Drastic changes ahead for the nitrogen fertilizer industry in the EU

We expect drastic changes in the European nitrogen fertilizer industry in the coming years. Natural gas prices will remain elevated in Europe, and ambitious and costly decarbonization policies are eroding the European industry’s competitiveness. The industry is being forced to rethink its business model and strategy.

It remains unclear if the nitrogen fertilizer industry in Europe will accept this, or if it will try to avoid these consequences by relocating (part of) production to other lower cost regions with less stringent decarbonization policies and lower energy costs, such as the US. The attractive and accessible tax credits of the US Inflation Reduction Act for clean hydrogen production and the promising improvements in CCS technology make the US an attractive location for the production of low-carbon ammonia. This signals potential for substantial exports of competitively priced low-carbon ammonia to the energy-deficient EU.

Meanwhile, the ammonia market could triple in volume in the coming decades as a result of new uses of ammonia, such as fuel for the maritime sector and as a carrier of hydrogen. Producers that are able to produce low-carbon ammonia at competitive prices will gain market share in a fast-growing market.

Natural gas is the main feedstock of gray hydrogen. Through a process called steam methane reforming, gray hydrogen is produced. This is a very emission-intensive process. Every kilogram of hydrogen produces 9 kg CO2. The emissions can be reduced considerably if carbon is captured and stored (CCS). Projects that are currently under development in the US aim to capture up to 90% to 95% of emissions. This results in low-carbon hydrogen, also referred to as blue hydrogen.

About 27% of all gray hydrogen produced in the world serves as feedstock for the production of ammonia, and 70% to 80% of all ammonia produced globally is used in the production of nitrogen fertilizers. The ammonia and nitrogen fertilizer industries are highly integrated. Nitrogen fertilizer producers typically produce their own ammonia on-site at the same production site as part of a single integrated nitrogen fertilizer production process. Only 10% of the world’s ammonia production is shipped and traded.

Typically, 70% to 80% of the cost price of gray ammonia are natural gas costs, depending on the plant size and the ammonia price. The availability of abundant cheap natural gas is therefore crucial for a viable nitrogen fertilizer industry in Europe.

Before the war in Ukraine, Russia was the main supplier of natural gas to Europe in terms of volume. In Q2 2021, Russia had a share of 31% of total EU natural gas imports and liquefied natural gas (LNG). Due to the war in Ukraine, this share dropped to 16% in Q2 2023. Russia’s declining share was mainly replaced by increased imports from Norway, the UK, the US, and Algeria.

The dwindling availability of cheap Russian natural gas has had extreme repercussions for the natural gas prices in Europe. For years, Title Transfer Facility (TTF), which is the most liquid reference for natural gas prices in Europe, had been trading in a range of EUR 10 to EUR 30/megawatt hour (MWh). In the run up to the war in the Ukraine, and at the start of the invasion, TTF displayed an extremely high volatility, thereby reaching an all-time high of EUR 339/MWh. Since then, volatility has come down considerably, and TTF prices have been moving in a trading range of EUR 25 to EUR 50/MWh. However, this is still three to six times the price of Henry Hub, the US equivalent of TTF.

Given the fact that natural gas is the main cost component of ammonia, high natural gas prices feed directly into ammonia prices. This is eroding Europe’s competitiveness. Being a natural gas deficient region, the consequences are that TTF prices will likely remain elevated in Europe relative to prices in the US. We therefore expect that Europe will remain a high cost producing region for years to come, as cheap Russian natural gas supplies are unlikely to return any time soon.

High natural gas prices aren’t the only challenge the fertilizer industry in Europe is facing. The EU is determined to reduce CO2 emissions in the coming decades and has embarked on an ambitious decarbonization path. New regulation has been implemented to force emission-intensive sectors, such as the ammonia industry, to decarbonize its production processes. Every produced metric ton of ammonia produces around 2.5 metric tons of CO2, which is twice as much as the emission-intensive production of steel.[1]

There are three important changes in EU regulations that force the industry to decarbonize. The Renewable Energy Directive (RED III), the phase-out of free EU emissions rights, and the Carbon Border Adjustment Mechanism (CBAM).

Renewable Energy Directive III

The revised Renewable Energy Directive (RED III) was agreed on in September 2023 and contains sector-specific binding sub-targets. RED III requires the hydrogen and fertilizer industry to replace 42% of gray hydrogen with Renewable Fuel of Non-Biological Origin (RFNBO, also referred to as renewable hydrogen or green hydrogen and all its derivatives) by 2030 and even 60% by 2035. These are challenging targets for two reasons.

