Hydrogen Business Models: details of the Low Carbon Hydrogen Agreement begin taking shape 

United Kingdom

In August 2021, as part of the UK Hydrogen strategy, the Department for Business, Energy & Industrial Strategy (“BEIS”) launched its first consultation on a business model establishing the financial support framework for low-carbon hydrogen (the “Business Model Consultation”). This consultation was published alongside a related consultation to define “low-carbon hydrogen” (“Hydrogen”) i.e. the Hydrogen which will be eligible for support under the business model (the “Hydrogen Standard Consultation”).

On 8 April 2022, BEIS published a raft of Hydrogen-related updates, including:

We summarise the key takeaways of the Business Model Response, LCHA Heads of Terms, Hydrogen Standard Response and Draft Guidance here. For our commentary on the Net Zero Hydrogen Fund (“NZHF”) Consultation Response and Funding Allocation Consultation, please see here.

Price support on offer

For the most part, BEIS intends to proceed with the minded-to positions set out in the Business Model Consultation i.e. to support new Hydrogen production capacity (of 5MW and above) through a combination of price support and volume support, being:

  • (price support) payment of a variable premium (calculated as the difference between a “strike price” (to enable producers to cover costs) and a “reference price” (the higher of the actual price received by the producer and the natural gas price)) - see figure below; and

  • (volume support) price support to be granted on a sliding scale whereby producers receive higher levels of price support during times of low offtake.

Hydrogen image 01

BEIS continues to favour a single business model to apply across different project types and sizes, building in flexibility e.g. around indexation and strike price and possibly running separate allocation processes for different project categories. What’s clear is that due to the way the support has been structured, blending of hydrogen onto the national gas network will not be compatible with the proposed payment structure.

Who can get support?

One change of tack is the proposed treatment of Hydrogen as a feedstock, which was previously not going to be supported. In light of stakeholder responses, BEIS, subject to compliance with subsidy control and public law principles, intends to allow Hydrogen producers to receive a subsidy for sales to feedstock users while continuing to develop additional measures to avoid possible distortions.

Additionally, BEIS is still considering how to accommodate “own consumption” projects, where there may be little or no commercial incentive for the producer to increase their achieved sales price, and sales to intermediaries, particularly where they intend to take ownership of the Hydrogen produced.

Due the nascent nature of the Hydrogen economy in comparison with the electricity market, BEIS considers that a different approach is needed to achieve the objectives of the Hydrogen business model in the absence of a Hydrogen price benchmark, however details of the anticipated direction of travel have not yet been provided.

Sources of funding

Likely to prove controversial is the confirmation that all Hydrogen produced should be levy funded by 2025. It is not clear if funding will come from an additional levy pot or within the existing subsidy budget.

In addition, BEIS does not see a compelling case for introducing a separate scheme for smaller scale projects (below 5MW) for business model support, but such projects will have the option to apply to ‘strand 2’ of the NZHF if they meet all other eligibility criteria (see our commentary on funding allocation here).

Within the scope of funding, at least for the initial projects, BEIS is considering the extent to which transport and storage (“T&S”) networks supporting carbon capture, usage and storage (“CCUS”) enabled Hydrogen production should be supported via the business models, i.e the Low Carbon Hydrogen Agreement (“LCHA”). The concern is that insufficient T&S infrastructure represents a risk for hydrogen producers that will stymie their ability to develop projects. The government plans to publish their findings on T&S infrastructure requirements alongside either a call for evidence or a further consultation later this year.

What are the terms of the contract: LCHA Heads of Terms

The Hydrogen business model is heavily based on the principles of the low-carbon CfD. Accordingly, the heads of terms of the proposed LCHA echo the terms of the AR4 CfD, with little detail of how they may need to be adapted for hydrogen projects. However, there are some early key differences - most notably in the mechanism for determining support level and payment mechanism. Key terms and how they compare to the AR4 CfD are:

Topic

Generic low-carbon CfD

LCHA Heads of Terms

Counterparty

Low Carbon Contracts Company (“LCCC”) (a private company owned by BEIS)

The Hydrogen Counterparty (identity yet to be determined)

Term

15 years

Between 10 and 15 years

Target of support

Supports production of low-carbon electricity in the operating phase

Supports production of Hydrogen in the operating phase

Eligible technologies

”Eligible generating stations” are defined under theContracts for Difference (Definition of Eligible Generator) Regulations 2014/2010.

