UK hydrogen production – further updates to LCHA terms

Introduction 

On 21 November 2023, the Department for Energy Security & Net Zero (“DESNZ”) shared an updated full-form front end agreement (the “Front End Agreement”) and Standard Terms and Conditions (the “Standard Terms and Conditions”) for the Low Carbon Hydrogen Agreement (together the “LCHA”) to members of the Hydrogen Production Business Model Stakeholder Forum.

This article outlines the key updates made to the LCHA since the last draft update in August 2023. DESNZ notes that the revisions are in response to feedback from the stakeholder forum and ongoing policy development. For further background and previous commentary on the subject please see here. 

Key changes to the LCHA

QCiL – clarifications on the scope of relief

In the recent draft of the Standard Terms and Conditions, any Change in Law arising from the Government’s ongoing Review of Electricity Market Arrangements (“REMA”) will not be deemed a Foreseeable Change in Law. This will mean a Producer is not prima facie excluded from benefitting from QCiL relief pursuant to a Change in Law stemming from REMA, though of course the other limbs of QCiL must be met.

Furthermore, the existing “EII TNUoS Charges Exemption Change in Law” concept has been expanded to include (as well as TNUoS Charges) changes in law that exempt electricity suppliers from DUoS Charges and/or BSUoS Charges under the EII exemptions (or any similar provisions that may be introduced). This has also been renamed to an “EII Network Charges Exemption Change in Law”. Additionally, the introduction of "H₂ Levy Revenue Support Regulations" has been explicitly excluded from the scope of the QCiL regime in the LCHA – which follows from the explicit provision for such regulations in the Energy Act 2023.

Required clauses in offtake agreements

Amendments to the Standard Terms and Conditions require Producers to include in any offtake agreements (a) one or more express contractual rights against the relevant Offtaker for non-material breaches of Offtaker Compliance Provisions, and (b) the right to terminate the offtake agreement for persistent, material, or wilful breaches.  

Producers and Offtakers will need to bear in mind such requirements when negotiating the terms of offtake agreements for projects backed by an LCHA.

RTFO Non-Compliance Termination Event

The scope of when a RTFO Non-Compliance Termination Event is triggered has been refined. Where previously an RTFO Non-Compliance Termination Event (i.e. a breach of the obligation not to claim subsidy under the LCHA and the RTFO in respect of the same volumes of hydrogen) required non-compliance on "three or more occasions," the current version specifies "three or more occasions… in any rolling three-year period", which is a more generous position for Producers.

Reflections of anticipated changes to LCHS Version 3

The Standard Terms and Conditions have incorporated anticipated modifications to version 3 of the Low Carbon Hydrogen Standard (“LCHS”), which we note has not yet been made public by DESNZ. The changes in this updated draft aim to synchronise terminology and reporting requirements between the LCHS and LCHA. Further clarification has also been provided on the circumstances which require the Producer's revision of its monthly reporting on the LCHS, which is triggered when misstatements, omissions, or errors are identified in the reporting.

Updates to the Front End Agreement

The updated Front End Agreement contains material updates in relation to the satisfaction of the Milestone Requirement. First, the definition of Total Project Pre-Commissioning Costs (i.e. the amount that Producers have to demonstrate having spent by the Milestone Delivery Date) now explicitly includes development costs. The definition of Material Equipment (pursuant to the “Project Commitments” method of satisfying the Milestone Requirement), has also been refined to specify equipment relevant to each technology type. 

The scope of Applicable Connection Documents (to be provided within 20 Business Days of LCHA signature) has been expanded to include an oxygen supply agreement.

Developments to the audit regime

The annual audit regime within the LCHA has undergone further developments. This includes a precise delineation of the scope of the Annual Audit's; specifying the responsibilities of the Producer in delivering the Annual Compliance Report and Annual Audit Documents to the LCHA Counterparty; and outlining the corresponding non-compliance regime. Additionally, a new annex has been introduced to the Standard Terms and Conditions, which provides details on the audit methodology and content of each annual audit report.

Clarifications on Own Consumption

The LCHA now specifies that for Producers acting as Own Consumption Offtakers, the “Relevant Invoiced Amount for Hydrogen” used for Feedstock Purposes and/or Fuel Purposes will not be calculated based on figures from an Offtaker Invoice. Instead, it will be detailed in the Payment Information Notice, supported by an internal transaction report.

A Producer acting as an Own Consumption Offtaker must also specify that it does not intend to use the hydrogen produced by the plant so as to increase or decrease the Difference Amounts payable to or by it.

Definition of Significant Common Ownership

The updated Standard Terms and Conditions require the Producer to submit a Know Your Customer Notice in relation to any transaction resulting in “Significant Common Ownership”, defined as a scenario where a single legal entity holds a direct or indirect interest of 25% or more in the equity share capital of both the Producer and an Offtaker. In this situation, the Producer is obligated to fulfil certain undertakings related to an Affiliate Offtaker.

Updates to Subsidy Control requirements

The subsidy control requirements within the Standard Terms and Conditions have been updated to include references to “International Funding”. This is defined as financial assistance from public authorities outside the UK or the EU, which cannot be combined with the LCHA in relation to the costs of the Project. The Producer's subsidy declaration at the ICP stage has been expanded to cover any such funding.

Undertaking relating to hydrogen transport

Pursuant to the updated Standard Terms and Conditions, the Producer is required to ensure that Hydrogen Transport Infrastructure is exclusively used by the Producer to transport hydrogen produced by the Hydrogen Production Plant.

Next steps

DESNZ has indicated the need for further updates, particularly in provisions related to CCUS-enabled projects, and especially in respect of CO₂ T&S cross-chain links. Furthermore, despite DESNZ's assurance to forum members that no further drafting amendments are expected for alignment with the LCHS, the updated draft has been adjusted to align with the latest draft of LCHS Version 3, indicating the likelihood of additional amendments to the LCHA upon the finalisation of Version 3.

In addition, the industry awaits DESNZ's upcoming announcement of the successful projects selected in the first electrolytic hydrogen allocation round (HAR1) in 2022. DESNZ has indicated that the successful projects will be revealed in the fourth quarter of 2023.

More broadly, and further to the latest update to the UK’s Hydrogen Strategy (our commentary on which is available here), the launch of a second hydrogen allocation round (HAR2) is expected by the end of 2023, with contract awards of up to 750MW to be made in 2025.