First, the current renewable hydrogen production capacity in Europe is somewhere in the tens of Megawatts, while we need high single digit Gigawatts just for the European ammonia production to reach the 42% target.[2] This means that we have a gigantic task ahead to build sufficient hydrogen production capacity in the coming seven years.

Second, the production cost of renewable hydrogen in Europe is three to six times higher than gray hydrogen, leading to substantial production cost increases for industries that use gray hydrogen as a feedstock and need to switch to green hydrogen. This will certainly erode the European industry’s cost competitiveness.

Renewable hydrogen imports from potential low-cost production countries such as Saudi Arabia, Qatar, Morocco, Namibia, Chili and Australia could be a future solution. However, these installations still need to be built, as well as the infrastructure and facilities to transport renewable hydrogen to the desired location and appropriate storage and distribution facilities. Large volumes of hydrogen will most likely be transported to Europe using ammonia (hydrogen plus nitrogen) as a carrier, as we will explain in one of the next sections. The necessary facilities to accommodate this in large volumes still need to be built, which means that a lot of work needs to be done before substantial volumes of renewable hydrogen can be shipped to the EU.

In the preamble of RED III, it is fully acknowledged that it will be difficult and costly for the ammonia industry to meet the target of 42% renewable hydrogen by 2030. For that reason, certain opt-out routes for certain ammonia production plants have been created. They can pursue the low-carbon (blue ammonia) route.

Phasing out free emissions allowances

Another major change in EU regulation that will drive up costs, is the gradual phase-out of free carbon allowances (EUAs) under the European Union Emissions Trading System (EU ETS). Currently, the ammonia and fertilizer industry receives free emissions rights. This will change. From 2025 on, the free emissions rights will be gradually phased out. From 2034 onward, the ammonia and fertilizer industry will have to pay for all its emissions. For the emission-intensive ammonia and fertilizer industry, this is another major cost increase, further eroding its cost competitiveness. However, part of the effect of this cost increase should be neutralized by the Carbon Border Adjustment Mechanism (CBAM), a third relevant piece of EU legislation.

The Carbon Border Adjustment Mechanism

The Carbon Border Adjustment Mechanism (CBAM) is a levy on carbon-intensive goods entering the EU. The price of the CBAM certificates will reflect the EU ETS prices corrected for any free allowances EU producers still receive, and carbon costs incurred during the production process in the producing country. In a nutshell, the CBAM aims to mitigate possibly unfair competition from the hydrogen and fertilizer industry outside the EU that doesn’t face any carbon-related regulation. The phase-in of the CBAM mirrors the phase-out of free EUAs.

This should, at least partly, mitigate the eroding competitiveness of the fertilizer industry in Europe versus fertilizer producers from abroad that want to export to the EU. But it doesn’t tackle the loss of the European industry’s competitiveness outside Europe on the global nitrogen fertilizer market. For European plants that export substantial volumes outside the EU, this is a serious issue, as they will lose market share.

[1] IEA, energy and emission intensities for key industrial products, 2021, IEA, Paris https://www.iea.org/data-and-statistics/charts/energy-and-emission-intensities-for-key-industrial-products-2021, IEA. Licence: CC BY 4.0

[2] According to the Clean Hydrogen Monitor 2023 of Clean Hydrogen Europe, Europe’s demand for hydrogen in the ammonia sector is 2.1 million metric tons per year. This compared in 6GW electrolyzer capacity assuming 6,000 full load hours and using the higher heat value.

Not only the hydrogen and fertilizer industry are forced to decarbonize. Other sectors are also facing decarbonization. Electrification is the most efficient way to cut emissions, but there are industrial processes where electrification isn’t an option, or where fossil fuels are used as a feedstock. This is the case for the refinery, steel, glass and cement industries, for example. Electrification also is not an option for certain transport sectors, such as the maritime sector and the long-distance aviation industry. The electricity generation sector itself must also decarbonize. Renewable energy sources like solar photovoltaic technology and wind can’t guarantee peak load and base load, but clean (renewable or low-carbon) gas-fired power plants can. Clean gas can also be used to store energy or replace strategic natural gas reserves.

For all these applications, clean hydrogen can be used. For some applications, clean ammonia, which is composed of 18% clean hydrogen and 82% nitrogen, could be more suitable due to its specific properties.

The two major uses of clean ammonia are likely as a fuel in the maritime sector and as a carrier for the transport of hydrogen by ship. Due to these new uses and some other applications, the ammonia market could at least triple in the coming decades, according to IRENA’s Stated Policies Scenario and 1.5 degrees Celsius Scenario.

