Strategic decision management as an instrument for navigating through opportunities and risks

The road to climate neutrality is picking up speed. Last week the EU accelerated the energy and climate transition and raised the target for reducing greenhouse gas emissions by 2030 from 40% to 55%. In the run-up to the next UN Climate Change Conference (COP26) next year, more and more countries are committing to climate neutrality, and here too the development is becoming more and more dynamic and concrete.

Even if there are different approaches regarding the definition of climate neutrality and suitable measures, what is clear across all countries and industries: the topic is getting serious. In addition to the goals, an acceleration of accompanying political and regulatory measures can be expected to achieve the climate goals. The EU Green Deal aims to mobilize at least 1 trillion euros in the EU for sustainable investments in the next decade.

Hydrogen, the energy carrier with great potential …

For Europe and Germany, hydrogen will play a central role to achieve the goal of carbon neutrality by 2050. Hydrogen will play several roles in the energy system of the future, namely as

  • Energy carrier (e.g. as fuel in mobility)
  • Storage medium
  • Essential element of sector coupling (e.g. for the conversion and storage of surplus electricity from renewable sources)
  • Feedstock for industry (e.g. for the decarbonization of production processes such as the replacement of hard coal coke in the steel industry)
  • Key ingredient for synthetic fuels together with captured CO2 emissions (e.g. from the cement industry)

The potential for hydrogen is enormous: According to analysts, green hydrogen could cover up to 24% of the total energy demand in the EU.

… and big challenges

The challenges on the way to realizing this potential are just as big as the long-term potential for hydrogen:

1. Technology and costs
Almost all technologies for the production and use of CO2-free hydrogen are currently not economically competitive with the fossil fuels used. Competitiveness is expected for the future due to economies of scale and technological progress, but the forecasts for the speed and extent are fraught with uncertainties

2. Supply of hydrogen in sufficient quantities
Next to the production of green hydrogen with renewable power, low carbon hydrogen can also be produced with nuclear power or natural gas (Blue hydrogen using SMR process together with Carbon Capture and Storage and Turquoise hydrogen is produced using pyrolysis technology). The latter two are however not universally accepted and may only be used for a transition period. For supplying Europe only with green hydrogen, the required renewable power capacities cannot be covered from Europe alone, so import flows must be built up

3. Development of infrastructure and market development (chicken-and-egg problem)
In addition to the availability of hydrogen, both the demand for hydrogen applications and the required infrastructure must increase. This integrated market development should, if possible, take place in parallel, but examples from the past with other technologies have shown that the parallel increase in supply and demand does not always work

4. Political-regulatory framework
The preceding challenges show how much market participants depend on political instruments (such as CO2 (floor) prices, subsidies, quotas, carbon contracts for difference) to support the transformation towards a hydrogen economy. Politicians have recognized the need, but it still takes time for these framework conditions to be concretized, partly because not all measures are undisputed or require international cooperation.

Companies in the affected industries need to act, but when and how?

Given the challenges outlined above, the way forward is not easy for companies in the affected industries. In addition to the uncertainties, there are also many crossroads with important decisions on the pathway towards the establishment of a new hydrogen value chain. It may be tempting to postpone decisions hoping for less uncertainty in the future. However, simply delaying decisions is not free of risk, as on the one hand the status quo is exposed to risks (e.g. due to the increase in the CO2 price) and on the other hand the timely entry into the newly designed hydrogen economy may be missed. The decision-making process should therefore start quickly.

The need for decision making is accelerating, as is the risk of wrong decisions

In view of the uncertainty and complex issues, a pro-active approach for high-quality decision management is required. The tools of decision science provide helpful process steps and methods for determining the optimal decision path

In the first step, the decision frame must be determined. Following the review of the decision situation, the objective of the decision and the scope are discussed and determined. In the case of different goals, priorities or rules for trade-offs should also be defined to be able to resolve possible conflicting goals. The set decision frame opens the possible solution space for generating alternatives.

Essential questions and considerations for the above steps are listed in the following list:

Setting the decision frame

  • Is decarbonisation the only goad or is it also about the possible establishment of a new business area?
  • Is there a clear idea of positioning in the value chain?
  • Does the entry into hydrogen business have an impact on the existing business model?

Definition of goals and trade-offs

  • What are the profitability criteria (absolute and relative to the core business); do the same profitability expectations also apply for pilot plants?
  • Is the reduction of the CO2 footprint a goal, should the CO2 avoidance costs be optimized?
  • Are there any learning objectives (technology)? Should a core competence be developed?
  • Should growth options or an “early mover” advantage be created?

Generation of alternatives

  • Variants for the timing of investments or the speed of transformation towards hydrogen
  • Approach for project development (e.g. stage gating the development)
  • Partner selection and structure of cooperation agreements
  • Internal resource allocation for the possible development of a core competence
  • Creation of real options; built-in flexibility in development (e.g. for later scaling)
  • Technology options
  • Positioning in the value chain

A sound analysis then enables a transparent comparison of the risks and returns of the different alternatives. Decision analysis not only enables a transparent comparison of the risk / return profiles of the individual alternatives but also enable specific questions to be answered, such as the question of the value of real options, the value of waiting or the value of missing information, i.e. what value does it bring for the decision to reduce the degree of uncertainty (this approach, for example, opens up further alternatives in which one invests in information).

The assumptions about the future are essential input for the analysis. In order to map the uncertainties, not only base case assumptions should be made, but a probabilistic forecast of the possible outcomes (at least for those assumptions with the greatest leverage on the result).

As a last step, it should be considered that there is still scope for decision making until the end of the implementation path which should be used. The assumptions made at the time of the decision should be continuously validated to be able to adjust the selected measures if necessary.

The topic of hydrogen is gaining momentum and will occupy the affected industries for years. It is therefore important to evaluate the opportunities and risks right now and to determine the strategic direction based on a high-quality decision framework.

Author: Daniel Dantine
© Decision Advisory Group GmbH