On 9 December 2024, the UK government published in its response (the “Response”), to its 2023 consultation on the need for intervention in the ‘Hydrogen to Power’ market (the “2023 Consultation”). The government intends to de-risk investment in hydrogen to power (“H2P”) and will do so by providing a subsidy mechanism that will take the form of an H2P business model based on elements of the CCUS Dispatchable Power Agreement (“DPA”). The government also expects that in due course H2P will be able to compete with other technologies and deploy through a competitive support process such as the Capacity Market (“CM”).
While the details of the scheme are not due to be confirmed until 2026, we provide an overview of the Response and the details the government have provided thus far.
Background
H2P involves the conversion of low-carbon hydrogen to produce low-carbon electricity. It is a technology that the government has identified as being key to its mission of delivering clean power by 2030 and accelerating net-zero. Low carbon dispatchable technologies, such as H2P, alleviate the reliance on weather-dependent renewables, providing inter-seasonal energy storage and also, in the long-term, potentially providing a decarbonisation pathway for unabated gas.
In the 2023 Consultation, the government identified two key barriers to H2P deployment: (i) the uncertainty and investment risk of H2P being a FOAK technology and (ii) the dependence on a critical enabling infrastructure, namely hydrogen production and feedstock, transportation and storage, which all pose supply-chain risks, and having low carbon hydrogen. The 2023 Consultation also set out the government’s belief that the peak rate of hydrogen consumption from medium to larger sized power plants will likely require hydrogen to be delivered via pipeline, will be heavily reliant on the availability of large-scale geological storage and accordingly large volumes of stored hydrogen.
Options for market intervention
In the 2023 Consultation, the government set out 3 options for market intervention (6 options were initially modelled, including participation in the CM, Deemed Generation CfD, and an unabated fossil fuel ban), including (i) a DPA-style mechanism, (ii) a Split Capacity Market, with separate auction for low-carbon dispatchable technologies, and (iii) a Revenue Cap and Floor.
Types of market intervention
- DPA-style mechanism
Under the Power CCUS DPA model, which was adapted from the Contracts for Difference Allocation Round 4 standard terms and conditions, facilities receive an Availability Payment, which is paid per unit of capacity that is available over time, regardless of dispatch. This provides a regular revenue stream to cover CAPEX costs and to help build investor confidence to support investment. The Power CCUS DPA also includes a Variable Payment, paid per unit of output, to help reduce the short run marginal cost of the Power CCUS plant.
The DPA-style mechanism was deemed by the government to be the most appropriate mechanism for market intervention for H2P, particularly in the medium and short term, and generally was supported by respondents.
- Split Capacity Market (CM)
A Split CM represents changes to the current CM that could reduce the problem of excessive inframarginal rents. Auctions would be separated, grouping less mature low-carbon dispatchable power technologies. Successful bidders would receive a Capacity Agreement for up to 15 years, providing them with a fixed monthly payment per kW of capacity that is available, regardless of how the asset dispatches (except in system stress events). Respondents ultimately agreed that this approach was unlikely to be able to adequately mitigate supply-chain risks and was, thus, disregarded by the government.
- Revenue Cap and Floor
This market intervention seeks to encourage developers to deliver capacity by limiting their exposure to price risks associated with the electricity market. Where the revenue received by an operator is below a minimum (the floor), the operator would receive a payment to bring its revenue up to the level of the floor. If the market revenue received by the operator were to be above the allowed maximum (the cap), the additional earnings would be returned. The Response set out that the majority of the respondents had agreed that a revenue cap and floor is unlikely to help raise investor confidence and that this mechanism may in fact disincentivise dispatch of H2P.
The Response
DPA Model
The 2023 Consultation proposed that providing Availability Payment through a H2P DPA would give investors increased revenue certainty through a stable regular payment that would not be linked to security of supply, although it would be linked to ability to dispatch in the market (no priority access to the grid is envisaged).
The DPA design also includes an option of retaining a Variable Payment, alongside an Availability Payment, which could be paid when the relevant H2P plant operates. The H2P DPA could, initially, be allocated through bilateral negotiation with the government; allowing for the strategic choice of H2P projects during a period before there are enough projects to run a price-based competition. As deployment barriers reduce and enabling infrastructure expands, H2P DPA contracts could move towards price-based competitive allocation. While the Response does not provide any indication as to how this competitive allocation would work, the government has alluded that the approach to developing the H2P DPA would be similar to that for the business models developed for the he broader hydrogen economy (i.e., the LCHA and the storage and transport business models).
