GAME CHANGERS: DECARBONIZING INDUSTRIAL HEATING

In the first edition of our ongoing Game Changers series, we examined the copper industry and demonstrated that, despite the small carbon footprint of the industry, and the relative abundance of available solutions with which the copper miners could decarbonize, there was still a need to pull multiple levers across different parts of the production chain. As we delve deeper into the challenges associated with decarbonizing the real asset eco-system and look forward to future posts that examine specific downstream industries with complex processes, we need to improve our industrial literacy.

Difficult to decarbonize businesses, especially those downstream of extractive industries, have two primary sources of emissions: the generation of heat and process-related emissions. Heat-related emissions take the form of energy needed to create the necessary heat and power to drive machines, transportation of products, etc. Process-related emissions, the most diverse and challenging to address, arise from how a business produces a product. Some industrial activities (like steel manufacturing) have both sources of emissions. In process and combined emissions industries, the chemical byproduct of burning fossil fuels often makes substituting a carbon-based heat source for a carbon-free heat source much more difficult.

Industrial Heating – An Important Extension of Every Investor’s Industrial Literacy

The industrial sector is made up of a staggering number of unique processes. From advanced manufacturing to chemical production to metal processing, the complexity and diversity of processes make industrials extremely challenging to decarbonize. While any single process-related decarbonization solution is unlikely to be portable across the entire sector, a cross-cutting opportunity is the decarbonization of heat. The generation of heat accounts for most industrial sector emissions and is responsible for more than 10% of total global atmospheric emissions.

Industrial processes produce critical goods at the lowest price possible within the context of highly engineered global supply chains. Efficiencies drive down costs, creating the semblance of economic sustainability, typically in the absence of environmental sustainability. This dynamic complicates the decarbonization process, particularly for heat generation.

There are two reasons for this. First, the energy cost associated with producing heat makes up a significant portion of operating expenses. Second, the plant and equipment are usually fit for purpose and depreciated over a multi-decade time horizon. Changing a heat source usually means management teams are faced with either an expensive retrofit and retooling of an existing industrial facility or a complete rebuild.

There is a yet-to-be-resolved tension within heat-driven industrial businesses between the current operating paradigm, in which economic sustainability primarily results from being the lowest cost producer, and environmental sustainability, which requires a more expensive source of heat.    

Approaches to Decarbonizing Industrial Heating

Heat demand can be characterized by temperature (how hot do I need my heat source) and load (the heat transfer rate required). The end-use application will dictate both variables. This is important because if the aim is to decarbonize heat, the new heat source must provide the requisite temperature and load for the end-use application. There are four broad approaches to decarbonizing heat in industrial processes: zero-carbon heat sources, zero-carbon fuels, electricity use, or capture carbon. Each method has strengths and weaknesses; all will likely find a fit for purpose use in a decarbonized future.

Zero-Carbon Heat Source: Instead of burning fuel to generate heat, we can harvest it directly from the environment. There are two high-level sources of zero-carbon heating:

1. Solar Thermal Energy for Industrial Processes (SHIP): Solar is an attractive resource due to it is abundance and lack of fuel costs, but intermittency, areal density, and achievable temperatures are an issue. Solar is also a highly geographic resource making it unsuitable for many locations. The resource intermittency of solar reduces capital utilization, which drives up total costs, a problematic feature for low margin businesses that compete on price. Furthermore, existing solar installations used to drive steam power cycles for electricity operate at maximum temperatures of 565 degrees C – roughly a quarter of the flame temperature of natural gas, hydrogen, or fuel oil. According to the research conducted by IRENA, almost 50% of global industrial processes require temperatures within the range of what is possible via solar heating.1 According to the National Renewable Energy Laboratory (NREL), two-thirds of domestic (US) industrial process heating is used for applications below 300 degrees C.2 SHIP appears to be a good source of heat for the Chemical, Food, and Beverages, Paper, Rubber, and Plastic, Textiles and Wood industries.

   • Those interested in learning more should consult: Solar-Payback.com

   • Companies with pure-play exposure to SHIP include Absolicon (ABSL) and Savosolar Oyj (SAVOS).

2. Geothermal: Geothermal is a theoretically attractive source of heat as it does not suffer from intermittency, and facilities have much smaller land footprints relative to solar. However, suitable geothermal reservoirs are not widely distributed and generate relatively low temperatures between 100-150 degrees C; insufficient for most indusial heat demand.

