In Short

The Situation: The Japanese Cabinet has approved a draft bill to financially incentivize the supply and utilization of low-carbon hydrogen and its derivatives ("Hydrogen Bill") as part of its push to reach net zero by 2050.

The Result: The Hydrogen Bill proposes a subsidy scheme whereby eligible projects will receive a top-up payment equivalent to the difference between a fixed or variable "Base Price" and variable "Reference Price" for both domestically produced and imported low-carbon hydrogen and its derivatives. The subsidy scheme aims to overcome the cost differential between low-carbon hydrogen and its derivatives and their fossil fuel alternatives.

Looking Ahead: It is expected that the Hydrogen Bill will be enacted in the current Diet session and the subsidy scheme will be in place by this summer, with a view to selection of the first subsidy recipients by the end of 2024. The subsidy scheme is intended to be in place for a 15-year period.

On 13 February 2024, in a joint statement with the Ministry of Environment, Japan's Ministry of Economy, Trade and Industry announced that the Japanese Cabinet had approved a draft bill—the Hydrogen Bill—to be submitted to the Diet to financially incentivize the supply and utilization of low-carbon hydrogen (carbon intensity of 3.4kg of CO2 per kilo of H2 or lower) and its derivatives, including ammonia, methane, and synthetic fuels. The Hydrogen Bill was announced alongside a bill which will establish new rights associated with the storage of CO2 emitted from factories and other sources and to provide more stable legal grounds for developing carbon capture and storage ("CCS") businesses in Japan ("CCS Business Bill").

The announcement of the Hydrogen Bill and CCS Business Bill marks a significant step in Japan's push to decarbonize its heavy industry as part of its plan to reach net zero by 2050. These announcements follow a series of major announcements by the Japanese government in the past year in this space, including:

• The raising of Japan's hydrogen use targets to 12 million tons by 2040, six times current levels;
• Declaring that the public and private sectors will invest 15 trillion yen in hydrogen-related businesses over the next 15 years; and
• Allocation of 3 trillion yen on subsidies for delivered low-carbon hydrogen (and its derivatives).

The Hydrogen Bill, which is expected to be enacted in the current Diet session and come into force this summer, stipulates that the Japan Organization for Metals and Energy Security ("JOGMEC") will provide subsidies to selected suppliers of low-carbon hydrogen and its derivatives in the form of grant funding in accordance with certified business plans.

The Hydrogen Bill itself does not have detailed provisions as to selection criteria, or subsidy amounts, which will be determined by JOGMEC, generally in accordance with an Interim Report released on January 29, 2024, by Japanese governmental subcommittees, including the Hydrogen and Ammonia Policy Subcommittee and the Decarbonized Fuel Policy Subcommittee (the "Interim Report").

The Interim Report focuses on the imperative of establishing a competitive large-scale supply chain for low-carbon hydrogen and its derivatives to realize Japan's objective of achieving carbon neutrality by 2050. A key aspect of this endeavour involves extending financial backing to stimulate the development of a robust domestic supply chain.

This initiative commences with the funding by JOGMEC of "pilot projects" in hard-to-abate sectors expected to commence supply of low-carbon hydrogen and its derivatives by 2030 through subsidies under the Hydrogen Bill, which are designed to offset the cost differential between low-carbon hydrogen (and its derivatives) and conventional energies, as summarized below.

Subsidy Scheme Overview

Rather than a fixed payment or tax credit, the Interim Report describes a subsidy scheme whereby recipients would receive a top-up payment equivalent to the difference between a fixed or variable "Base Price" and variable "Reference Price." The subsidies would be available for both domestically and foreign-produced hydrogen and derivatives over a 15-year period.

