Hydrogen Business Models: A picture emerges

On 8 April 2022, the UK Government published its responses to the consultation package on the Low Carbon Hydrogen Business Model (Business Model) (alongside its responses to the consultations on the Net Zero Hydrogen Fund and Low Carbon Hydrogen Standard). 

In advance of opening up the two main funding mechanisms for hydrogen, i.e. the £240m Net Zero Hydrogen Fund and the joint allocation round for electrolytic projects for the Hydrogen Business Model and Net Zero Hydrogen Fund, it is interesting to see the market’s response to the proposed Hydrogen Business Model which in effect will mimic the CfD regime for renewables. The government had asked industry participants 21 questions in relation to its proposed business model in August 2021. 

The responses address each of these questions; below is a brief summary of the emerging market consensus and government responses in respect of certain key points: 

1. The responses indicated support for a contractual, producer focused business model that provides revenue support to low carbon hydrogen producers. The government confirmed that it would continue to proceed with this proposal.  
2. The responses also indicated support for considering price and volume risk separately. By way of reminder, the government’s current proposal is to:
   1. mitigate market price risk by topping-up producers’ revenues up to an agreed “strike price”. Where the hydrogen reference price exceeds the “strike price”, producers will be required to repay revenues down to the agreed “strike price”. The effect of this is to provide producers with a stable revenue stream.
   2. provide volume support, through a sliding scale mechanism whereby more price support is provided where volumes sold are low.
3. The market provided a positive response to the proposal of a variable premium (based on three main components, i.e. the price at which the relevant producer sells the hydrogen, a price floor set at the natural gas price and a contractual price discovery mechanism that allows the subsidy to reduce over time). The government confirmed that it would continue to follow this approach.
4. The participants indicated that they agreed with the inclusion of indexation in relation to the main input fuel/energy costs to a technology specific benchmark and some respondents indicated that they would like to see indexation of other production costs to inflation. The government confirmed its support for indexation applying to the strike price as an important aspect of the Business Model which protects producers against unmanageable and uncontrollable changes to input costs and government from over subsidy, while providing end users with security of supply.
5. The participants indicated support for the government proposal to apply the same proposed Business Model across different production technologies and operating patterns (although concerns were raised by a number of participants that the same Business Model may not cater variations between technologies) and for not varying the proposed Business Model to cater for smaller scale projects. The government confirmed that it would continue to develop the proposed Business Model so that it could work across different project scales and technologies and that it did not see a compelling case for introducing a separate scheme for smaller scale projects.
6. General consensus appeared to emerge that a contract duration of around 15 years would be acceptable, with the government confirming that it expects the contract duration to be between 10 – 15 years.
7. The participants indicated that the allocation of risk set out in the proposed Business Model was broadly acceptable.
8. The responses suggested that in the near-term bilateral negotiations would be the most appropriate mechanism for allocating the Business Model contracts (with the general view being that such bilateral negotiations would be an important mechanism for kickstarting the hydrogen economy and getting projects to achieve “final investment decisions” in the hydrogen market); however, many respondents agreed that  a transition to a more allocation process such as an auction would be preferable in the longer term. The government confirmed its plans in relation to allocation including alignment with the Net Zero Hydrogen Fund (NZHF) and ambition to move to price competitive allocation by 2025 as  soon as legislation and market conditions allow.
9. The responses were less categorical in respect of selecting a single preferred funding option for the proposed Business Model; amongst the respondents who offered a single preferred option for funding the business model, most favoured general taxation or a levy, with some favouring carbon pricing. The government confirmed its inclination to introduce a levy to fund revenue support provided through the Business Model, subject to consultation and legislation being in place.
10. The majority of respondents agreed with the proposal to allow projects to include small scale hydrogen transportation and storage costs as part of the projects’ overall costs of production when bidding for a Business Model contract. The government confirmed that it would allow some transportation and storage to be supported through the Business Model, where necessary and subject to affordability and value for money considerations.