UK hydrogen production – January 2024 updates to LCHA terms

Introduction 

On 25 January 2024, the Department for Energy Security & Net Zero (“DESNZ”) shared with key industry stakeholders an updated full-form front end agreement (the “Front End Agreement”) and Standard Terms and Conditions (the “Standard Terms and Conditions”) for the Low Carbon Hydrogen Agreement (together the “LCHA”).

This article outlines the key updates made to the LCHA since the last draft update in November 2023, on which you can read our commentary here. For commentary on the most recent developments in UK hydrogen production more broadly, please see here.

Key changes to the LCHA Standard Terms and Conditions

Low Carbon Hydrogen Standard Version 3

In line with previous amendments, the Standard Terms and Conditions have been updated to reflect the Low Carbon Hydrogen Standard (the “LCHS”) Version 3 draft. This includes alignment of terminology across the LCHS and the LCHA.

Change in Applicable Law & Compliance with the LCHS

The LCHA has been updated to bring the LCHS within the scope of the LCHA’s Change in Applicable Law (“CiAL”) regime (which industry participants may be familiar with from the terms of the renewable CfD). This will enable the LCHA Counterparty to amend or supplement the LCHA in the event that a CiAL renders any part of the LCHS illegal, invalid, unenforceable or inoperable. This change is an exception to the general principle of LCHS “grandfathering” (i.e., that Producers comply with the LCHS as it was when the LCHA was signed). Note that as no compensation is payable as a result of a CiAL or related amendments, this increases the risk borne by Producers of a CiAL.

Furthermore, Condition 51 of the Standard Terms and Conditions has been updated to include a right for the LCHA Counterparty (and an ability for the Producer to request the same) to amend or supplement the LCHA in the event that any amendments or updates to the LCHS Data Annex render any cross reference to the LCHS Data Annex within the LCHS Agreed Version incorrect or inoperable.

Initial Conditions Precedent – electricity storage and hydrogen transport

The Initial Conditions Precedent (“ICP”), to be satisfied following entry into the LCHA, have been updated to require Producers to provide a:

• a description of any electricity storage used by the Facility (whether subsidised by the LCHA or otherwise); and
• a description of any hydrogen transport infrastructure that is not subsidised through the LCHA (where previously only details of subsidised transport were to be provided).

These changes reflect the development of DESNZ’s approach to the use of both subsidised and non-subsidised battery storage infrastructure by hydrogen projects, which will be of significance to prospective electrolytic producers.

Operational Conditions Precedent - subsidised transport and storage infrastructure

The Operational Conditions Precedent (“OCP”) drafting has been updated to clarify that, where a Producer has received subsidies in respect of Hydrogen Storage Infrastructure and/or Hydrogen Transport Infrastructure under the LCHA, the Producer must provide evidence to the LCHA Counterparty that the relevant infrastructure has been commissioned and is ready for commercial operation.

Performance Testing dates

The Testing Requirements set out in Annex 2 of the Standard Terms and Conditions have been updated to provide the Producer more flexibility in setting its Performance Test Date. The Producer can now set an estimated 20 Business Day (“BD”) window six months in advance of its anticipated Performance Test date. This is then narrowed down by the Producer to a 10 BD fixed window by giving notice to LCHA Counterparty two months prior to the start of the relevant Proposed Test Date Window. Finally, no later than one month prior to the scheduled BD window,  a single date is confirmed by the Producer.

Sliding Scale Top Up Condition

The conditions in which the Sliding Scale Top Up Amount is payable to Producers has been redrafted to clarify the circumstances in which it is payable (i.e. where the actual volumes of hydrogen invoiced are less than the Reference Volumes). Amendments also clarify the exceptions to this: (i) where the shortfall in volumes is due to the Producer’s (or its Representatives’) breach of the LCHA, (ii) where the Facility has been operated specifically for the purposes of maximising any Sliding Scale Top Up Amount (i.e. an anti-gaming provision), (iii) where the production facility is unavailable, curtailed or derated (except due to reasons (i), (ii) and (iv) stated here), and (iv) where any non-subsidised hydrogen storage, hydrogen transportation, or electricity storage outages gave occurred. 

