This article emphasizes the operational and economic dynamics of electrolyzers under different configurations and market environments, explaining how connection types and operating modes influence revenue, incentive mechanisms, and the power system (see Figure 1 below). The ongoing economic viability of electrolyzers will depend on continuous technological improvements, effective regulatory policies, and a structured pathway that balances cost-effectiveness support schemes with the flexibility potential of electrolyzers.
Figure 1: Connection types of electrolyzer-related operating modes (without energy storage) and their main objectives and sources of revenue.
1) Power Connection Types and Operational Impacts
Electrolyzers that are only connected to hydrogen networks and co-located with renewable energy sources (RES) operate in a "dispatchable" mode—potentially not affecting the grid. Although this configuration has lower electricity prices, the operating duration will be limited by the intermittency of renewable energy. Electrolyzers connected to grids near hydrogen demand centers will align their operations with local hydrogen consumption needs by considering electricity procurement costs and demand-driven hydrogen production. Independent electrolyzers connected to both electricity and hydrogen networks have the highest flexibility, allowing them to adjust operations based on electricity and hydrogen market prices, hydrogen demand, and grid conditions (e.g., participating in system service markets).
2) Operating Modes and Their Objectives
Electrolyzers can operate under different modes. In the base load mode, electrolyzers focus on high capacity utilization, stabilizing electricity costs through long-term power purchase agreements (PPAs), sharing capital expenditures (CAPEX), and ensuring stable hydrogen production. In the market price-driven mode, the objective is to optimize electricity costs, operating during low electricity price periods for efficient hydrogen production. In the user demand-driven mode, it balances market opportunities with stable contracts. In the system support mode, priority is given to ensuring grid stability, generating revenue through demand response (DR) and system services, though this may affect the stability and consistency of hydrogen output.
3) Phased Trends
Acceleration Phase (up to 2030): Due to financial stability and CAPEX recovery needs, the base load operating mode is favored, with government subsidies and purchase guarantees being crucial during this phase.
Maturity Phase (up to 2050): As advanced hydrogen infrastructure becomes widespread and renewable energy penetration increases, flexible operating modes become more feasible, enhancing profitability through revenue diversification from system services (or sales of by-products like heat and oxygen).
4) Potential Revenue Streams and Profitability
Hydrogen sales are the primary revenue source for electrolyzers, with costs (and profits) significantly influenced by electricity market prices or PPA conditions (electricity costs account for a large portion of operating expenses, OPEX). System services theoretically have revenue potential, but practical opportunities are limited due to competition from mature technologies like battery storage and strict technical requirements. Therefore, enhancing the flexibility of electrolyzers through automation and control technology is key to effectively entering the system service market.
5) Policy and Technical Considerations
As electrolyzer technology advances and costs optimize, reliance on CAPEX subsidies should gradually be phased out. Future support should shift towards reducing OPEX, such as favorable PPAs or exemptions from RES taxes. Regulatory frameworks, including RFNBO (International Sustainable Development and Carbon Certification) certification and GOs (Guarantees of Origin), are crucial for ensuring market trust and promoting green hydrogen production. However, when RFNBO compliance cannot be guaranteed, it may limit available flexibility potential. Long-term investments in energy storage solutions and advanced automation technologies (similar to other DR assets) are essential for enhancing the overall flexibility of electrolyzers and their entry into the system service market.
Balancing Hydrogen Production with Grid Flexibility Challenges
Achieving a balance between grid-friendly hydrogen production and meeting hydrogen demand requires coordination of technical, economic, and regulatory factors. As a core technology for decarbonizing energy systems and producing green hydrogen, electrolyzers may face conflicting dual priority objectives: providing cost-competitive hydrogen for industrial markets while supporting the power system (see Figure 2 below). Hydrogen demand typically requires continuous production, whereas electrolyzers connected to the power system depend on flexible operations—this flexibility is limited by the need to maintain stable hydrogen output, making it difficult to synchronize hydrogen production with electricity market conditions or system demand. Operators also tend to maximize operating hours to ensure commercial profitability, and investment decisions are often disconnected from the potential benefits of flexible operations. Additionally, frequent starts and stops can degrade electrolyzer performance, further discouraging operators from providing system services to the grid.
Figure 2: Economic pressures on electrolyzers at the intersection of the hydrogen and electricity industries.
These operational challenges are exacerbated by economic pressures: at least at this stage, green hydrogen must compete with fossil fuel-based hydrogen in industrial applications, necessitating competitive pricing. High electricity prices complicate achieving this goal, especially in the absence of subsidies or other price-stabilizing mechanisms. Insufficient competitiveness may weaken the willingness to support grid operations. Electrolyzers operate most efficiently at high load factors, but their participation in system services often requires intermittent operation, which not only reduces efficiency due to frequent starts and stops but also increases hydrogen production costs. While providing system services can generate additional revenue, changes in operating modes may encroach on hydrogen production revenue. The existing regulatory environment (especially EU RFNBO requirements, see Section 4.3.3) affects the flexibility potential of electrolyzers. Furthermore, technical requirements often create entry barriers for DR assets. Consequently, operators are more inclined to prioritize maximizing hydrogen production rather than adopting operating modes based on market prices or system support.
