[co-author: Aleksandra Dulska]

Strategy positions UK as a world leader in the hydrogen space, supporting 9,000 plus jobs and unlocking £4 billion in investment by 2030.

On 17 August 2021, the Department for Business, Energy and Industrial Strategy (BEIS) published the UK’s first Hydrogen Strategy (the Strategy). The Strategy sets out the government’s roadmap for achieving its ambition of 5GW of low carbon hydrogen production capacity by 2030, as identified in the Ten Point Industrial Revolution Plan released in November 2020, with government projections indicating that 20-35% of the UK’s energy consumption could be hydrogen-based by 2050.

Forecasts suggest that by 2030, hydrogen could play an important role in decarbonising certain highly polluting industries that are unsuitable for electrification, such as chemicals, industrial furnaces, and long-distance or heavy-duty transport, as well as replace natural gas in powering around three million homes a year. The Strategy clarifies the government’s view that developing the UK hydrogen sector will achieve the twin goals of reducing the UK’s carbon footprint in line with the UK’s net zero commitments, whilst stimulating significant job creation and economic growth in the industrial sector.

What Are the Major Features of the Strategy?

The Strategy highlights key actions to scale up hydrogen production in the UK:

• Developing a twin-track approach of supporting multiple technologies, including “green” electrolytic and “blue” carbon capture-enabled hydrogen production
• Collaborating with industry to develop a UK standard for low carbon hydrogen, which will bring certainty for producers and users that the hydrogen the UK produces is consistent with the UK’s net zero commitments
• Reviewing the infrastructure needed to underpin hydrogen power
• Working with industry to assess the safety, technical feasibility, and cost effectiveness of mixing 20% hydrogen into the existing gas supply, which could deliver a 7% emissions reduction compared to natural gas
• Launching a hydrogen sector development action plan in early 2022, to outline how the government will support companies to secure supply chain opportunities, skills, and jobs in hydrogen

The Strategy also contains a hydrogen roadmap for the next decade, which outlines how the industry must evolve in order to meet the 2030 targets. Key to this development will be ensuring adequate funding; in this regard, the Strategy refers to the simultaneous publication of consultations on both low carbon hydrogen business models and the Net Zero Innovation Fund which are discussed below.

Alongside the Strategy, BEIS also published:

BEIS posits that this wider package of policy documents is essential if the UK is to meet its Sixth Carbon Budget and net zero commitments.

Which Business Models Will Be Used To Help Execute the Strategy?

In the Business Model Consultation, the government proposes to use Contracts for Difference (CfD) — a funding mechanism that has proven success in developing offshore wind capacity in the UK — to underpin the hydrogen business model and bridge the gap between the high costs of producing low carbon hydrogen and cheaper fossil fuels.

CfD provide revenue assurance to low carbon hydrogen producers in the case of market volatility in wholesale prices. CfD would pay producers a flat rate for the hydrogen over a set period of time, which would be the difference between a “strike price” (reflecting the overall value of a unit of hydrogen needed to cover the producer’s costs) and a “reference price” (reflecting the market price the producer would receive per unit of hydrogen). This premium has the potential to turn negative over time (i.e., triggering a payment from the producer to the government) should the market price of hydrogen increase considerably, ensuring a cap on taxpayer funding should public money not be required to support the economic viability of hydrogen projects.

The Business Model Consultation acknowledges the challenges in setting a reference price for hydrogen, as, unlike in the electricity market, this space lacks a market benchmark hydrogen price. The government proposes a number of options in mitigation, including using the price of natural gas or the input energy used by the hydrogen producer, as well as plans to engage with price reporting agencies to create a market benchmark hydrogen price. The government’s suggested approach at this stage is to use the higher of the natural gas price and the achieved sales price of hydrogen in relation to initial projects, then develop and adopt a benchmark in due course. The government is also seeking views on other design features of the proposed contracts, including contract length, compatibility with other policies, and how the strike price will be indexed. In addition, and as a related policy matter, the Business Model Consultation seeks views on whether CfD premiums should be met out of general taxation or via surcharges on household energy bills.

The consultation closes on 25 October 2021, and final decisions on the shape of the business model and the subsidy mechanism are not expected until 2022, meaning first contracts would only be allocated from the first quarter of 2023.

Conclusion

The policy package has received mixed responses so far, with some stakeholders welcoming much-needed clarity and others questioning whether the package is ambitious enough, especially in light of the UK’s leadership role in the upcoming COP26 conference.

Many countries view hydrogen as key to transforming carbon-intensive sectors, but concerns remain, especially around reliance on blue hydrogen, which is produced using natural gas and carbon capture and storage technology and is often not carbon neutral. The Low Carbon Hydrogen Standards Consultation in particular aims to address some of these concerns.

These concerns aside, the government perceives advantages in keeping all options outlined in the Strategy viable, in a bid to more rapidly transform the UK’s energy system.

It remains to be seen whether the government’s strategy will realise hydrogen as a viable option for bringing down emissions and position the UK as a global leader in this space ahead of COP26. Latham & Watkins will continue to monitor developments in this area.