Missing in action: Iceland's hydrogen economy; Once aimed boldly at the 21st century, Iceland's hydrogen dream seems to have been hijacked by privateers with a 19th-century vision.

In 1998, the tiny country of Iceland (population 300,000) stunned the world by announcing its intention to be the vanguard of the scientific and engineering quest to achieve a hydrogen energy economy--that is, to eliminate its dependence on fossil fuels in favor of the limitless possibilities of clean hydrogen. An article in the November/December 2000 issue of World Watch described Iceland's activity and aspirations: the Icelandic Hydrogen and Fuel Cell company had been formed; a prototype ship was expected to be launched by 2006; the energy transformation could be completed by 2030 or 2040. A leading proponent was Bragi Arnason, a chemist nicknamed "Professor Hydrogen," who had argued as early as 1993 that Iceland was an ideal laboratory for showing the way toward the energy economy of the future. Arnason was "something of a national hero," wrote author Seth Dunn.

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"Many people ask me how soon this will happen," Arnason said in 2000. "I tell them, 'We are living at the beginning of the transition. You will see the end of it. And your children, they will live in this world.'"

Perhaps--but events of the last few years suggest that Professor Arnason might have cause for disillusion. Officially, the national hydrogen agenda is unchanged, and Iceland continues to receive tremendous favorable media attention for its hydrogen plans. But the only material evidence of the transition is three hydrogen-powered buses that have roamed the streets of Reykjavik since 2003, fueled by a single electrolyzer station. No fleet expansion seems imminent, despite promises, nor are there any hydrogen ships or cars. More importantly, no research facilities have been built and no hydrogen industry is materializing. In fact, Iceland's hydrogen production is actually declining. The country used to produce a fair amount of hydrogen from electrolysis, which was combined with atmospheric nitrogen to make ammonia-based fertilizer. But the fertilizer plant was shuttered in 2004. As a result, hydrogen production has fallen to almost negligible levels in 2006--just enough to power those three buses, the lonely harbingers of Iceland's presumed new hydrogen future.

There seem to be no concrete plans to alter any of this, either. In mid-2006, Jon Bjorn Skulason of Icelandic New Energy (INE), a company owned in part by the National Power Company (NPC) and ostensibly formed to promote Iceland's hydrogen economy, was quoted repeating a common refrain: "People are asking when it will be a reality, and it will take some more time.... I think it will be about 10 to 15 years ahead." A visit to INE's website reveals a plethora of acronyms representing past and current projects such as the hydrogen bus demonstration, many of which appear to be European Commission-funded initiatives where INE merely tags along. There seem to be little or no tangible deliverables in these projects, nor concrete timetables. A faint ray of light is a proposed Hydrogen Energy Technology Centre, which promises, in some undetermined future, collaboration between Icelandic academic and research facilities and INE. Considering that INE was founded in 1999, the pace of progress is unhurried.

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Indeed, it seems that Iceland is passively relying on others to shoulder the initiative and the critical funding of research, while merely offering the country as a staging ground. In a 2003 ministerial meeting of the International Partnership for the Hydrogen Economy in Washington, D.C., industry and commerce minister Valgerour Sverrisdottir said of Iceland's plans, "Our contribution would be to offer the country as a suitable base for hydrogen demonstration projects and a technical testing ground."

All this is disappointing enough. But worse, Iceland's government is now engaged in a blitzkrieg against its beautiful wilderness, working furiously to dam some of the country's most powerful and scenic rivers and erect hydroelectric power plants to supply electricity for polluting aluminum smelters owned by foreign interests.

The country's first aluminum smelter, built in 1970 outside Reykjavik and now owned by Alcan, was expanded to 160,000 metric tons per year in 1997 and has been authorized to produce as much as 460,000 tons per year, provided the electricity becomes available. Noroural, owned by Century Aluminum, has operated a smelter that uses geothermal co-generation power since 1998. Its capacity was expanded earlier this year from 90,000 tons to 220,000 tons, and a further expansion of 40,000 tons is expected next year. Another 150-250,000-ton smelter utilizing geothermal power has been proposed for the Reykjanes peninsula west of Reykjavik, to be built by 2010. Alcoa and Icelandic authorities have been discussing an additional large aluminum smelter with associated power projects for the north of Iceland.

