series hybrid, the engine tends to be downsized, with a focus on a two-cylinder engine, with a narrower
operating range. This can reduce the cost to around two thirds of the cost of a conventional GDI turbo engine. Moreover, while a
series hybrid ICE is mechanically simple, it has more complex thermodynamics. Recent demonstration projects indicate that
these can in theory achieve nearly 70% thermodynamic efficiency, around 20% higher than conventional ICEs. The extent to
which range extenders make economic sense compared to a battery electric vehicle depends to a large extent on the vehicle
size, use profile and additional range provided. For example, in the case of the London EV Company taxis, range extenders are
an economic means of increasing the range of the vehicle to nearly 400 miles, while maintaining the battery size at just 33 kWh.
However, as battery costs continue to fall, the cost advantage of range extenders diminishes relative to BEVs.

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While bigger batteries remain the current trend among automotive OEMs, lifecycle carbon emissions increase as battery size
increases. The EU regulatory framework is currently focused on tailpipe emissions, which does not capture the lifecycle
emissions from larger batteries. However, carbon lifecycle analysis is expected to come to the fore through the EU Green Deal
with post 2030 targets focused more on lifecycle carbon emissions.

A PHEV with a 20 kWh battery can have lower carbon lifecycle emissions compared to a BEV with a 45 kWh battery, based on
the existing EU power mix. Even for a fully decarbonised power grid such as Norway, the lifecycle carbon emissions would be
less for a PHEV when the BEV battery size rises above 45 kWh. With this is mind, the role of range extenders could still come to
the fore as the EU grapples with the most effective pathways towards decarbonisation.

Biofuel market extends reach beyond road transportation

The EU Renewable Energy Directive (RED) II requires a minimum of 14% of the energy consumed in road transport by 2030 to
be renewable energy. Plans for achieving this are set out in the NECPs published by member states. Most have placed a
greater emphasis on increasing the use of renewable electricity in the transport sector through the higher deployment of EVs
rather than a further ramp up in the use of biofuels. The impact of RED II is explored in more detail in a recent insight “Impact of
the EU Renewable Energy Directive (REDII) on biofuels demand”

As the European Green Deal will require a higher rate of decarbonisation than is currently set out in the NECPs, there is
renewed focus on biofuels for hard to electrify sectors such as aviation and shipping.

With the focus shifting to advanced biofuels derived from wastes and residues, Hydrotreated Vegetable Oil (HVO), is becoming
a key focus for future development. HVO production can be adapted to produce a kerosene-range product (bio-jet), which can
be blended with existing jet fuel without engine modifications. Introducing blending mandates for bio-jet, otherwise known as
Sustainable Aviation Fuel (SAF), is likely to be a key area of development to reduce the carbon impact of aviation.

Currently only Norway has a blending mandate for bio-jet in place, at 0.5% from the start of 2020. A key issue is feedstock cost
and supply availability, making it difficult to scale up biofuels from waste. Indeed a 1% blending mandate was proposed in
Norway from 2020, which was subsequently halved to just 0.5%. Other European markets such as France and Spain are
assessing a 2% mandate from 2025 onwards, while a 30% rate has been proposed for 2030 for most Scandinavian markets.

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Currently there is around 70 kb/d of HVO production capacity in Europe, which is expected to increase to around 100 kb/d
through expansions and new refineries. The greatest increases are in Sweden due to refinery expansions by Preem and a new
biorefinery from ST1.

Current mandated volumes of bio-jet (in Norway only) amount to just 100 b/d, while a 2% mandate across Europe in 2025 would
be equivalent to 30 kb/d. A 30% blending mandate by 2030 would ramp up demand for bio-jet to around 480 kb/d. To set this in
context, we forecast that biodiesel use in the road sector in Europe, will amount to 420 kb/d by 2030.

While the use of LNG in the shipping sector is expected to continue to grow, there are increasing concerns regarding methane
slip from vessels. Methane in the atmosphere is eighty times more damaging than CO2 for climate change. There is a
substantial difference between the level of methane slip between high pressure and low pressure dual fuel LNG engines. While
high pressure engines are more expensive, the level of methane slip is substantially lower.

There is increasing interest in shifting towards biomethane as an alternative, more sustainable fuel. Known as methane
upcycling, this involves capturing methane that currently goes into the atmosphere from existing sources such as sewage and
food waste. Given the considerable climate impact from methane entering the atmosphere, the collection and use of biomethane
is becoming a high priority. Moreover, biomethane capture from waste has a relatively low capex compared to other biofuels.

Nevertheless, there could be a greater pull on this feedstock within stationary uses of natural gas, which account for most uses
of methane, and where the potential for methane slip is much lower than in transport applications.

Synthetic methanol for shipping shows some promise

Synthetic e-fuels tend to be produced by combining hydrogen with carbon dioxide. However, these fuels are very costly to
produce. The high energy intensity of producing green hydrogen makes the process very inefficient - at around 12% overall
efficiency compared to 72% for an electric battery.

Nonetheless, research is continuing into the prospects for this market and one of the most interesting developments for e-fuels
is synthetic methanol. The carbon dioxide hydrogenation process works by decomposing water to create a hydrogen gas using
renewable energy, which then bonds with the carbon dioxide on the surface of the catalyst to create methanol. However, a key

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issue that remains is the considerable amount of electrical energy that is required by this process and how that can be sourced
from renewable sources.

Nevertheless, considerable improvements have been made to the process of converting carbon dioxide and hydrogen to
methanol, by developing a new catalyst that uses a specific formulation of palladium and copper. This particular catalyst lowers
the energetic requirements to speed up the reaction of carbon dioxide and hydrogen, and also ensures a higher percentage of
the products go to creating methanol. Overall this results in a much more energy efficient process to produce methanol, which
could develop as a fuel of the future for the shipping industry.

Methanol could become an attractive option in the shipping industry given it is relatively straightforward to retrofit existing
vessels to use methanol. While some trials of methanol powered ships have already taken place, the fuel is not currently
competitive relative to existing marine fuels.

Summary of key points

Heavy-duty road transport

• Electrification in this sector is focused on the urban bus sector

• LNG is expected to make inroads into the long-distance road freight sector

• Hydrogen for long distance road freight could become competitive during the 2030s

Aviation

• Bio-jet is currently only mandated in the Norwegian market, amounting to just 100 b/d

• An SAF blending mandate of 30% across all of Europe by 2030 would amount to nearly 500 kb/d

Shipping

• LNG is expected to take more market share in the marine fuels market than any other transport segment

• The use of synthetic methanol shows promise due to recent breakthroughs on catalyst efficiency

Rail

• Hydrogen is suited to parts of the rail network which are hard to electrify, but only one project is currently operational in
Europe

• Remaining oil use in rail transport is now very small so that the market potential for hydrogen is much more limited compared
to road freight

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Base case outlook for European fuel use in heavy duty sectors in 2030

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