Other sectors must also contribute their share in cutting emissions. One of the sectors where ammonia will likely play a key role in decarbonizing its operations is the maritime sector. In 2018, the maritime sector was responsible for 13.5% of all greenhouse gas (GHG) emissions caused by the transport sector in the EU in that year.

There are several directives that target the GHG emissions in the sector, of which the FuelEU Maritime initiative is the most prominent one. In a nutshell, the FuelEU Maritime initiative aims to kick-start the use of clean shipping fuels (renewable and low-carbon) and also sets a binding GHG emissions reduction path for the sector. This path starts in 2025 with 2% in 2030 and ends in 2050 with 80%.

The FuelEU Maritime initiative also contains a binding target for the use of RFNBOs of 2% of total energy used in the maritime sector in the EU in 2034. However, in practice, EU certified low-carbon hydrogen that meets the 70% CO2 reduction threshold compared to gray hydrogen on a lifecycle basis, will likely also become eligible, given certain conditions.

Another important legislative change is the inclusion of the maritime sector in the EU emissions trading system. The maritime sector operating in the EU will have to gradually pay for its GHG emissions starting in 2024. From 2027 onwards, all emissions must be paid for.

The current fuel used in the maritime sector is heavy fuel oil. Replacing this with a cleaner alternative is an effective way to cut emissions. Often suggested low-emission and zero-emission alternatives are renewable ammonia made of renewable hydrogen, or low-carbon ammonia made of low-carbon (blue) hydrogen. There are also other alternatives beyond the scope of this publication.

A major advantage of ammonia is that it is a CO2 emission-free fuel. Another advantage of ammonia as a fuel is that it is already being shipped today. About 20 million metric tons, which is about 10% of total world production, is traded and shipped each year. This is a great benefit because the ships to transport ammonia, the infrastructure and safety and handling procedures for loading and unloading ammonia already exist, though not yet on the scale we will need.

The largest risk of the use of ammonia is that it is highly toxic. Another risk is the potential formation of other GHG emissions during combustion, such as nitrous oxide, N2O. This GHG is 264 times more damaging to the atmosphere than CO2. Ammonia slip due to potentially incomplete combustion is also a cause for concern, given its toxicity. The latter is a big safety concern during refueling. The shipping industry therefore needs to find solutions for these issues before clean ammonia can be used as a clean fuel.

A second new use of ammonia is as a carrier for clean hydrogen (green and blue). Gray hydrogen is always produced at locations with abundant natural gas supplies, as natural gas is the principal feedstock. Like ammonia, most hydrogen today is produced as part of an on-site integrated production process, usually in the refinery and fertilizer industry.

However, this will drastically change in the near future. Europe’s heavy industry needs large volumes of clean hydrogen to decarbonize its production processes. Other sectors, such as the heavy duty transport and the aviation sector, also require large volumes of clean hydrogen.

Going forward, imports to the EU from low-cost energy regions are likely to increase further due to cost-competitive reasons and the fact that Europe won’t have sufficient renewable energy sources to become autonomous when it comes to clean hydrogen. These imports will partially be transported through pipelines in the long term and by ship in the short to medium term. Major European ports are already planning hydrogen infrastructure and facilities.

However, hydrogen’s properties make it extremely difficult to store and transport. It has a low volumetric energy density under normal atmospheric pressure. So it needs compression (350-700 bar) or liquefaction at -253C to mitigate this. Strict safety precautions must be taken, as hydrogen is also highly flammable and easy to ignite.

To avoid these difficult properties, an easy to handle carrier can be used. By converting hydrogen into ammonia through a process called Haber-Bosch (Figure 1), hydrogen is mixed with nitrogen to become ammonia. Nitrogen is widely available and captured directly from the air.

Among ammonia’s more favorable properties are its boiling point at just -33C compared to hydrogen’s -253C. Ammonia burns more slowly, and sustaining combustion once it gets started is difficult. But perhaps the largest advantage is that ammonia contains more hydrogen (H2) than pure hydrogen in terms of kg of H2/m3 due to its volumetric density. Ammonia (NH3) is therefore more suitable to transport than pure hydrogen (H2).

A major drawback of ammonia as a hydrogen carrier is its high toxicity, which was addressed in the previous chapter, as well as the conversion losses. Each conversion costs energy.

The high natural gas prices compared to other regions, the stringent decarbonization regulation from Brussels, and the new growth markets for clean ammonia are forcing the vertically integrated nitrogen fertilizer industry in Europe to rethink its strategy. They take a couple of factors into consideration.