But the largest of all of these projects, and arguably the one of the greatest ecological consequence, is the 690-megawatt hydropower plant Karahnjukavirkjun, soon to be completed north of the Vatnajokull glacier in the northeast of Iceland. It will dam two major glacial rivers, Jokulsa a Dal and Jokulsa i Fljotsdal, both to service an aluminum smelter being built by Alcoa that will double the country's energy use in metals industries. When this project was presented to the parliament for a vote in 2002, the economic arguments for it were an expected 1-percent increase in GDP, a 14-percent increase in exports in the first decade, and 1,000 permanent new jobs in the aluminum industry and secondary services. It was said that the project would bolster the economy of the eastern part of the country and stabilize a population decline caused by a lack of economic opportunities.

By itself, if its electricity output were devoted to the production of hydrogen, Karahnjukavirkjun would be large enough to supply all land and sea vessels of Iceland with hydrogen fuel. Instead, the development path chosen by the country's leaders leaves the promise of the hydrogen economy languishing in utter neglect with no tangible government support. It remains little more than a quick coat of paint on an industrial model that is starting to resemble Victorian England more than the progressive development path that many expected.

Elemental Choice

A sound energy and industrial policy for Iceland (or any country) should strive for an optimal balance among various objectives, such as economic growth, job creation, diversification of the economy, and an improved balance of trade. (Many would also add resource conservation, environmental protection, and the promotion of public health and wellbeing.) Proponents of expanded metals smelting in Iceland might argue that all these objectives are being served in optimal balance.

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They would be wrong, however. Expansion of the aluminum industry presents lesser opportunities for economic and social benefits than channeling the equivalent energy and capital into the buildup of a true hydrogen economy entailing not only fuel production but also research, science, and associated industries.

An economy that builds industry and research facilities around hydrogen would require a large number of highly skilled workers in both. This contrasts with the transient plant construction jobs (mostly filled by foreign workers), jobs in metals smelting, and mere translocation of auxiliary service industries offered by smelting expansion. Any economist can confirm that, in the end, it is the high-value-added industries and businesses that contribute most to economic prosperity, while commodities such as aluminum are seldom engines of spectacular growth and longterm economic and social advancement.

What about economic diversification and balance-of-trade benefits? Iceland's fisheries have always been, by far, the largest source of export earnings. Nevertheless, and despite the metals industry gaining ground, the country's trade deficit was a huge 26 percent of GDP in the first quarter of 2006, in large part due to the cost of constructing hydropower plants. The currency was buoyed for a while as the inflationary pressure of the construction boom forced the government to raise interest rates to over 13 percent. Yet the fear of a post-boom recession has driven currency speculators away, causing extreme oscillations. Recently, the Financial Times said Iceland was jumping out of the frying pan and into the fire by seeking to "escape the capricious capital markets by becoming reliant on a single commodity." Export potential in hydrogen-related manufacturing industries and technology would seem more promising in the long term, in addition to reducing gasoline imports.

The economic value added per unit of energy would tend to be much larger from advanced industries, research, and technology development than from the commodity trade, especially considering that the NPC (which is jointly owned by the national government and the City of Reykjavik) is taking on most of the risks of the commodity markets. The Icelandic Nature Conservation Association (INCA) recently confirmed an earlier assertion that the expected return on investment for the new hydropower plants would be far below what a private investor would demand, so the NPC will be effectively subsidizing power sales to aluminum smelters. INCA concluded that the projected net present value of revenue would be US$420 million below the initial construction cost (assuming a 9-percent average cost of capital instead of the NPC's unrealistically low 6.9 percent). Moreover, the NPC typically negotiates variable rates for power that are indexed to the market price of the commodity; if the price of aluminum drops, so does the price of power to the smelters, which are wholly foreign owned. The government has thus not only subsidized the power but also effectively assumed most or all of the operational risk of the smelters.

Aluminum Cant

The catalog of disaster goes on. Subsidized aluminum production is economically inefficient and harmful because it postpones unnecessarily the transition into advanced materials, such as carbon fiber, that have far greater fuel efficiency benefits. Subsidies also weaken otherwise strong economic incentives to recycle aluminum. Despite the huge potential energy savings, only a fraction of the used metal is ever recycled.

