Hydrogen production – updated LCHA terms published

Counterparty

Low Carbon Contracts Company Limited (“LCCC”).

No change.

Term

The standard term of the LCHA will be 15 years. This may be shorter where the Producer exceeds the LCHA Sales Cap or the Permitted Annual Sales Cap in 3 fiscal years (see below).

DESNZ is considering the treatment of hydrogen produced prior to the Start Date, for example as part of the Commissioning process.

No material changes.

Eligible Technologies

Producers are required to commission an installed capacity of no less than 95% of the Installed Capacity Estimate by the Longstop Date. Producers can opt to reduce the initial installed capacity estimate up to a maximum of 10% in the first 12 months of the LCHA.
Under the LCHA Qualifying Volumes are volumes purchased by a Qualifying Offtaker and that comply with the LCHS. Producers will be eligible for payment under the LCHA for these volumes of hydrogen produced.
Non-Qualifying Volumes are those purchased by a Non-Qualifying Offtaker (including offtakers that export hydrogen for use outside the UK and/or inject hydrogen into the Gas Transportation System for blending), or which do not meet the LCHS. The volumes of hydrogen will only be taken into account when calculating the payment that is to be made back to the LCHA Counterparty.
RTFO Volumes (i.e. volumes in respect of which Renewable Transport Fuel Certificates are claimed) will not be eligible to receive subsidy under the LCHA.A detailed process in respect of a “Qualifying Offtaker” has been set out in the Standard Terms and Conditions. Producers will have to give notice to the LCCC requesting confirmation of any new offtaker as a “Qualifying Offtaker”, and provide details in respect of the offtaker’s identity, corporate structure, details of the facility at which the hydrogen will be used, details of the offtake arrangement (including disclosing a copy of the relevant agreement), and other compliance requirements.

There has been a change to the definition of Non-Qualifying Volumes, which has been extended to include a catch-all “any other volumes which are deemed to be ‘Non-Qualifying Volumes’ pursuant to any provision of this LCHA”. This introduces an element of discretion for LCCC that may be unhelpful to producers.

The definition of Qualifying Volume has also been updated to clarify that it does not include any Measured Hydrogen Output which is deemed not to be LCHS Compliant.

There have also been changes to the process in respect of a “Qualifying Offtaker” (now set out in Condition 36). Under the LCHA, the Producer must now provide the Offtaker Confirmation Request Notice no later than 30 Business Days rather than no later than 15 Business Days.

There is also now a distinction between a Small Offtaker (purchasing less than 750 MWh (HHV) a year) and a Large Offtaker (purchasing 750MWh or more (HHV) a year). This constitutes different disclosure requirements to the LCCC, with Large Offtakers carrying a higher disclosure burden.

There is also an updated mechanism for the LCHA Counterparty to query a Producer’s Offtaker Confirmation Request Notice.

Required Installed Capacity

Producers are required to install 95% of their “Installed Capacity Estimate”. Failure to do so by the Longstop Date is a termination event for LCCC. Where no notice of the Final Installed Capacity of the Facility is given, the Final Installed Capacity is deemed at 80% of the initial Installed Capacity Estimate.

This figure has been lowered to 90% - reflecting the additional construction and commissioning risk faced by FOAK hydrogen projects benefitting from the LCHA.

Determining the level of Support

The Producer will be paid a premium (the “Difference Amount”) for each unit of hydrogen that is a Qualifying Volume when the Strike Price exceeds the Reference Price for Qualifying Volumes.
The Difference Amount is calculated as follows:
(Strike Price – Reference Price for Qualifying Volumes) x Qualifying Volumes
Non-Qualifying Volumes will be taken into consideration only when the Reference Price for Non-Qualifying Volume exceeds the Strike Price, meaning an amount will be payable by the Producer to the LCHA Counterparty.
The Difference Amount will be calculated as follows:
(Reference Price – Strike Price for Non-Qualifying Volumes) x Non-Qualifying Volumes

The payments will be made on a £ per MWh (higher heating value) basis and it is expected that the size of the Difference Amounts payable by the LCHA Counterparty will decrease as the hydrogen market develops.
RTFO Volumes will not be taken into consideration when calculating the Difference Amount.
In short, if the price for Non-Qualifying Volumes is above the Strike Price, the difference received for Non-Qualifying Volumes will be set off against payments due or owed to the producer (or is part of the amount payable to the LCCC).The LCHA contains provisions in relation to the indexation of the Strike Price, the Capital Return Component, and certain CCUS-Enabled Non-Variable Costs.

