On 17 August 2021, the United Kingdom Government Department for Business, Energy & Industrial Strategy (BEIS) launched its hydrogen strategy – a plan for a world-leading hydrogen economy set to support over 9,000 UK jobs and unlock £4 billion investment by 2030.
In addition, BEIS also launched:
– its long-awaited consultation on a business model for low carbon hydrogen production; and
– the Net Zero Hydrogen Fund (NZHF) consultation. This sets out the proposed scope, design and delivery of the £240 million NZHF, which intends to make grant funding available to support the capital costs of developing and building low carbon hydrogen production projects.
Background to the Proposals
In the Prime Minister’s Ten Point Plan for a Green Industrial Revolution published in November 2020, the UK stated its aim for 5GW of low carbon hydrogen production capacity by 2030. The objective of the business model described in the consultation is to incentivise the production and use of low carbon hydrogen through the provision of ongoing revenue support.
The model’s aim is to overcome one of the key barriers preventing the deployment of low carbon hydrogen projects, namely the cost gap between low carbon hydrogen and higher carbon “counterfactual” fuels. A “counterfactual fuel” is fuel replaced by hydrogen for a given customer – for example, diesel, if hydrogen is sold to a diesel customer in place of that customer using diesel.
The Government describes a variety of end users for hydrogen, including refinery process heating, transport, industrial heating, hydrogen blends used in Combined Cycle Gas Turbines (CCGTs), and ammonia production.
Summary of the Business Model Proposal
The Government is favouring a variable premium price support model to mitigate hydrogen market price risk for investors, on a sliding scale based on increased volume to mitigate hydrogen volume offtake risk. This innovative proposal will require intense scrutiny by developers and funders of potential hydrogen production projects, and many will wish to respond to the consultation, which closes on 25 October 2021.
The proposal will also be keenly watched by businesses trading in counterfactual fuels who may also wish to respond to the consultation. Their markets could be affected by the proposals – and the Government repeatedly states it is keen to avoid “market distortion”.
The consultation sets out the key parameters considered in designing the business model. The business model is intended to be applicable to a range of production technologies, particularly natural gas reformation with CCUS (“blue hydrogen”) and electrolytic hydrogen (“green hydrogen”). Other production technologies, such as hydrogen from biomass gasification with CCUS, are also possible.
The funding mechanism for the support described in the model has yet to be published but will likely involve funding by consumers. Further consultations from the Government can be expected on consumer funding. For carbon capture, consumer funding models based on contracts for
differences (CfDs) are proposed, and similar models may also be ultimately proposed for low carbon hydrogen.
A Standard for “Low Carbon Hydrogen”
The Government intends hydrogen produced to meet a future UK low carbon hydrogen standard to qualify for and receive business model support. The standard is intended to define what is meant by ‘low carbon hydrogen’ and set out maximum acceptable levels of greenhouse gas emissions associated with different production technologies.
Government and Consumer Risk Taking
The Government recognises that it has a role in managing two key risks for early hydrogen projects: market price risk and volume risk. The intention is, evidently, to pass on such risks to consumers, rather than taxpayers. The Government sees the nature and balance of risks between hydrogen production facilities and Government evolving as the market matures- and implicitly intends increasingly more risks taken by the private sector as the hydrogen sector develops.
Hydrogen Market Price Risk: A Variable Premium Price Support Model
Hydrogen market price risk is the risk that the price the producer is able to achieve for selling hydrogen does not cover the cost of producing it, as hydrogen is unable to compete against counterfactual fuels, such as natural gas or diesel. This makes it uneconomical to produce low carbon hydrogen and attract the necessary investment in a production plant.
In the consultation the Government considers various price support options including fixed price, fixed premium and variable premium, and also considers an approach to reference price options including input energy price, natural gas price, counterfactual fuel price, achieved average sales price of the hydrogen production plant, market benchmark price, carbon price, and natural gas plus carbon price. Indexation methodologies are also considered – inflation linked, actual input energy cost, and natural gas benchmark.
The Government indicates that its preferred approach is a variable premium price support model, as this enables flexibility and the possibility that the level of subsidy can reduce over the length of the contract as the market evolves, rather than only across allocation rounds. For reference price, the Government prefers an approach that comprises the highest of two inputs: the natural gas price and the achieved sales price. The Government aims to integrate a market benchmark price into the reference price at the earliest opportunity for future projects. The Government is planning further work on the appropriate approach to indexation.
Hydrogen Volume Risk: A Sliding Scale Pricing Model for Volume Support
Hydrogen volume risk is the risk that a hydrogen production facility is unable to sell enough volumes of hydrogen to cover costs with reasonable confidence. This may happen due to inconsistent demand for hydrogen by offtakers, offtakers are slow to adopt and use contracted hydrogen, unforeseen outages or unplanned closure of offtakers, an offtaker’s market conditions or financial circumstances unexpectedly change, or a sole demand user no longer requires low carbon hydrogen, in each case leading to stranded hydrogen production assets.
A number of options for volume support are considered, including availability-based payments, partial Government offtake (take or pay), Government offtake backstop (Government as buyer of last resort when hydrogen volumes cannot otherwise be sold), Government offtake frontstop (Government support triggered on the last hydrogen volumes that cannot be sold, as opposed to the
first volumes that cannot be sold) and sliding scale. Sliding scale involves the Government providing volume support not by purchasing hydrogen, but indirectly through progressive price variation with higher prices where hydrogen sales volumes are low, declining as volumes increase. The Government indicates that the sliding scale approach for volume support is the Governments preferred option.
The Government also analyses other considerations including the contractual length/duration of support, and the scaling up of volumes at a supported plant above the supported capacity. The allocation method of the proposed business model is also considered, with two options: bilateral negotiation, and auction.
Consumer Funding Mechanism
Details of the revenue mechanism by which consumers will fund the hydrogen business model will be provided later this year. Unlike for the Government’s proposed carbon capture usage and storage models (CCUS), taxpayer funding for low carbon hydrogen production, other than the NZHF, is not proposed.
This may be because hydrogen raises an additional complication: as there are many end-uses for hydrogen, the chosen funding mechanism must be considered across a range of different sectors and consumers, not just one consumer. This may make the approach more complex than mechanisms used to support clean electricity (for example Contracts for Differences, Renewables Obligations and Feed in Tariffs).