This nonsense prevails in Iceland, and in many developing countries, because of "national" power companies that have no real accountability to any shareholders. When it comes to resource extraction, these companies proceed in the name of the public interest as "government agencies," with limited scrutiny and absolute power. But when their business decisions are questioned, they turn secretive as they switch labels and claim business confidentiality as "corporations."

Resources and capital are squandered when national power companies absorb commodity risk and subsidize power prices, thus keeping commodity prices artificially low. The resulting environmental damage is pronounced in both its scale and in its futility. If thousands of hectares of land eventually are to be submerged to fuel the nation's future prosperity, should this land be wasted and practically given away in a mindless competition with developing countries for the investment dollars of Alcan and Alcoa? Or should the power be allocated to the highest value-added economic activity that truly encourages a more sustainable and progressive future for the next generation?

The vast lands being flooded under hydropower reservoirs appear, to some, to be barren wasteland. But other more perceptive observers correctly identify varied flora, critical migratory bird habitat, and intense natural beauty. Aluminum plants emit enormous quantities of greenhouse gases such as sulfur hexafluoride (S[F.sub.6]) and roughly two tons of carbon dioxide (C[O.sub.2]) for every one ton of aluminum. As a result, Iceland's greenhouse gas emissions have grown tremendously in recent years. The environmental cost is significant, but what is most painful is that the land and climate are being sacrificed to subsidize heavy industry rather than to bring about any real progress for the nation.

In sum, through its expansion of the aluminum industry and its low and variable power prices, the NPC is subsidizing resource waste, hastening environmental degradation, and holding back implementation of superior advanced materials. It may be a drag on national and global prosperity rather than an engine of progress. Meanwhile, the promised hydrogen economy is left to stagnate.

Rum Punches

Extractive economies are often prone to focus on easy short-term profits at the expense of longterm viability. Poor nations may do this out of desperation, but wealthier governments that should have a clear view of the danger may do it as well, driven by ideology or the chance for personal gain. Could this be true of Iceland's energy policy?

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Many Icelanders became suspicious of government intentions when the NPC was less than forthcoming about the economic viability of Karahnjukavirkjun. But that is not the only reason. In 2001, the National Planning Agency, which is responsible for environmental impact assessments and advises the government on planning and building issues, recommended against the project, but the minister of the environment nullified the agency's recommendation and the agency capitulated. An official information request by Arni Finnsson, president of INCA, revealed in January 2003 that National Power Authority geophysicist Grimur Bjornsson had voiced doubts to his superiors in February 2002 about NPC's own environmental impact assessment and suggested that geological instability might be a threat to the integrity of the proposed dams, contrary to the NPC's assertions. In the context of a statement by Bjornsson on national television in August 2006 that his superior had stamped his report confidential back in 2002, Finnsson noted that the findings were never shared with the parliament before the project was approved. When the NPC acknowledged this summer that the dams would need structural reinforcements at a significant cost, Bjornsson's current employer, the municipal power company of Reykjavik, ordered him to stay mute on the topic, according to the Icelandic newspaper Morgunblaoio. Following that public revelation, the gag order was reversed.

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Why would the government be pursuing Karahnjukavirkjun and other projects like it if it means subsidies to the aluminum industry, covering-up of risk assessments, foolhardy dam construction, scrapping of environmental impact assessments, and generally sidelining the hydrogen economy? Are the projected new jobs and export growth reasons enough to justify the government's intensive construction schedule for new power projects during the past few years?

It is my firm belief that the reason for the hurried construction agenda is an impending plan for the full privatization of the electricity sector of Iceland. There has been no public discussion of this possibility that I am aware of and the government has stated that it has no specific plans to sell generating assets to private parties. But the circumstances are compelling.