Subsidy Amount

The Base Price would be determined on a case-by-case basis. Project proponents would need to propose a fixed value or formula-based variable Base Price, noting:

• The proposed Base Price should represent the amount per unit volume to recover all fixed and variable costs of production and supply, as well as a profit allowance.
• For domestic production, production costs would be subsidized; for overseas production and shipment, both production and shipment costs would be subsidized; in the case of shipment of MCH or NH3, dehydrogenation costs may also be subsidized.
• The fixed Base Price or formula used to calculate the Base Price should not change over the 15-year subsidy period.
• 10% of construction costs can be included in the Base Price for capital expenditures, but any unused amounts would be deducted from the Base Price or refunded, if paid.
• Price fluctuations due to changes in foreign exchange rates and raw material costs for production can be accounted for using a prescribed formula with a cap.
• Review of the Base Price may be requested where new or innovative technologies result in reductions to input costs.

The Reference Price would be determined for each project by the government using publicly available information, using the highest of the following:

• The price at the time of arrival in Japan of raw materials and fuels that would be displaced by low-carbon hydrogen, plus a price for "environmental value";
• The actual sales price of hydrogen or its derivatives at the time of arrival in Japan (if produced overseas) or at the production site (if domestically produced); and
• If the low-carbon hydrogen/derivatives are applied to the existing hydrogen and ammonia market, the price based on records of past transactions and sales prices.

Approved participants in the subsidy scheme would receive top-up payments covering the difference between the Base Price and the Reference Price (where the Base Price exceeds the Reference Price). However, at times when the Reference Price exceeds the Base Price and participants are considered to be receiving excessive profits, participants would be required to pay back the difference between the Base Price and the Reference Price.

This subsidy scheme is designed to allow producers and suppliers to sell low-carbon hydrogen or its derivatives at a price that would be competitive with the existing alternatives. It is hoped that the scheme will improve price certainty and thereby increase the likelihood that offtakers will commit to buying volumes, which, in turn, will provide greater certainty for investors.

Selection Criteria

Proposed low-carbon hydrogen supply projects should satisfy certain conditions and be evaluated comprehensively relative to other applicants, including on whether the projects would:

• Follow a business plan jointly developed by suppliers and offtakers in "hard-to-abate" sectors (e.g., steel and chemical industries), in order to lead the transition to low-carbon hydrogen/derivatives through capital investment and technological innovation;
• Substantially contribute to strengthening of industrial competitiveness in international markets and domestic emission reductions;
• Be expected to commence supply over 1,000 tons of low-carbon hydrogen and its derivatives per year by 2030 and continue supply for at least 10 years after cessation of the 15-year subsidy program;
• Lead to development of self-sustaining supply chains and of new related businesses that would foster new industries and markets domestically or internationally;
• Contribute to local communities (e.g., through production of low-carbon hydrogen/derivatives, job creation, or utilization of surplus renewable energy); and
• Have a feasible, efficient, and reasonable business plan to achieve self-sufficiency after the subsidy period (including credible offtake arrangements and Base Price).

Timing of Implementation

According to the Interim Report, the Japanese government intends for the subsidy scheme to be in place and applications accepted around the summer of 2024, with a view to selecting the first recipients by the end of 2024.

We will continue to monitor and report on developments in Japan and the broader APAC region over the coming months. However, if you have any specific questions or requests in relation to this insight or any related issues, please do not hesitate to get in contact with one of our team.

Three Key Takeaways

1. Japan's Decarbonization Drive: The announcement of the Hydrogen Bill and the CCS Business Bill are significant steps in Japan's commitment to achieving net zero emissions by 2050 and represent the latest of a number of substantial investments in this space by the Japanese government.
2. Financial Incentives for Low-Carbon Hydrogen and its Derivatives: The Hydrogen Bill will introduce a subsidy scheme to financially incentivize the supply and utilization of low-carbon hydrogen and its derivatives and to improve their competitiveness when compared with fossil fuel alternatives.
3. Subsidy Scheme Framework: The subsidy scheme envisages eligible projects receiving a top-up payment representing the difference between a Base Price and Reference Price of the low-carbon hydrogen and its derivatives. Applicants are expected to be evaluated against criteria regarding their competitiveness and contributions to carbon emission reductions. Applications for subsidies are expected to be assessed this summer with the first subsidy payments to be made by the end of 2024. Prospective applicants should continue to monitor for updates and make necessary preparations once appropriate.