The LCHA also contains a clawback right for LCCC where the Producer has received a Difference Amount payment in respect of Non-Qualifying Volumes – amounts will either be set off against other payments to the Producer or repaid.

There are no substantial changes to the calculation of the Difference Amount.

The August 2023 LCHA does, however, introduce the Carbon Cost Protection Amount and the PILOHS Amount in Conditions 19 and 20. These conditions apply to CCUS-Enabled Facilities only.

Carbon Cost Protection Amount

This is calculated with reference to the UK ETS Allowance Reference Price (calculated each year), and broadly multiplies this figure by the amount of emissions of the facility during an outage of the CO2 T&S Network.

PILOHS Amount

This represents a payment in lieu of hydrogen sales during an outage of the CO2 T&S Network. It multiplies the volumes produced during the outage by the “CCUS-Enabled Non-Variable Costs Strike Price” and a “Capital Return Component”.

Price Discovery Incentive

Producers are incentivised to achieve prices for Qualifying Volumes above the Floor Price.
The Producer receives an amount linked to the increment by which the Reference Price for Qualifying Volumes exceeds the Floor Price for each unit of hydrogen.
Where the Reference Price for Qualifying Volumes is higher than the Floor Price and is equal to or lower than the Strike Price, the Producer will receive 10% of the difference between that Reference Price and Floor Price.
Where that Reference Price exceeds the Strike Price, the Producer will receive 10% of the difference between the Strike Price and the Floor Price.

Note that the Floor Price for “feedstock offtakers” is different to other offtakers, being the lower of either (i) the Strike Price or (ii) the Gas Reference Price multiplied by 1.2. DESNZ’s intention is that this ensures that it better reflects the cost of unabated hydrogen.

Amendments have been made to the calculation of the Gas Reference Price (that feeds into Price Discovery Incentive).

Volume Support

Instead of a backstop PPA, the LCHA provides volume support where the Producer is producing hydrogen and its offtake/sales volumes fall.
In these instances, the Producer will receive an additional amount (the “Sliding Scale Top Up Amount”) for each unit of hydrogen sold which is a Qualifying Volume.
This Sliding Scale Top Up Amount will be set by the LCHA Counterparty and will not be negotiable at project level.
The offtake/sales volumes will include all volumes of hydrogen produced by the relevant facility, including Non-Qualifying Volumes and RTFO Volumes.
No support will be provided where the Producer’s offtake/sales volumes fall to zero.

There are no significant changes to the volume support mechanism. However, the calculation of the “Sliding Scale Top Up Amount” has been amended to take into account any PILOHS Volumes and any QCiL Adjusted Revenues Volumes.

Volume scaling

The LCHA sets out the following caps on the production of hydrogen by LCHA Producers as follows:

The “LCHA Sales Cap”: Where the “Total Accrued Volume” (i.e. the total volumes of hydrogen invoiced under the LCHA, as adjusted) exceeds the LCHA Sales Cap, the LCHA will automatically expire on a no-liability basis.

The “Permitted Annual Sales Cap”, which precludes any LCHA payments for volumes above the cap, and gives the LCCC a termination right where this is exceeded in 3 consecutive or non-consecutive fiscal years.

Notably neither the proposed “volume floor” nor the termination event for failure to sell sufficient volumes of hydrogen (both included in the HoTs) are included in the LCHA. 

The calculations for the “LCHA Sales Cap”, the “Permitted Annual Sales Cap” and in relation to “Automatic Expiry” have all been updated to take into account PILOHS Volumes and QCiL Adjusted Revenues Volumes.

The calculation for the Permitted Annual Sales Cap has also been updated so that it applies the same formula for the fiscal year in which the Start Date occurs as the other fiscal years.