In 2003, a new law created an administrative separation between power production and power distribution, as has been done in the United States and elsewhere, as a first step towards wholesale competition in electricity generation. As noted earlier, the NPC can construct power plants essentially at will as a government agency, yet claim corporate secrecy privileges when queried on negotiated terms and power prices to industry. After deregulation and privatization, private power producers would initiate all new power projects. No nongovernment agency or corporation is empowered to simply appropriate land and hydropower resources without taking the matter to the nation (the owners) and negotiating a fair price. If the buyer were not the government--which presumably would act in the best interest of the nation--then any potential deal would be very closely and publicly scrutinized. The price demanded by a more inquisitive public might be too high for any deal to be reached and the power project might come to a stop. However, if by that time the government has already dammed most of the large rivers, the possibility of the nation ever negotiating a fair price for its resources would be gone. So privatization is likely to be initiated only after the huge construction boom is complete and all the most valuable hydropower resources are already tapped and under government control.

At that point, the government will auction off the power plants. The bid prices will be lower than those the nation would have demanded from a private party under open market conditions at the time the plants were originally built, and they will be lower than the initial construction cost. This follows from the fact that the terms of current power deals are an effective subsidy to the aluminum plants. Future buyers of the hydro plants might not be able to fetch a much higher price for the power, even if they tried to renegotiate. But they would also require a higher return on equity than the government because they are investors and not a government that simply wants to utilize resources at any cost. They will also have to borrow money for the purchase and most likely at a higher rate than the government of Iceland pays. They will therefore demand a higher return on debt as well to cover their cost and risk. The result is that their bids for the assets need to be very low to generate a high-enough return--certainly lower than the initial construction cost to the government. In other words, the new plants would be sold below book value at a net loss to the nation.

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This is a devastating one-two punch. First, the government taps energy resources that probably would not have been economic to pursue, at least for aluminum production. This robs the nation of the opportunity to allocate the resources later (or leave them untouched) under transparent conditions and in a manner that creates the greatest value. Then the government sells those same resources at a loss, as dictated by the "free" and "rational" market.

The environmental and social losses, and the greater loss to the future prospects of Iceland, are unquantifiable. Moreover, if, as some metals proponents claim, the plan is to pursue the hydrogen economy (even at a leisurely pace) alongside the metals industry development, that opportunity may be waning. The resources are rapidly being co-opted by the government and tied to the metals industry indefinitely.

Ironically, this is happening at the hands of the politically conservative proponents of "free markets" who, on this occasion, are more than willing to set aside their ideals of letting the markets dictate resource allocation, at least until they have had an opportunity to personally manipulate the outcome through their economically questionable construction frenzy and power price subsidies. Thus, political or economic ideology alone cannot explain current policies, and Icelanders are left to wonder what other motivations might account for them. One explanation may be that a certain oligarchy in Iceland's elite circles of power and finance sees an opportunity to transfer national resources into private hands at bargain prices. It happened in Russia with its oil and gas resources after the fall of the Soviet Union and, at this rate, it may happen in Iceland in the next few years.

Emperor Narcissus 

Icelanders are proud of their relatively clean environment, but it is largely a product of natural conditions rather than any actions of our own. The cold wind from the north has done more than any native of Iceland to maintain the pristine views. Our small population--lacking the coal, iron ore, and other mineral resources for the polluting industries typical of the 19th century and enjoying relatively abundant renewable energy and clean water--barely needs to lift a finger to sit so pretty.

Maybe too pretty. You may stop minding your looks when you take them for granted. Iceland is starting to make mistakes as the government abrogates the responsibility and initiative to fully fund and support a new development path. The favorable image it still manages to project globally with its presumed hydrogen plans only encourages this indolence, as the nation gazes adoringly, like Narcissus in Greek myth, at its own reflection in the media mirror. Thus Iceland slides backward toward the exhausted development model of a bygone era.

Why are people not outraged? A few Icelanders are very upset about the power projects themselves, because of their environmental effects and questionable economic justification. But most do not see the second blow coming, when the losses will be cemented through privatization. My countrymen are on the brink of selling their most precious assets, the energy, the land, and all its beauty at a net economic loss--not to mention the loss of pride, opportunity, and promise for the generations to come. Three shiny hydrogen buses blind the rest of the world to the threadbare nature of the emperor's new clothes. That's why I hang my head these days whenever I am asked about the promising new hydrogen economy of Iceland.

Freyr Sverrisson, a native Icelander, is an independent energy policy consultant in the United States.

For more information about issues raised in this story, visit www.worldwatch.org/ww/iceland.