What (economic) problems would Iceland experience from the early transition to a fossil-free economy?

Application of hydrogen systems

Application of hydrogen fuel cells in practice today is limited by their high cost, the costs of hydrogen production, and, naturally, lack of infrastructure. The main drivers of cost reduction in coming years will be development encouraged by likely continuous hike of oil prices and government policies pursuing greener energies. Those effects will be curbed by counter-effort pushing full exploitation of existing technologies (and by oil lobbies).

Figure: 50 kW engine costs progression (Chalk, Miller)

Using today’s clean technologies, the cost of delivering 1kg of hydrogen at the pump stands prohibitively high at minimum $7/£4.5, depending on production technology (Haman, Stiever, 2007). Power derived from 1 kg of hydrogen roughly compares with power carried by 1 gallon of regular gasoline, which means the hydrogen cost at pump needs to be squeezed to about a third of the current level to become competitive (Rajeshwar, McConnell, Licht, 2008).

Figure: Hydrogen cost at the pump (produced by clean electricity)

Iceland relies on cheap electricity to provide for cheap hydrogen production. In this sense, the island country has a unique position in the world. For the world to cope with these issues, major developments in harnessing renewable energy will be necessary.

        Hydrogen infrastructure - production, distribution and storage

To cover the roughly 1600 km route around Iceland (majority of towns and inhabited areas are along the coast) minimum of 20 refilling stations will be required. 

The advantage of hydrogen is that it can be produced at the pump site. Also, technologies are in development which will enable home production and refilling stations. However, hydrogen infrastructure needs to be highly pressurized, requiring costly energy intensive and reliable distribution systems. Though, Iceland due to its size and early devotion encourages investments of first mover companies as a prototype economy. On the other hand, hydrogen economy feasibility research estimates the infrastructure costs (of lean hydrogen system, just suitable to effectively cover the needs of motorists, roughly 20% density of oil infrastructure) to be comparable to the maintenance costs of current oil distribution systems. (illustrated in a study of conditions in the USA (conducted by GM) which estimates, that a US wide hydrogen infrastructure to support 1 million hydrogen powered vehicles and placing a hydrogen fueling pump within 2 miles of the homes of 70% of the US population as well as every 25 miles on the interstate highways connecting the 100 largest cities, would cost between $10 billion and $15 billion (Lipman, Kammen, Ogden, Sperling, 2004). Other studies show that oil industry in the US spends at least $11 billion a year just to maintain its service station fleet (Rose, 2005).) Pursuing infrastructure development within Icelandic small scale and under the circumstances given may thus be possible without major government investments by application of suitable policy mix and environment encouraging foreign investment.

Iceland's transportation industry consumed almost 200 million litres of gasoline in 2000 (Energy and resources Iceland, 2000), which has risen since. The hydrogen equivalent of 2000 gasoline volume consumed would require supply of roughly 70000 tons to be produced a year. Between 700-900 MW source of electric power would need to be employed in order to produce that volume of hydrogen. That is almost 50% more than the amount provided by existing geothermal power plants today (Calculations based on Thompson, McConnell, Mosleh, 2005). Producing necessary amount of electricity to power transport industry will likely be one of major challenges of hydrogen economy. The capacity, however, exists as today only between 20%-25% of the technically and environmentally feasible hydropower (under 2000 MW employed) and conventional geothermal power (under 600 MW employed today) is harnessed in Iceland (Iceland energy authority, 2006 and 2007).  

        Related projects will encourage inflow of foreign capital and add up to the economic growth and well being of inhabitants. Powering transportation with locally made electricity would accumulate wealth at home instead of financial outflows to foreign suppliers (of oil). Economic growth related to technological and knowledge intensive industries may lead to improved competitive position of Icelandic economy, impact the living standards of inhabitants and employment conditions in a positive sense.

        Barring the cost of early transition

In period of transition between technological paradigms, there is usually a period of coexistence of evolving and established technologies, when the new technology strives to become competitive and efficient while the established technology is pushed ‘to its limits' and to 'buy more time'. We can anticipate that at the time of Iceland's intended early transition to a fossil-free economy the adoption of clean transportation systems will likely not yet be fully accomplished globally, due to probable technological and market reasons.