While most respondents to the consultation agreed both with the governmental analysis of the benefits and risks of a DPA-style mechanism and also with its assessment that the mechanism is the most suitable option for H2P market intervention, there were nevertheless still some concerns regarding the ability of the mechanism to sufficiently address fuel supply risks and the risks posed by the nascency of the UK hydrogen supply chains.
Several respondents specifically cited the Hydrogen Production Business Model’s (“HPBM”) design as a key risk for H2P, stating that it favours “baseload production” and, therefore, baseload offtake, which H2P is not. Linked to this is the ongoing concern about the ineligibility of Risk Taking Intermediaries (“RTIs”) for subsidised hydrogen under the HPBM as a key barrier for the deployment of H2P. Despite persistent industry statements about the important role that RTIs play in a market, helping to derisk investment and manage liquidity, the government wishes to maintain this restriction thus curbing the pace of development in this sector.
In relation to the interaction between the H2P business model and other hydrogen support mechanism, the government acknowledged that the alignment and co-ordination of these business models will be critical for developing the hydrogen economy, noting that interdependencies exist with hydrogen storage and production. The government also noted industry concerns that the hydrogen value chain infrastructure may not necessarily develop where, when or in the amounts required, and that the proposed collection of subsidy mechanisms could create market distortions. While the Response does not provide detail as to how these distortions might be prevented or overcome, the government has stated that it will undertake further market engagement exercises before the design of the H2P BM is finalised.
Capacity Market
The Government’s analysis on the CM indicated that some lower-CAPEX H2P plants could be deployed through the CM, provided they had ready access to hydrogen fuel and were located within or close to enabling hydrogen infrastructure. Conversely, the analysis indicated that more CAPEX-intensive H2P plants could require CM clearing prices of up to £120/kW to deploy.
The biggest concerns raised by respondents regarding the CM centred around the lack of fuel availability and the nascency of the technology, noting these as significant barriers preventing deployment of H2P in the short term. A number of respondents also raised concerns regarding CM non-delivery penalties and the impact this would have on investor confidence, while some opposed the proposal to enable H2P to compete in the CM, noting the potential to create geographic distortions in the market with H2P deploying close to hydrogen infrastructure and, therefore, potentially sending locational signals to viable plants from elsewhere in the system.
The Government confirmed that enabling participation of H2P in the CM will be complex and that it expects more CAPEX intensive plants to compete in the CM in the longer-term, once deployment costs have fallen.
Next Steps
The government has committed to delivering a H2P BM based on a DPA-style mechanism and to enable H2P to participate in the current Capacity Market at some future date. Further details on this are expected in Spring 2025 when the government also plans to establish an H2P Expert Working Group to support on the design of and policy development for the H2P BM.
This Response comes alongside the wider update to the UK’s Hydrogen Strategy (link: https://assets.publishing.service.gov.uk/media/6761915126a2d1ff18253493/hydrogen-strategy-update-to-the-market-december-2024.pdf) published on 18 December 2024.
Whilst largely providing a look-back on key activities from 2024, the Strategy update also sets out plans for 2025. This may go a little way to address some of the wider concerns raised by industry regarding the usefulness of blending projects, RTIs, and clustering subsidies for hydrogen infrastructure together to mitigate subsidy alignment risks, at least to say when future updates can be expected.
Namely H2P projects will want to see how version 4 of the Low Carbon Hydrogen Standard evolves and the all important development of a Low Carbon Hydrogen Certification Scheme. What’s more, it will be important for H2P projects to factor in how government policy to water demand for hydrogen production and electricity sourcing for H2P projects impacts the costs and revenues of H2P projects.
However, the most important next step for the success of H2P and other hydrogen project remains the need for transport and storage infrastructure – an update on which is expected in 2025. As the wider energy market gets to grips with changes in the grid connection system, it is interesting to note that it will be NESO again who will manage the coordination of hydrogen transport and storage infrastructure (though not until from 2026). Co-ordination of the rollout of production, transport, storage and use requires oversight and direction that can only be dealt with at government level. The industry will be looking to the government for this in 2025.
Social Media cookies collect information about you sharing information from our website via social media tools, or analytics to understand your browsing between social media tools or our Social Media campaigns and our own websites. We do this to optimise the mix of channels to provide you with our content. Details concerning the tools in use are in our Privacy Notice.