UK hydrogen business model consultation highlights complexities

Out-Law News | 23 Aug 2021 | 8:49 am | 3 min. read

Creating an effective and appropriate business model to support and encourage the production of low carbon hydrogen will be a complex task for the UK government, an energy markets expert has warned.

Ronan Lambe of Pinsent Masons, the law firm behind Out-Law, urged prospective hydrogen producers in England to respond to a government consultation on its proposed business model, published alongside the first UK hydrogen strategy. The consultation, which proposes a technology neutral subsidy based on a contracts for difference (CfD) model, closes on 25 October.

“The consultation is evidence of the government reaching out to industry to help it create a robust, effective and above all attractive business model which will result in the stimulation of large-scale low carbon hydrogen production in the UK,” he said. “In the UK hydrogen strategy, the government explains that due to the nascent nature of the market, it will need to work closely with the private sector to encourage low carbon hydrogen production.”

“Although one can understand a desire to use one form of business model to support different methods of low carbon hydrogen production, it remains to be seen whether a ‘one size fits all’ approach, with limited ability to tailor support to the different methods of producing low carbon hydrogen and no specific support for small-scale projects, will stimulate the market in the required way. The fact that BEIS has been unable to provide a ‘minded to’ position on such critical issues as how to index the strike price and what duration of support will be provided to eligible production projects is perhaps testament to the complexity of creating a single model to support the production of a commodity which is subject to a wide range of market barriers,” he said.

The UK hydrogen strategy targets 5GW of low carbon hydrogen production capacity by 2030, equivalent to the amount of gas consumed by over three million UK households each year. Hydrogen could potentially be worth £900 million to the UK economy and create over 9,000 jobs by 2030, rising to 100,000 jobs, £13 billion and 20-35% of the UK’s energy consumption as production increases through to 2050.

The strategy acknowledges the need for “rapid and significant scale up” of hydrogen production and use if these ambitions are to be met. An attractive UK investment environment backed by demand-side incentives will be needed in order to encourage the significant private sector investment required. Its proposed business model is based on the CfDs available to qualifying renewable energy generators, which offer developers a guaranteed price for their electricity while protecting consumers from paying increased support costs when prices are high.

Lambe said that elements of the proposed model would be familiar to many in the electricity industry, although the proposal was “more complex” than the existing scheme.

“The government has taken advantage of the lessons which have been learned from multiple rounds of CfD allocation in the renewables industry, which is considers to have been a major contributor to the decarbonisation of the electricity generation sector and the reduction in the levelised cost of energy from renewable sources,” he said.

“The use of a two-way CfD, modelled on the low carbon/renewable CfD, allows the government to ensure that any support provided to low carbon hydrogen is not excessive. If the support is no longer needed because the value of hydrogen reflects the costs of producing it, the CfD no longer pays out to the producer. The government has one eye on competitive auctions for low carbon hydrogen production support in the future and electing for a CfD model means that it can utilise the successful application and auction architecture which exists with the low carbon/renewable CfD,” he said.

In the absence of a reliable market benchmark price for hydrogen that can be used to calculate the premium, the government is proposing seven different options for calculating a reference price. Its ‘minded to’ position involves a reference price which is the higher of two prices: the ‘achieved sales’ price at the plant, and the price of natural gas. Other levers designed to reflect ‘volume risk’ – the risk that the producer is unable to sell sufficient quantities of hydrogen to cover its costs – would also feed into the formula.

Lambe said that the government’s reference price proposal “may represent a ‘best of a bad lot’ amongst reference price options in the absence of a liquid market price”.

“The fact that ‘gainshare mechanisms’ and ‘periodic payments linked to achieving or exceeding a defined pricing threshold or benchmark’ are referred to in the consultation without more detail may give cause for concern that an already relatively complex reference price mechanic could become even more complicated to administer and apportion value to over time,” he said. “All this before one considers the impact which BEIS’ minded to position on addressing volume risk – a ‘sliding scale’ of support, which reduces as the volume of hydrogen sales increases – will have on the calculation.”

At the same time, Lambe said that a fully functioning UK low carbon hydrogen market would require a range of policy and regulatory interventions beyond the subsidy mechanism.

“The eventual business model for low carbon hydrogen production will need to be accompanied by support from the government to encourage the markets in storage and transportation of, and demand for, hydrogen,” he said.

The government intends to announce its response to the consultation on the business model in the first quarter of 2022 and then aims to finalise the business model, enabling the first contracts to be allocated in the first quarter of 2023, according to the consultation.