Recommendations
Future Sustainability of the Electrolyzer Business Case for Independent Electrolyzers: The long-term sustainability of the electrolyzer business case depends on the design of support schemes—how to balance initial financial incentives with fostering self-sustaining market operations. Support mechanisms aimed at reducing CAPEX can accelerate the adoption and development of electrolyzer technology, driving progress along the learning curve. However, since CAPEX accounts for about 20-30% of the total cost structure, focusing solely on CAPEX reduction may overlook other important factors affecting long-term viability (e.g., operating electricity prices, taxes). Reducing CAPEX subsidies is crucial, especially in the early stages of market and technology development, to lower entry barriers and encourage investment. As manufacturers gain experience and improve efficiency, CAPEX will naturally decline, reducing the need for ongoing support. Once sufficient cost reductions and technological maturity are achieved, continued CAPEX subsidies may lead to inefficient resource allocation and dependency. Therefore, establishing a gradual exit timeline for CAPEX support is essential to avoid market shocks from sudden terminations. Exit mechanisms could be based on measurable milestones, such as market penetration rates, reductions in LCOH (Levelized Cost of Hydrogen), and/or technological maturity (i.e., when electrolyzer technology reaches a stage where further CAPEX reductions are limited and commercially viable). While CAPEX-centric support is beneficial during the growth phase, OPEX (especially electricity procurement costs) poses a larger and more enduring challenge to the long-term business case for electrolyzer operators. As electrolyzers mature and scale, their viability becomes increasingly sensitive to electricity prices. Given that long-term electricity costs are influenced by market dynamics, renewable energy availability, and regulatory frameworks, support mechanisms must evolve to address these factors. However, several considerations must be taken into account during the transition of support mechanisms: even with efficient electrolyzer technology, high and unpredictable electricity costs will still undermine the business case; changes in regulatory conditions may hinder investment, as evidenced by the impacts of the 2022-2023 energy crisis. Therefore, stable regulations surrounding hydrogen certification and hydrogen GOs (Guarantees of Origin) are crucial.
Incentives for Grid-Friendly Site Selection and Flexible Operations: To enhance the flexibility of electrolyzers and minimize consumer costs, a multifaceted strategy integrating technical, regulatory, and economic aspects is needed. This article summarizes the following recommendations:
Phased Adjustment of CAPEX Subsidies: While CAPEX subsidies are critical for early adoption and lowering entry barriers, continued reliance after technological maturity may lead to inefficiencies and dependency. A phased approach linking CAPEX support to milestones such as market penetration rates or cost reductions can ensure a smooth transition to self-sufficient operations.
Facilitate Long-Term Renewable Energy PPAs: Providing electrolyzers with stable, low-cost electricity supplies allows them to manage production costs predictably. Although multiple factors (especially RFNBO compliance requirements) may exert strong competitive pressure on the PPA market, PPAs could still be key to the electrolyzer business case. Governments and regulators can assist by simplifying PPA contracts and ensuring fair terms that align with market dynamics.
Flexible Connection Agreements: To achieve faster grid connections and lower connection costs while avoiding future grid congestion, flexible connection agreements may be a useful option for coordinating the needs of electrolyzer operators and transmission system operators (TSOs).
Location Signals: Through market design, regulations, or inclusion in support schemes, guide electrolyzer operators to make site selection decisions that align better with system constraints, avoiding exacerbation of grid congestion and related costs.
Access to System Service Markets: This is crucial for ensuring electrolyzers (and other demand-side flexibility) are effectively integrated into the grid-friendly manner. To incentivize flexible operations, regulatory frameworks should lower barriers for electrolyzers to participate in ancillary services and DR programs (similar to other demand-side assets). Streamlining the pre-certification management process for providing grid services makes it easier for operators to contribute to reliable grid operations. By participating in frequency regulation and congestion management services, additional revenue can make flexible operations more attractive (though this depends on the availability of automation and control equipment). Additional DR programs for load shifting or peak shaving may help avoid grid congestion, although these are more transitional measures before DR is fully integrated into a technology-neutral system service market. Finally, encouraging investments in hydrogen storage through mixed support schemes could enhance operational flexibility in the maturity phase.
Exemption from Renewable Energy Taxes: This can be linked to periods of high RES output as a supplementary measure.
Coordination of Regulatory Requirements with Grid Demand: Discussions around regulatory requirements for green hydrogen production highlight the mismatch between decarbonization goals and electricity system demand. In the long term, it is crucial to coordinate both while recognizing grid limitations to drive the energy transition. To achieve balance, the design of GOs and RFNBO requirements should consider flexibility: especially during the acceleration phase, time-related rules should account for their impact on operating costs, providing sufficient space for electrolyzer operators to align production with system demand; geographical relevance should consider available grid capacity and renewable energy generation, encouraging system-aware site selection decisions. Focusing on these strategies can establish a long-term mechanism that rewards flexible, responsive hydrogen production.