While these changes should give Producers greater certainty about the circumstances in which the Sliding Scale Top Up Amount is payable, these amendments do narrow slightly the circumstances in which producers can benefit.

Hydrogen Storage Infrastructure and Hydrogen Transport Infrastructure

The relevant Producer undertakings have been amended to clarify that the creation or presence of security interests in respect of these assets is permitted. This is in line with the Ownership undertaking set out in Condition 30.1(E) of the Standard Terms and Conditions. Both undertakings now also cover exclusive ownership and use of the infrastructure.

Additionally, the Standard Terms and Conditions have been amended so that a breach of the above undertakings is a Termination Event for the purposes of the LCHA.

Derived Data Agreement

Condition 22.10 of the Standard Terms and Conditions has been updated to clarify the position of the Derived Data Agreement (a draft of which has not yet been published). Until a Derived Data Agreement has been entered into, the Producer shall not be able to access Derived Data (i.e. the Gas Reference Price, the Natural Gas Strike Price, the Floor Price and all underlying data relating to their calculation), and the LCHA Counterparty is not required to provide the Producer with related Payment Calculation Data.

Hydrogen Levy Introduction

Updates have been made to the Standard Terms and Conditions and its Annex 11 to facilitate a transition from exchequer to levy-based funding. The updates are made with the aim to mirror the Contract for Difference Allocation Round 4 contract as closely as possible, i.e. by introducing analogous “pay-if-paid” provisions that relieve the LCHA Counterparty from liability for non-payment where it is not in receipt of corresponding funds from levy payers.

Key changes to the LCHA Front End Agreement

Hydrogen Transport Infrastructure definition

The definition of Hydrogen Transport Infrastructure in the Front End Agreement has been amended to clarify that the use of such infrastructure to transport hydrogen to an Offtaker’s transport and/or storage network can be carried out either directly or indirectly. Therefore, hydrogen transport infrastructure transporting hydrogen to a storage facility can also be included in this definition. This can therefore also be subsidies under the LCHA.

Annex 1 – Facility Description

Annex 1 has been amended to clarify that the description of the Facility in the Front End Agreement should include a description of any Electricity Storage System which is subsidised under the LCHA.

Furthermore, the requirement to provide coordinates for Meter Measurement Points in the Front End Agreement has been removed. This is because this requirement forms part of the OCP.

Annex 4 – Project Commitments

The ‘Facility Requirements’ at paragraph B of the Front End Agreement have been amended to clarify the evidence the Producer must provide the LCHA Counterparty to demonstrate it holds appropriate rights to undertake the project. These are in relation to both the Site and to any site on which Off-site Hydrogen Storage Infrastructure or Off-site Fixed Hydrogen Transport Infrastructure are located.

Annex 5 – Strike Price Inclusions

This Annex has been updated to only capture the categories of cost included in the strike price. The indicative price associated with each such category should therefore no longer be recorded and set out in this Annex.

Annex 6 - Redactions

The ‘Initial Capital Return Component’, ‘Total Project Pre-Commissioning Costs’, and ‘Total Capex Payment’ figures have been added to the list of information set out in the Front End Agreement to be automatically redacted from publication.

Next steps

Although DESNZ has indicated that this newest draft contains all provisions required for contracts to be awarded to the first electrolytic hydrogen projects, it has also noted that it is expecting to make further amendments to the provisions specific to CCUS-enabled hydrogen projects. Additionally, Producers are still waiting for DESNZ to share a draft of the Derived Data Agreement.

As set out in one of our recent publications (found here), the Second Hydrogen Allocation Round (HAR2) was launched in December last year and is currently open. Applications must be submitted by 19 April 2024 and successful projects are expected to be announced later this year.

More broadly, it is believed that the government will be making a further update on its Hydrogen Strategy by the end of this year. It therefore remains to be seen whether this may require the terms of the LCHA to be further updated.