Regulating hydrogen transport and storage - options to choose from

United Kingdom

The UK Government’s Department for Business, Energy and Industrial Strategy (“BEIS”) is currently consulting (the “Consultation”) on its proposed ways of regulating hydrogen transport and storage infrastructure, including on the role of hydrogen blending in supporting the hydrogen economy. Development of hydrogen transport and storage infrastructure will be essential to enable the Government’s aim of increasing the production capacity of new low carbon hydrogen to 10GW by 2035.

The Consultation considers multiple options for regulating hydrogen storage and infrastructure, including whether models such as RAB based economic regulation, CfD or cap and floor structures would be best suited to attract investment into such projects.

Context

The Consultation follows the wider UK Hydrogen Strategy and will work alongside the business model for low-carbon hydrogen production (the Low Carbon Hydrogen Agreement, or “LCHA”) which is currently being developed, with an aim for the first contracts to be allocated from 2023.

For further commentary on how the UK hydrogen sector is taking shape, please see the Low Carbon Hydrogen Agreement business model and the UK’s hydrogen strategy more generally.

Hydrogen transport infrastructure

The Consultation sets out the following types of hydrogen transport:

Type

Description

New or repurposed pipeline

  • Purpose-built to transport hydrogen or repurposed from existing natural gas pipelines to transport hydrogen.
  • Can carry a range of volumes over varying distances, most likely as a gas or through a carrier.

Road or Rail

  • Carried as a gas, liquid or through a carrier.
  • Suited to transport lower volumes over shorter distances, or medium distances with rail

Sea

  • Most likely carried through a carrier.
  • Suited to transport higher volumes over long distances.

BEIS considers that onshore pipelines (whether new or repurposed) will become the preferred method of transport infrastructure. This is not only due to the lower costs as volume of hydrogen increases, but also because of the anticipation that vehicular transport infrastructure, particularly by road, will be more prevalent in the hydrogen economy’s infancy. As the production of hydrogen scales up, the transport infrastructure will scale up.

Hydrogen storage infrastructure

The UK Government anticipates that hydrogen can be stored in a variety of ways:

UK Government image article 29-9  

Figure 1: Types of hydrogen storage infrastructure included in the Consultation

The Consultation anticipates that, initially, the requirements may be low enough that the storage costs can be taken from support from the Renewable Transport Fuel Obligation (the “RTFO”), or the Hydrogen Business Model (which are designed primarily to support the production of hydrogen) without the need for a separate business model. That is clearly not sustainable where the storage requirements are long term and for much larger quantities, including in part because the terms of the LCHA pay on sale of hydrogen and so would not separately deal with costs of storage.

BEIS’ initial view is to provide support to prospective owners of storage facilities, who would not benefit from the LCHA or the RTFO and would therefore have exposure to volume risk (i.e. there is no guarantee that there would be customers looking to purchase hydrogen storage capacity).

Business model design options

The Consultation sets out a list of proposed business models as summarised below:

Category

Business Model

Regulated returns

Regulated Asset Base (RAB) with allowed revenue

Storage providers/owners and operators of hydrogen pipelines would agree an “allowed revenue” (the amount the provider could recover across a specified period) with a regulator ahead of the price control period. The allowed revenue would be conditional on operational performance targets being met.

Users would be charged in accordance with an agreed methodology, which would likely form part of a code that also includes the basis for access. Revenues would also be subsidised by an external funding mechanism whilst the hydrogen economy is in its infancy. The risk would be transferred to the external subsidy funder, resulting in a guaranteed regulated return which would provide investors with certainty.

Revenue cap and floor

Storage providers/pipeline owners and operators would agree on a revenue cap and floor with a regulator which would apply for a specified period. The storage providers/pipeline owners and operators would be able to recover revenues from users up to the cap, with the floor being the minimum amount the provider could recover.

If the floor is not reached, revenue would be topped up to that minimum threshold through the subsidy and if the cap is exceeded, the excess revenue would be transferred to the subsidy funder.

 

Contractual payment

Contracts for difference (CfD) (transport)

The asset owners would agree on a strike price for operating the asset. The asset owners would be paid a variable premium by an external funding provider and, essentially, receive a subsidy covering the additional cost of transporting the hydrogen. BEIS considers that this manages the price risk, although risks associated with uncertain supply and demand and small user base would remain.

Contracts for difference (CfD) (storage)

Unlike other arrangements, a CfD to support hydrogen storage would need to address volume risk rather than price risk and could be done through a variable strike price.

Some volume risk would remain with the provider and the funder of the scheme, but this could be mitigated by “wrapping” the CfD arrangement in a cap and floor mechanism.

