Out-Law Analysis 5 min. read

Australia’s hydrogen future hinges on security of payment legislation clarity

Understanding the role of security of payment legislation (SOPA) in the states of Queensland and Western Australia, and its impact on emerging hydrogen extraction methods, will be crucial to the success of prospective hydrogen plant projects in Australia.

Historically it was not clear whether SOPA applied to the construction of renewable energy projects given the language of the legislation and various exemptions included in the legislation. However progressive amendments to SOPA in Queensland and Western Australia, have generally remedied this uncertainty in relation to traditional renewable energy projects, including solar and wind.

Since the release of the Australian government’s ‘State of Hydrogen Report’ in April 2023, state governments have taken steps towards encouraging further investment in the production and extraction of hydrogen. The backing of new industry and governmental collaborators as well as the expansion of existing legislative schemes are all welcome developments. However, these steps are only the first stages of the broader adjustment required to minimise regulatory uncertainty and ensure confidence in Australia’s hydrogen industry.

One source of uncertainty in this space is whether SOPA will apply to commercial hydrogen supply chains in key hydrogen states like Queensland and Western Australia. Without the protection of SOPA, which is intended to reduce the incidence of insolvency in the construction industry, contractors may be unwilling to shoulder the brunt of the construction risk. This could, in turn, stall bidding and contract negotiation for proposed projects.

Additionally, an inconsistent understanding of the application of SOPA could lead to disputes during the course of the contract, threatening delays, relationship breakdowns and significant additional costs for disputing and related parties.

As such, with hydrogen having emerged in the last decade as a likely resource on which global decarbonisation initiatives will lean, Australia’s ability to realise its many advantages as a potential leader in the production and export of hydrogen is tied to understanding the interaction between SOPA and hydrogen extraction activities.

The applicability of SOPA to hydrogen projects

When assessing the applicability of SOPA to hydrogen projects, the key provisions for consideration are the mining exemptions. These are set out in section 65(3) of Queensland’s Building Industry Fairness (Security of Payment) Act 2017 (QLD) and section 6(3) of Western Australia’s Building and Construction Industry (Security of Payment) Act 2021 (WA).

The Acts set out that, for the legislative safeguards to apply, the works undertaken must fall under the definition of ‘construction work’. In the QLD Act, the exclusion includes “the extraction of … natural gas”. Equally, despite some differences in language and the insertion of some non-mining related sub-sections, section 6(3)(a)-(b) of the WA Act operates to the same effect.

The first question is whether hydrogen can be considered a 'natural gas’. This question is yet to be tested by the courts. Ultimately, any result will necessarily depend on expert opinion given at trial. However, the chemical similarity between the two substances would tend in favour of a reading that natural gas and hydrogen are, for the purposes of the Acts, the same.

However, whether hydrogen is a ‘natural gas’ is not the sole determinant of whether the exemption will apply. The works involved must also themselves comprise the extraction of natural gas. Tehcnological advancement has facilitated two new modes of hydrogen extraction. The extraction of existing natural hydrogen deposits underground – ‘white’ or ‘gold’ hydrogen – and the isolation of hydrogen with electrolysers powered by renewable energy – ‘green’ hydrogen – are two methods which have been proposed as a supplement to existing renewable energy initiatives. These methods enable the decarbonisation of manufacturing processes as well as facilitating more efficient redirection of generation surplus.

As the courts have yet to consider these two modes of extraction, it is necessary to rely on existing interpretations of the mining exemption. Historically, the mining exemption was intended to have, and has been given by the courts, a narrow construction. Applying this narrow interpretation would indicate that the exemption will only apply as far as the works themselves constitute physical, ground extraction. As such, the extraction process of naturally occurring hydrogen, such as white or gold hydrogen, may be more likely to fall within the scope of the exemption due to its reliance on traditional oil and gas extraction techniques such as fracking. The exemption would not, however, extend to ancillary activities, such as the construction of project offices, roads or other infrastructure supporting extraction activities.

It is less certain whether the creation of green hydrogen by electrolysis would constitute ‘extraction’. The methodology involved in this scenario does not comprise traditional mining or hydrogen extraction practice. However, this is unlikely to be enough to distinguish it from the extraction of naturally occurring hydrogen. Accordingly, there is a reasonable argument for the process of electrolysis being excluded from the Acts.

As for the works facilitating electrolysis, while this remains a question for the courts to answer, an argument may be made that highly technical plant components are also excluded from the Act, despite narrow interpretations in more recent case law. That being said, as with the extraction of naturally occurring hydrogen, ancillary works which are not highly technical are unlikely to fall within the exception.

In Western Australia, the scope of related works has the potential to be altered by section 6(3)(d). This enables the Western Australian government to create regulations excluding particular activities, such as the installation of manufacturing equipment, or equipment for conveying materials, from the Act. Though there are no regulations presently in effect under the Act, this is subject to change at any time, and parties engaged in hydrogen extraction activities are encouraged to check whether regulations have come into force.

Implications for contractors

Where the mining exemption does not apply, the SOPA regime will protect the contractor or sub-contractor’s right to payment across several stages of the hydrogen project’s life cycle.

Despite the potential applicability of SOPA legislation, there exists a degree of trepidation for parties seeking to enter the industry, given the absence of established practices and precedent. However, as public and private investment increases, contractors, developers and financiers will be prompted to consider hydrogen extraction opportunities. To reduce their risk, parties should review the structure and interfacing of their contracts.

One consideration for companies is to establish whether the payment mechanisms in place, and corresponding contractual relationships, are sufficiently clear and understood by all parties. Parties to hydrogen projects should take care to ensure that, where a contractor or subcontractor is completing work on multiple sites, each party understands the relationship between the works and the way fees are structured for these works, so that payment claims are enforceable at all stages. Also worth considering is whether the works which parties seek to have covered under SOPA are appropriate for payment in instalments, or whether they are better suited to one-off payments.

Companies should also consider whether interfacing procedures enshrined in significant contracts are sufficient so that handover between design and construct, and operation and management phases, can be managed in light of different payment regulation schemes. Alternatively, all stakeholders to a hydrogen contract may wish to consider whether aligning contractual payment provisions with SOPA in any event offers a ‘best for project’ approach – ensuring that there are clear payment processes while giving contractors a level of certainty as to their cash flow.

By safeguarding against these common contractual pitfalls, parties are better positioned to take advantage of the increased interest in hydrogen production. Moreover, greater market confidence in the viability of hydrogen projects, legally as well as financially, will enable Australia to capitalise on its inherent advantages and become a global leader in hydrogen innovation and production.

Co-written by Marcus Bombardiere of Pinsent Masons.

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