First, the new use cases of ammonia create optionality, which opens additional markets for the industry. The value for the industry shifts from its end product, nitrogen fertilizers, to its intermediate product: ammonia. From there it has the option to sell it to the food chain or the fuel chain, with the knowledge that the growth of the ammonia market will predominantly be driven by the new uses, i.e. fuel and hydrogen carrier.

Second, the high costs, eroding competitiveness, and attractive alternative locations must be considered. It is obvious that the ambitious EU decarbonization requirements that are enforced on the ammonia and fertilizer industry require enormous investments. These come on top of the elevated natural gas prices in Europe. Relocation of hydrogen and ammonia production facilities to lower-cost natural gas regions, such as the US, could therefore be an attractive option. The accessible and generous tax credits of the US Inflation Reduction Act (IRA), make it even more compelling to invest in low-carbon hydrogen and ammonia facilities there, when compared to the complex patchwork of subsidies in the EU.

Third, CBAM comes with two considerations. CBAM protects the competitiveness of ammonia and nitrogen fertilizer production in the EU, not outside the EU. If an integrated fertilizer plant remains located in the EU, it must accept its eroding competitiveness for exports to regions outside the EU. This will likely result in a loss of market share in a booming ammonia market. This is not an attractive outlook.

The second consideration is that hydrogen and ammonia exports from abroad to the EU will become subject to a CBAM levy. The magnitude of the levy will depend on the GHG emissions embedded in the imported ammonia (or hydrogen). Current carbon capture and storage (CCS) projects have an overall CO2 capture rate of 50% to 60%, which means that if exported to the EU, they must pay the CBAM-levy for the remaining GHG. However, several new projects in development in the US aim for 95% or higher capture rates. In order to obtain the EU certification of low-carbon hydrogen, a reduction of at least 70% CO2 emissions must be achieved versus its gray version on a lifecycle basis, i.e. including upstream and downstream emissions. This comes down to a maximum threshold of 3.38kg CO2 per kg of hydrogen.

For installations in the US, this is challenging but achievable, according to research published by the US Department of Energy (DOE). However, the DOE’s conclusions were based on research which includes baseline data from 2017 for natural gas emissions. The new methane emissions rule for oil and gas drilling codified in the Inflation Reduction Act with the US Environmental Protection Agency (EPA) regulations released in conjunction with COP28, should see additional achievements in emissions reduction from off-the-shelf technologies, like pneumatics valve replacements and the end of any existing routine flaring. This brings the EU threshold within reach.

Of course, the CO2 emissions related to the transport to Europe must still be added. Future improvements in CCS technology and clean shipping fuels should be able to bring the EU threshold more comfortably within reach. This would allow US-based ammonia producers to ship their low-carbon ammonia to the EU paying only a minor CBAM levy.

Taking all these factors into consideration, fertilizer producers in Europe could conclude that it is a financially attractive solution to decouple the integrated production process and relocate the emission-intense hydrogen and ammonia production to a location where natural gas is available at a lower cost, and where decarbonization regulation is less strict. In these locations, new low-carbon ammonia facilities can be built to produce EU certified low-carbon ammonia at a lower, more competitive cost.

As such, the US is perceived by the industry as an attractive location, given the IRA tax credits and the fact that it is a stable trading partner with a trusted jurisdiction and low political risk. Disruptions at major export points and shipping routes are minimal, and if they occur it is often due to weather conditions. The low-carbon ammonia can be shipped to other regions and to the EU where a CBAM levy needs to be paid over the remaining CO2. This low-carbon ammonia can then be sold at competitive prices. This could allow producers to gain global market share in a booming market for clean ammonia, while staying clear of the adverse repercussions on its competitive position.

However, there is currently a barrier to a swift route to the low-carbon ammonia market in the US. This concerns the issuance of a so-called ‘class VI’ permit from the US Environmental Protection Agency, which is necessary for permanent geologic storage. This can take more than two years to receive, although we acknowledge that the EPA issued four additional permits ahead of the close of 2023, and that several were granted in Wyoming. Where states have primacy, currently North Dakota and Wyoming, issuance has tended to be quicker.

For individual EU member states, the relocation of production capacity outside the EU is an unwelcome development that needs to be countered. Many offer financial support for CO2-reducing investments, and create some leeway in the interpretation and national implementation of the EU decarbonization regulation. This could offer nitrogen fertilizer plants just enough comfort to keep their plants operational in Europe.

In part two of this article series, we will take a closer look at the potential repercussions on exports, sector economics, and alternative pathways for the nitrogen fertilizer industry in Europe.