The UK Hydrogen Strategy

Pillsbury Winthrop Shaw Pittman LLP

UK Government begins consultation process on a comprehensive plan to achieve a low-carbon hydrogen economy.

TAKEAWAYS

  • While over 30 countries have announced hydrogen roadmaps, the UK Hydrogen Strategy is unique in that it sets out a whole systems approach in developing the hydrogen value chain, which specific milestones from today through the mid-2030s, including a business plan that includes a revenue model that will provide support for hydrogen producers.
  • The UK Hydrogen Strategy is technology-neutral, meaning that it supports all zero-carbon hydrogen, including that produced by nuclear energy.
  • The UK has committed £240M to a Net Zero Hydrogen Fund and £60M toward hydrogen supply and storage solutions. The Strategy also states that one of its objectives is to promote opportunities for foreign investment.

On 17 August 2021 the UK published its UK Hydrogen Strategy document (the Strategy) for developing a low-carbon hydrogen sector in the UK. The entire suite of documents is publicly available at this link. While over 30 countries have published hydrogen strategies, the UK Hydrogen Strategy stands out as it is comprehensive: (1) it sets out specific and achievable near-term goals, (2) it allocates funding, and (3) it seeks to support the entire hydrogen value chain. The Strategy demonstrates how the UK is “leading by example” with specific plans to support decarbonization and address the challenges posed by climate change.

The UK has committed to achieving net zero carbon emissions by 2050. To reach that goal, decarbonise “hard to electrify” UK industrial sectors, and provide flexible energy for heating, power and transportation, the UK is focused on developing its hydrogen infrastructure. Hydrogen can also act as energy storage to shore up any intermittency issues associated with renewables like wind and solar power on the grid. The Strategy supports the UK’s decarbonisation goals by setting out a series of commitments from the UK Government that set out how the UK will deliver its vision for a low-carbon hydrogen economy.

The Strategy envisions that the UK will rapidly and significantly scale up hydrogen production and lay the foundations for a low-carbon hydrogen economy by 2030, and details how the UK Government will support innovation and stimulate investment in the sector. The Strategy is focused on near-term achievement of specific goals: 5GW of low-carbon hydrogen production capacity with potential for rapid expansion post-2030; and plans to see 1GW production capacity as early as 2025. Not only is there a focus on near-term goals, but the Strategy also details how the UK will develop the supply chains and skills needed to reach such goals, as well as create jobs and export opportunities for the UK. Additionally, the Strategy includes infrastructure plans to support the scale up of the UK’s hydrogen network and storage infrastructure required for a UK hydrogen economy. The Strategy’s “whole system” approach to hydrogen is unique among countries’ hydrogen roadmaps announced thus far and is specifically intended to promote foreign investment.

Development of a Hydrogen Business Model

The Strategy proposes development a hydrogen business model (the Hydrogen Business Model) and plans for a revenue mechanism to provide directed funding. The objective of the business model is to kick-start the industry by attracting private sector investment. A significant barrier to the hydrogen economy is that producing and selling hydrogen is currently more expensive than most high-carbon fuel alternatives. Absent government incentives, private investors may not choose to invest into low-carbon hydrogen projects because of uncertainty about securing a return on their investments. The Hydrogen Business Model, which is still under development, will provide revenue support to hydrogen producers to overcome the initial cost gap between low carbon hydrogen and higher carbon fuels, with the aim of enabling producers to price hydrogen competitively and encourage private sector investment in hydrogen projects.

The preferred approach to closing the price gap is a “Variable Premium” model where the hydrogen producer is paid a premium for the hydrogen produced. The premium is calculated as the difference between a strike price and a reference price (i.e., market price) for each unit of hydrogen sold. This mechanism is similar to the “contract for difference” approach that has been successfully deployed for low-carbon electricity generation assets. The strike price covers the producer’s anticipated cost of production and below that price the difference between market and production costs are made up from the revenue scheme. If market price goes above the strike price, the producer will be required to pay the excess back to the government.

The Strategy also has provisions for volume support to ensure that adequate capacity exists regardless of whether there is demand. This could be in the form of capacity payments, or government contracts to buy set quantities of hydrogen, for example. Having launched a consultation on the Hydrogen Business Model concurrently with the publication of the Strategy, responses to the consultation on the Hydrogen Business Model are expected in early 2021 and are to be published alongside indicative heads of terms for the Hydrogen Business Model. This process will enable first contracts to be allocated from Q1 2023.

The outstanding issue, however, is the source of funds for the business model’s payments. The short answer is that end-use consumers may ultimately pick up the bill. The current plan is for hydrogen support to mirror support for renewable electricity. Revenue support for renewable electricity has been funded by passing on costs indirectly to consumers—for example supplier obligation costs which suppliers pass on to energy bills. The UK Government’s plans assume a similar approach would be taken for funding hydrogen production projects, but accounting for consumer affordability. Although revenue support is needed in the near-term, the UK Government expects reliance on it to taper off as the hydrogen market matures.