   • Producers of Geothermal Electricity: Ormat (ORA), Polaris Infrastructure (PIF), Contact Energy Limited (CEN), Innergex (INE), Mercury NZ Limited (MCY)

   • Geothermal Tech: Climeon (CLIME B), NIBE Industrier AB (NIBE B)

Zero-Carbon Fuels

Burning gas, coal, or oil is the primary method for industrial process heat today. Hydrogen, ammonia, and biofuels are alternative fuel sources that, when burned, produce little to no emissions. Hydrogen produces water when burned; ammonia produces nitrogen. Many Industries have extensive experience with these fuels as feedstock but less experience burning them directly for heat. To be adopted as an industrial fuel, either must be produced cost-effectively at scale using zero-emission technology.

Direct fuel substitution is possible in some situations but not all. In some cases, a direct substation is more difficult as the heat source provides heat and serves as a reactant. Steel production is a good example: in a blast furnace, coking coal is used to create heat, and the carbon monoxide byproduct is the primary agent to convert iron oxide to iron. Even if the cost of producing alternative fuels from renewable resources becomes cost-effective, direct fuel substitution for heat generation only applies to end-use applications that do not rely on hydrocarbon byproducts in their process.

Of the zero-carbon fuel sources, hydrogen has received the most attention as of late. Although hydrogen's potential remains significant, a matter we have discussed elsewhere, the end-use market and final aggregate demand are open-ended questions. We believe that the 2020-2030 period will be one of market development for hydrogen and pilot projects. Full-scale industrial operations utilizing hydrogen are still some years off.

• Those interested in Hydrogen Producers should look at the significant industrial gas firms: Air Products (APD), Linde (LIN), & Air Liquide (AI), those interested in pure-play advanced hydrogen technologies, such as electrolyzers, should look at ITM Power (ITM), NEL ASA (NEL) and Mcphy Energy (MCPH).

• Hydrogen is an opportunity being pursued by many firms at this point, and few if any international oil companies, utilities, or industrial conglomerates are not making some efforts to figure out a hydrogen path/product. All will likely provide investors some hydrogen exposure.

Electrification of Heat: We can also generate heat from electricity. The challenge with electricity is that for most industrial users, electricity costs exceed fossil fuel costs. As a result, to be cost-competitive, electric sources of heat generally require a heat output per unit of electrical input to be greater than one. This is why hydrogen production using renewable electricity as a generating source is 2-3x more expensive than natural gas. Electrified heating technologies must gain proportionally in efficiency if electricity costs do not fall below fossil fuel costs.

Heat pumps are an attractive solution here. Unlike resistive heating, one unit of electricity can often result in more than one unit of useful heat. Heat pumps, however, have high up-front capital costs relative to boilers which translates into significantly longer payback periods. Additionally, industrial heat pumps today can only supply heat up to 180 degrees C and rarely offer over 1 MW of capacity.

At a large scale or a network level, complete heat electrification requires a massive increase in electrical transmission. In the United States, roughly double the electricity would need to be running through the wires to meet industrial thermal energy demand alone (it would be an order of magnitude more if you include high penetration of EVs or transportation electrification).

The challenges of decarbonizing industrial heat are not insurmountable. But they are nonetheless real and will likely require significant changes to either product cost or company cost structures, or more likely, both. A few takeaways:

• Some applications, like steel, will have more difficulty accepting fuel substitution.

• All options will substantially increase the production cost and wholesale price of industrial products.

• Most substitutes today are technically more challenging and more expensive than carbon capture and storage (CCS). CCS is not without its costs and documented challenges. Still, it is actionable today and has the added benefit of capturing emissions from byproduct processes, but just carbon emissions from heat.

• The hydrogen hype is not without merit; combusting hydrogen is likely the readiest heat source across all options (its use cases relative to minimizing the levelized cost of heat). However, the promise today lies in reforming natural gas and decarbonizing with CCS (blue hydrogen). It has the best cost profile, most mature supply chain and would add ~10-50% of wholesale product costs. Importantly, it would provide a pathway to substitute hydrogen produced by electrolysis of water from carbon-free electricity (green hydrogen). However, if implemented today, carbon-free hydrogen would increase wholesale production costs by 200-800%.