Pathways Toward Progressive Flexibility and Competitiveness
This article emphasizes the different estimates and methods for the expansion of electrolyzer capacity in the medium to short term (acceleration phase) and long term (maturity phase), which is crucial. Clearly, during the phase when the hydrogen market is not yet established and available hydrogen infrastructure is limited, more support may be needed compared to the maturity phase. Nonetheless, to ensure the ongoing viability of electrolyzer business cases without compromising flexibility potential, time dimensions must be considered. The path toward maturity must account for the different needs and characteristics of electrolyzers during the acceleration, growth, and maturity phases, while ensuring that the power system does not incur excessively high costs over the long term (see Figure 3).
Figure 3: Related measures for the path toward subsidy-free flexible hydrogen production.
Acceleration Phase: Laying the Foundation
The primary goal of this phase is to incentivize investment, technology deployment, and innovation. First, achieving dual coordination is key:
For grid-connected electrolyzers, ensuring that their operators coordinate with power system TSOs to achieve location-aware site selection.
Coordination among electricity and gas TSOs and hydrogen network operators (HNOs) in integrated infrastructure planning to maximize overall energy system efficiency.
To guide electrolyzers toward more flexible future operations, support schemes should aim to reduce initial financial risks and promote market entry. In the early stages, direct financial support such as capital grants or investment subsidies can help offset the high upfront costs of installing electrolyzers and infrastructure—this includes gradual exit plans. These incentives should focus on early adopters to encourage economies of scale. Although electrolyzer operators are less likely to choose operating modes other than base load and user demand-driven in the initial phase, intense competition for PPA contracts may provide additional incentives, prompting them to secure at least part of their electricity supply through the electricity market, potentially unlocking latent DR potential in the initial phase. This means that the flexible operation of electrolyzers should not come at the cost of completely losing subsidies—during the acceleration phase, not all hydrogen produced may meet RFNBO standards. In this initial phase, purchase agreements that stimulate hydrogen demand can protect electrolyzer operators from quantity and price risks, enhancing project bankability. At the same time, power system TSOs need to consider the future potential of electrolyzers to participate in system services and the measures needed to achieve this (e.g., from connection requirements, baseline methods, etc.).
Growth Phase: Scaling and Stabilization
In this phase, the flexibility of electrolyzer technology itself is crucial for sustainable scaling. Electrolyzers should technically provide significant contributions to system flexibility and resilience through implicit DR.
Implementing "cap-and-floor agreements" can stabilize revenue by guaranteeing a minimum hydrogen price while limiting potential volatility, reducing investment risks and attracting private capital—this is vital for building a robust hydrogen industry. This approach is compatible with user demand-driven and market-based operating modes. By the end of this phase, "cap-and-floor agreements" can be gradually reduced, encouraging operators to increase market exposure while adapting to price signals and resisting extreme fluctuations. However, these contracts should be regularly reassessed to ensure their relevance without suppressing market dynamics. Other performance-based incentives could take the form of exemptions from RES taxes (which account for about 15% of overall LCOH, see Figure 4) linked to priority electricity use during high RES output periods. In areas prone to congestion, applicable flexible connection agreements can promote passive contributions to congestion management during this phase.
Figure 4: Hydrogen levelized cost of hydrogen (LCOH) composition for grid-connected independent electrolyzers (outer circle) versus dedicated renewable energy co-located electrolyzers (inner circle) based on default values from the European Hydrogen Observatory calculator 2023.
Maturity Phase: Moving Toward Subsidy-Free Flexible Operation
Like other emerging technologies, the operation of electrolyzers in the maturity phase should primarily rely on market mechanisms rather than direct support, including gradually phasing out direct subsidies such as investment grants, allowing market competition to drive cost reductions. Long-term PPAs are expected to remain relevant over the long term, but once all additional and relevant requirements must be adhered to, competition for favorable PPA conditions may intensify, driving up PPA prices and hydrogen production costs. Nevertheless, PPAs can serve as another tool to help maintain relatively stable operating costs without substantial public subsidies. Finally, as the availability of hydrogen storage increases and hydrogen infrastructure becomes interconnected, electrolyzers will be better positioned to provide system services such as balancing or congestion management. Throughout these phases, a balance must be struck between incentivizing flexible, efficient hydrogen production and minimizing system costs (such as costs arising from increased congestion risks). This means that the path toward the competitiveness of electrolyzers must be combined with progressive grid upgrades and location signals to encourage asset siting that aligns more closely with system needs. In congested areas, flexible connection agreements should also be considered as a policy option, as proposed in the latest "Electricity Regulations." The core purpose of any support mechanism is to facilitate investment in the expansion of new technologies, rather than becoming a major component of their revenue. The European Network of Transmission System Operators for Electricity (ENTSO-E) recognizes the importance of electrolyzer technology and other hydrogen facilities for future decarbonization efforts. The primary factors influencing the electrolyzer business case should always be the growing and increasingly diverse demand for hydrogen (expanding the hydrogen market) and the development of hydrogen infrastructure, networks, and storage (enhancing their flexibility potential). Diversifying hydrogen sales channels (such as industrial, transportation, and electricity) while maintaining operational flexibility to respond to market conditions is a key strategy for reducing quantity and price risks.
Author: Zhen Ma
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