The Strategy also provides further detail regarding the Net Zero Hydrogen Fund (NZHF) to be launched in early 2022. The Fund will support commercial deployment of new low-carbon hydrogen production projects during the 2020s and will provide up to £240 million of government co-investment to support new low carbon hydrogen production out to 2025.

Measuring the carbon impact of hydrogen production

Because there are a variety of different ways to produce hydrogen, the carbon impact varies with the source of the energy used to produce it. Current hydrogen production in the UK is almost all derived from fossil fuels, using steam methane reformation from natural gas without capturing and storing any of the resulting carbon emissions. To combat these emissions, the Strategy adopts a controversial twin-track approach to supporting both electrolytic “green” and carbon capture-enabled “blue” hydrogen production, alongside other potential production routes.1 While Chris Jackson, the former chair of the UK Hydrogen & Fuel Cell Association, stepped down from his post due to this twin-track approach, the UK Government believes this twin-track strategy will enable the rapid growth of the sector while bringing down costs. Notably, the Strategy is technology-neutral, and it includes blue hydrogen in its discussion alongside green hydrogen produced by nuclear energy and renewables.

The controversy may be settled by the inclusion of a clear definition of what production methods are acceptable for both blue and green hydrogen. In order to measure the carbon impacts of various technologies, the Strategy proposes development of a UK low-carbon hydrogen standard. The proposal is essentially an emissions standard that defines what is meant by ‘low-carbon’ hydrogen. It will define a methodology for calculating greenhouse gas emissions associated with hydrogen production and a greenhouse gas emissions threshold against which different low-carbon hydrogen production pathways would be measured. This will ensure that only low-carbon hydrogen makes it to market. This has generally been coined a “colourless” approach.

Concrete, attainable goals

The Strategy sets out a holistic approach to hydrogen that considers the entire value chain and provides for these specific expected outcomes:

  • Progress towards 2030 ambition: 5GW of low-carbon hydrogen production capacity with potential for rapid expansion post-2030; hope to see 1GW production capacity by 2025.
  • Decarbonisation of existing UK hydrogen supply: Existing hydrogen supply decarbonised through CCUS and/or supplemented by electrolytic hydrogen injection.
  • Lower cost of hydrogen production: A decrease in the cost of low-carbon hydrogen production driven by learning from early projects, more mature markets and technology innovation.
  • End-to-end hydrogen system with a diverse range of users: End-user demand in place across a range of sectors and locations across the UK, with significantly more end users able and willing to switch.
  • Increased public awareness: Public and consumers are aware of and accept use of hydrogen across the energy system.
  • Promote UK economic growth and opportunities, including jobs: Established UK capabilities and supply chain that translates into economic benefits, including through exports. UK is an international leader and attractive place for inward investment.
  • Emissions reduction under Carbon Budgets 4 and 5: Hydrogen makes a material contribution to the UK’s emissions reduction targets, including through setting the country on a pathway to achieving CB6.
  • Preparation for ramp-up beyond 2030—on a pathway to net zero: Requisite hydrogen infrastructure and technologies are in place with potential for expansion. Well-established regulatory and market framework in place.
  • Evidence-based policy development: Modelling of hydrogen in the energy system and input assumptions improved based on wider literature, qualitative and quantitative evidence and real-world learning. Delivery evidence from innovation and deployment projects collected and used to improve policy making.

Public Consultation

The legislative process in the UK involves extensive interaction with stakeholders when developing government action plans. Therefore, the Strategy was accompanied by separate requests for public comments through three separate “consultations” published alongside the Strategy. Those consultations seek comments on a proposed Hydrogen Business Model, a UK Low-Carbon Hydrogen Standard, and the Net Zero Hydrogen Fund. The package also included an annex setting out the analysis and evidence underpinning the Hydrogen Strategy and consultations.

Final thoughts

The Strategy is comprehensive, thoughtful, and provides strong evidence that the UK Government is serious about tackling climate change. We look forward to seeing the further progress and developments once the various public consultations are closed for comment. There is (inevitably) some criticism of the Strategy by certain stakeholders, stating for instance that 5GW of capacity is not sufficiently ambitious or criticising the support for blue hydrogen as a necessary transition technology to develop the hydrogen economy in the UK. Nevertheless, we hope that other governments will soon follow with comprehensive plans of their own.

1 “Green” hydrogen is produced by using low-carbon energy sources and processes, while “blue” hydrogen is produced from carbon-intensive processes, but the resultant carbon is captured before it can escape into the atmosphere.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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