These are:

  • dedicated biomass with CHP station;
  • energy from waste with CHP station;
  • generating station connected to a complete CCS system;
  • hydro generating station;
  • nuclear power station; or
  • station which generates electricity by the use of any of the following sources of energy:
    • gas, other than landfill gas or sewage gas, formed by the anaerobic digestion of material;
    • gas or liquid formed by gasification or pyrolysis of biomass or waste;
    • landfill gas;
    • naturally occurring subterranean heat;
    • sewage gas; solar radiation when captured by a photovoltaic array;
    • tidal movement where the station has a declared net capacity of less than 1GW;
    • tidal stream;
    • waves; or
    • wind.

 

For each round of CfD allocations, the eligible technologies are divided into “pots” and government confirms the level of economic support available (“Pot Budget”) and the amount of generating capacity that supported (“Capacity Cap”) in respect of each pot.

Hydrogen which meets the Low Carbon Hydrogen Standard will be eligible for support (a GHG emissions intensity of 20gCO2e/MJLHV of produced hydrogen or less).

This is a single threshold using absolute emissions set at the point of production, and covers upstream emissions from the feedstock, such as natural gas, input materials, and emissions from the production process (including energy supply emissions).

Additionally, projects must:

  • be located in the UK;
  • achieve COD by end of 2025;
  • utilise core technology that has been tested to Technology Readiness Level of at least 7;
  • be a new build, electrolytic Hydrogen production facility;

 

  • have identified at least one offtaker;
  • have identified an electrolyser supplier;
  • have a minimum Hydrogen production capacity of 5MW; and
  • have demonstrated access to finance.

 

 

 

 

 

 

 

 

 

Application for CfD

Application

Applications are submitted and assessed by the “Delivery Body” (National Grid ESO) against set criteria including evidence that required project documents are in place.

Assessment

Once the Delivery Body has determined the eligible applications received, they will compare the aggregate value and generating capacity of these allocations against the Pot Budgets and the Capacity Caps. Where these are exceeded, the Delivery Body will determine that a competitive allocation process or auction is required to determine the recipients of the CfDs.

Sealed Bid

The eligible applicants then submit “sealed” (i.e. non-public) bids with the lowest priced bids required to make up the capacity for each pot being selected by the Delivery Body and awarded a CfD.

Application

Applications are submitted to and assessed by BEIS. against the following criteria:

  • deliverability - the level of confidence government has in the delivery plan put forward by the project and the date at which the project can, credibly, be operational by;
  • emissions - the extent to which the project delivers carbon savings to the economy and contributes to the UK government’s 2030 aim and emission reduction targets, including CB6 and net zero;
  • cost considerations - whether the project will deliver cost-effective hydrogen;
  • economic benefits - the contribution the hydrogen plant will make to the economy;
  • market development and learning - the extent to which the project offers growth and learning opportunities in the production and usage of hydrogen; and
  • additionality of electricity source - whether a project’s low carbon electricity source is met by new low carbon generation and does not divert low carbon electricity from other users to avoid negative impacts on wider decarbonation.

Sealed Bid or bilateral negotiations

Agreeing the LCHA will be subject to due diligence, engagement and likely to involve strike price bids. BEIS is considering both bilateral negotiation and “sealed bid” processes.

Determining the level of support

The generator is paid a strike price set in advance for each MWh of electricity produced.

When the actual electricity price is lower than the strike price, the LACC tops this up to the strike price. Where the actual electricity price is higher than the strike price, the generator pays back the difference.

The strike price is set in respect of each technology by reference to the successful bids received.

The producer is paid a premium, calculated as the difference between the Strike Price and the Reference Price for each unit of hydrogen sold (the "Difference Amount").

Payments will be made on a £ per MWh (higher heating value (HHV)) basis. As with the generic CfDs, payments will be two-ways, with the Producer paying the Hydrogen Counterparty the difference between the Reference Price and the Strike Price if the Reference Price exceeds the Strike Price.

Volume scaling i.e. the ability to increase levels of generation and receive subsidy support for those increased amounts.

None offered.

BEIS is considering whether a Producer should be permitted to increase the volume produced within an existing Facility above any level initially set out in the LCHA. However, any additional volumes will not be subsidised through an existing LCHA.

Backstop PPA

Generators who are unable to find a route to market for their low-carbon electricity will benefit from a “offtaker of last resort” arrangement whereby a licenced supplier will purchase their electricity for a limited 12-month period and at a reduced price.

Government isnotminded to act as offtaker of last resort.

Instead, the LCHA will include a sliding scale of support provided indirectly through price variation, with generators recovering higher unit prices where offtake volumes are low, and LCHA payments declining as offtake volumes increase. It is expected that the sliding scale could be adjusted depending on project and technology.

Unlike the backstop PPA, this does not protect generators in the event that their offtake contracts has terminated without replacement.