Capacity availability

Storage providers/owners and operators would be paid to provide storage/transport capacity when and where required.

For storage, requirements for tranches of capacity could be tendered, subsequently introducing and promoting competition into proceedings. This would provide revenue certainty to providers but may not encourage usage on its own.

For transport, payments would be made based on existence of pipeline, rather than use, therefore mitigating risks of revenue uncertainty and a small user base.

Government offtake front stop/long term capacity booker

Government would agree to reserve a certain volume of storage/transport capacity for a defined number of years. The providers would prioritise the resale of this capacity with the Government acting as the offtaker of last resort if that capacity remained unsold.

The volume/capacity reserved by the Government would be equal to that necessary and proportionate for de-risking the investment to the extent that the Final Investment Decision (FID) could be taken by the developer. This would mitigate against risks of uncertain supply and demand and a small user base.

Other

Co-investment by Government

The Government could choose to co-invest in selected facilities considered to be of strategic importance. Such an endorsement could leverage additional private sector capital and could lower the amount of revenue that a facility would need to cover its costs.

This would provide greater confidence to investors and would also mitigate against demand and supply uncertainty, and a small user base.

Long term financing arrangements (underground gas storage facilities only)

Supported by an external funding mechanism, long-term financing arrangements would enable developers to finance the purchase/lease of “cushion gas” on terms that would not be available on the market.

Merchant/counterfactual model

Essentially no business model would be applied – market forces would determine investment.

Revenues would be uncertain which could act as a deterrent to investors. On the other hand, providers would be able to take advantage of opportunities if demand turned out to be greater than expected, e.g., charging higher prices to users.

Obligations

Compulsory stock obligation (storage only)

Market participants would be obliged to hold a certain volume of hydrogen in store by means of a Compulsory Stock Obligation (“CSO”). The CSO could be a requirement to physically hold certain volumes of hydrogen (a physical obligation) or a requirement to ensure that someone else is holding volumes (a paper obligation).

The scope of a CSO could be limited to market participants above a certain size/market share threshold.

End user subsidies

End user subsidy (storage only)

Market participants would be paid for storing volumes of hydrogen in excess of a minimum threshold either as a rebate against storage costs, as something similar to an interest payment for depositing hydrogen or through a payment-in-kind style arrangement.

The Consultation proposes that models may be used in conjunction with one another, or that different business models may be used at different development stages of the hydrogen economy. This may have practical limitations. For example, it is difficult to envisage how a fully-merchant model could transition into a RAB model.

Ultimately, BEIS considers that a RAB model is the most suitable model in the long term because a mature hydrogen transport and storage network will face market barriers closely resembling those of other natural monopolies.

In this context the proposals are likely to follow that being proposed for CCUS, (“CCUS TRI”). It features a “user pays” revenue model (similar to the current gas network), a statutory regulator with both the power to grant licences and to economically regulate industry participants, and a government support package to protect investors and users against specific risks.

Strategic Planning

Mindful of the risk of stranded assets, the Consultation suggests that central network planning, a co-ordinated approach, and an approach that evolves over time are key to planning for transport and storage infrastructure. In this BEIS focuses on the “low or no-regrets” projects which have systemic importance, with a view to fast tracking their development, such as:

  • For transport infrastructure, projects which facilitate the build-up of capacity to connect producers to known demand points;
  • For storage infrastructure, projects where demand for storage is already present, and therefore their usage is guaranteed from the outset.

While the Consultation states that strategic planning could take place through industrial collaboration, central planning, and/or effective market structuring; the approach to the strategic planning inevitably will influence or be influenced by the business model which is chosen. An approach where decisions are made centrally will likely create barriers to a market-focused business model and, conversely, a market-led plan may be less conducive to a regulated model.

Hydrogen blending

BEIS foresees hydrogen blending as potentially being an effective way to manage volume risk and de-risk investments in the early stages of the development of hydrogen transport and infrastructure in the UK. BEIS considers that blending could act as a reserve offtaker, absorbing excess volumes of hydrogen where there are no alternative routes to market. This can manage volume risk in situations where producers may have been unable to sell enough volume of hydrogen to cover their costs, which BEIS believes could incentivise the development of additional capacity in low-carbon hydrogen. Furthermore, this “reserve offtaker” can bridge the gap in demand while transport and storage infrastructure develops and can manage volume risk even when an offtaker exists. This position is somewhat more positive on hydrogen blending than that taken in other policy papers such as those relating to heating. Ultimately the role of blending hydrogen with methane remains an underexplored area.

Next steps

The Consultation closes on 22 November 2022. Details of how to respond and the full text can be found here.