        We can anticipate that:

        1. Cars powered by new technology will be more expensive than traditional ones
        2. By end of the transition period, cars with traditional engines will still be present in Iceland

The first point translates into additional cost for people buying cars. In general, the supply curve for cars would shift up resulting in lower demand for cars and possibly less people choosing to drive a car after the transition is completed. The government may accept such situation or may wish to influence the demand (curve).

Figure: Supply of cars and new technology

The government may choose to subsidy for customers the difference in cost (fully or partially). Subsidy basically shifts the demand curve upwards. A partial or zero subsidy would result in likely drop in sales of cars (to somewhere between Q1 and Q0) and it may be expected that less people would drive a car after the transition than before.

Figure: Automobile market in Iceland (medium run)

Price of cars before and after the transition. To maintain the number of vehicles in the economy after the transition, different approaches can be employed to push demand curve up (or supply curve back down)

Cars as a utility product usually see relatively low price elasticity (usually between 0.8-1.3). In Iceland with relatively large number of cars and high proportion of luxury vehicles, the higher boundary may well apply. The rise in transportation cost may show effect in general price levels throughout the economy and thus buying power of people. As well, it will affect demand for substitute products where higher absolute cross elasticity, such as risen demand for public transport service. The relative proportion of car classes will likely change as well, with luxury cars demand substituted partially by demand for cars of lower classes (as complimentary product of inferior character). On the other hand, consumers would be motivated to buy new vehicles if their operation was more cost efficient.        

Negative effects may be decreased if the country manages to maintain high economic growth throughout the transition period and secure rise in incomes. It should be the aim of the government to maintain the living standards of inhabitants over such major transition and elaborate on migration strategies eliminating the negative effects of transportation cost related (cross) elasticities (related to income, substitute products, quality of products and services consumed in economy, general demand for cars).         

Figure: Anticipated number of (drivable) cars over the period of transition (2035 as the year of transition)

Virtually every owner of a vehicle would need to buy a new one somewhere during the period of transition, if they choose to continue driving. Thus, an external stimulation of demand for cars will arise for a certain period. A short term upward shift of demand curve could be encouraged even more through other measures, such as a deduction of value of an old vehicle from the price of a new one. Subsequently, these vehicles could still be resold to other countries. Demand for cars may be expected to remain stable or even rise in the short run despite the upward shift of supply curve.

The transition period shall be designed over a number of years, with sub-periods when cars with old and new technology are sold simultaneously (e.g. 3 years), followed by sub-period when both types are driven but only new technology based ones are sold (e.g. another 2 years). Eventually this will lead to a complete transition, when oil is not imported to the country and thus only new technology cars are sold and driven (date to be set to somewhere between the years 2030-2040).

Figure: Anticipated proportion of cars available in the final year of transition depending on year of production
         

At this time, likely a number of vehicles powered by traditional engines will still be in hands of some inhabitants, which will represent a minor share of vehicles from within the transportation industry and range of costs to their owners depending on their age. In overall the government would need to apply some financing mechanisms to assist the transition process in order to eliminate negative financial impact on the car owners. A special fund accumulated over a number of years before and during the period of transition could serve this purpose.

Conclusion

There are number of other technologies which appear as possible candidates for a major role in future transportation industry. From ammonia based fuels, rechargeable batteries powered engines, vegetable oil and methanol based technologies, to mention the most competent ones. Iceland’s strategy is a long term one and the first steps have been made. However, strategy leading to a hydrogen economy may still turn out as a government failure if the world eventually chooses to take some other path. Energy storage in form of hydrogen relates mainly to harvesting of Iceland’s abundant and relatively cheap clean energy resources. However, the engine technologies, if not further pursued globally, may not develop in terms of extend of competition and size of market to reach the maximum efficiency in terms of production and usage of the technology. Thus, shall the quantity produced remain relatively low in global terms (red area in figure) cost of transportation in Iceland would remain relatively expensive and inefficient also in the future.

Remark

Even though Icelandic natural conditions are very attractive, many of the potential investors in the country’s future energy and transport sector must be distracted by current economic downturn and its extensive impact on Icelandic economy. However, I chose not to back away from the topic as this strategy is of a long term character, aiming at time periods more than 20 years away. The natural conditions will still be there and economic conditions will improve. Iceland may eventually abandon or reschedule their intentions, however, similar transition, to hydrogen or other technologies, will be experienced by other countries worldwide, though, over a possibly longer period. Thus, I consider certain assumptions and conclusions made in this paper relevant and applicable also in other circumstances or to alternative technologies.

References

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