Funding

TheContracts for Difference (Electricity Supplier Obligations) Regulations 2014/2014provide for every licenced electricity supplier to make a “CfD period contribution” to the LCCC. This is designed to ensure that the LCCC has sufficient funds to meet its obligations to top up generator payments where the market price for electricity falls below the strike price.

This contribution, known as the “CfD levy”, is ultimately passed on to consumers as a charge in their energy bill.

The LCHA will initially be taxpayer funded, with a transition to levy funding anticipated to take place no later than 2025. This will be subject to further consultation and new legislation.

Total amount of support available £ and MWh

As set out above, for each allocation round the government publishes the level of financial support which will be available to each pot of eligible technologies, and how much generating capacity from each technology pot will be supported.

This means e.g. an eligible offshore wind project will not just compete against other eligible offshore wind projects for support, but against all eligible technology types in the pot.

The amount of support for funding a LCHA contract is not yet known.

However, support towards capex spend may also be available through strands 3 and 4 of the NZHF (see more detail on this here).

State Aid

The EU-UK Trade and Cooperation Agreement contains state aid requirements that must be complied with in respect of energy subsidies post-Brexit. These apply to the low-carbon CfD regime and include:

  • that subsidies must be awarded via a transparent and competitive process; and
  • that subsidies must not affect obligations or opportunities to participate in electricity markets.

The approach is likely to follow the AR4 CfD provisions in relation to subsidy control (including provisions prohibiting cumulation in respect of the same eligible costs), subject to being amended to reflect the proposed business model.

The subsidy control provisions will need to be consistent with the Subsidy Control Bill (currently going through Parliament).

Interplay with other support schemes

As part of a CfD application, the applicant must make “cross-subsidy declarations” providing information on other subsidies which the generation station is in receipt of. Recipients of subsidies under the following schemes are not eligible for support via the CfD:

  • Non-Fossil Fuels Obligation;
  • Scottish Renewables Obligation;
  • Capacity Market; and
  • Subject to certain exclusions, Renewables Obligation.

In addition, the generating station cannot already be in receipt of another CfD.

As per the Business Model Consultation, the government supports “revenue stacking” and will consider this in the context of the need to avoid double subsidisation.

Comment

The publications provide further detail on BEIS’ thinking on business model support for Hydrogen that will be required to achieve the government’s recently updated goal of achieving 10GW of Hydrogen capacity by 2030 (see here for our commentary on the energy security strategy), as well as supporting deployment of Hydrogen at the levels that would support the UK’s aim to achieve net-zero by 2050.

The publications provide further detail on BEIS’ thinking on business model support for Hydrogen that will be required to achieve the government’s recently updated goal of achieving 10GW of Hydrogen capacity by 2030 (see here for our commentary on the energy security strategy), as well as supporting deployment of Hydrogen at the levels that would support the UK’s aim to achieve net-zero by 2050.

While the LCHA Heads of Terms are helpful and have been welcomed by the industry, important elements around payment provisions and where the funding will come from remain to be developed. Given the wider pressures of rising energy prices and the impacts of this on businesses and electricity consumers overall, the scope of the levy and who it will apply to will be a point of careful consideration for government. What’s more given the failure of so many suppliers in the British market (more than half have exited the market in the last 2 years), the pressures on remaining electricity suppliers will need to be factored in when casting the “levy” net.

In addition, some in the industry may be disappointed that blending has not been included in the business model or that the government has not provided a separate support scheme for smaller projects. The decision for the levy funding is expected to need new primary legislation, which will impact the timeline for rendering government’s Hydrogen ambitions a reality. BEIS have confirmed that government intends to legislate subject to the availability of Parliamentary time. Further details of this are expected to be in the Queen’s Speech on 10 May 2022.

Other aspects, including how price support for own consumption projects and sales to intermediaries will operate, the absence of a Hydrogen price benchmark, indexation methods, and contract length, will also need to be answered so as to allow projects needing this clarity to proceed.

Investors looking at hydrogen projects in the UK as part of the European and global landscape will also need to understand how the UK’s Hydrogen Standard compares to those proposed in the EU and elsewhere, especially where such investors are supporting projects looking to export hydrogen around the world. It would be a disadvantage if the hydrogen standards in different countries led to the development of a fragmented hydrogen economy instead of all supporting the global achievement of the Paris Agreement goals.

Next steps

BEIS aims to finalise the business model in 2022, enabling the first contracts to be allocated from 2023.

Overall, the government has set clear delivery aims through to 2035 in its 2035 hydrogen delivery plan (see figure below), which anticipates 2GW of hydrogen production in construction and operations. Clearly much of the hydrogen delivery also depends on the other strands that are promoting the development of CCUS clusters remaining on track.

Hydrogen image 02