Total amount of support available

Costs that are to be eligible for support under the LCHA and are not to be automatically excluded from the Strike Price have not been explicitly confirmed. However, DESNZ has stated that these are likely to include:

• capex and opex associated with the construction and operation of the relevant facility (excluding capex funded by the NZHF or other approved funding scheme);
• an allowed return on investment;
• input energy costs;
• capex associated with the construction of hydrogen transport infrastructure, but not the opex associated with operating it (excluding capex funded by the NZHF or other approved funding scheme);
• capex and/or opex associated with the construction and/or operation of hydrogen storage infrastructure (excluding capex funded by the NZHF or other approved funding scheme); and
• leasing costs associated with specified hydrogen transport and or storage infrastructure.

Ineligible costs (which are excluded from the Strike Price calculation) will include:

• indirect and direct taxes;
• capex and/or opex associated with capturing additional revenue streams;
• costs in relation to Electricity Storage pursuant to the Electricity Storage negative undertaking; and
• any costs associated with the provision of ancillary services.

No material changes.

Indexation

CCUS-enabled facilities:

The natural gas component of the Strike Price will be calculated by multiplying the monthly Gas Reference Price by an agreed proportion of up to 1.15 MWh (HHV) of hydrogen produced and sold each month.
All other components will be CPI indexed. CO₂ T&S charges fall outside of the Strike Price.
Electrolytic Facilities:
The full Strike Price will be indexed to CPI.

No material changes.

Billing and Payment

The main payment for each Billing Period will comprise the following:

• the Difference Amount – payable either by the LCHA Counterparty or the Producer as applicable,
• the Price Discovery Incentive Amount – payable by the LCHA Counterparty to the Producer,
• the Sliding Scale Top Up Among – payable by the LCHA Counterparty to the Producer,
• the CO₂ T&S Outage Relief Event Strike Price Deduction Amount – payable by the Producer to the LCHA Counterparty (for CCUS-enabled facilities only), and
• the Monthly CO₂ T&S Charges Amount – payable by the LCHA Counterparty to the Producer (for CCUS-enabled facilities only).

There are minimal changes in relation to billing and payment. Under Condition 21.4, the Producer agrees that it is not entitled to raise a Dispute in respect of an estimated Achieved Sales Price for each Relevant Offtaker in respect of Qualifying Volumes or Non-Qualifying Volumes or the applicable methodology. The new Condition 21.5 also relates to payments following a Payment Information Notice and accompanying Directors' Certificate.

The requirement to include the sums of the Strike Price Exclusion Amounts in respect of either Qualifying Volumes and Non-Qualifying Volumes has also been removed.

There are also new requirements in relation to KYC notifications, with a corresponding payment suspension right for the LCHA Counterparty in circumstances of breach.

Charges for CCUS-Enabled Facilities

For CCUS-Enabled Facilities connected to a CO₂ T&S Network, the LCHA Counterparty will be required to pay the Producer certain CO₂ T&S Charges in proportion to the Qualifying Volumes/Total Volumes ratio. The CO₂ T&S Charges Amount will comprise of:

• Flow Charge;
• Capacity Charge; and
• Network Charge.

Indexation for CCUS-Enabled Facilities is subject to further review by DESNZ.

No material changes.

State Aid

Subsidy control provisions in the LCHA follow those for AR4 CfD. The LCHA prohibits subsidy cumulation in respect of the costs of the Project and an obligation for Producers to repay any subsidy it receives other than the LCHA subsidy.
Exemptions to the no subsidy rule include: (i) Net Zero Hydrogen Fund funding; (ii) Renewable Transport Fuel Certificates; and (iii) any Approved Scheme of Funding.
Breach of this undertaking will give the LCHA Counterparty the right to suspend all payments under the LCHA.

No material changes.

Qualifying Change in Law (“QCiL”)

The LCHA contained QCiL provisions mirroring those in CfD AR4, that provide relief (in the form a payment) for the Producer where there is a “Qualifying Change in Law”.

No material changes.

Interplay with UKETS

While certain facilities could be eligible for free allocation of allowances under the UK ETS, the LCHA prevents Producers to from applying for or receiving these free allowances. Breach of this prohibition would entitle the LCHA Counterparty to terminate the LCHA. DESNZ is still considering the way in which the prohibition will be detailed in the LCHA.

The updated LCHA includes further references to the UK ETS. The Carbon Protection Amount (as mentioned above) is to be calculated by multiplying the Eligible Carbon Cost Protection Emissions by the UK ETS Allowance Reference Price (each for the relevant calendar year).

Conditions 19.7 and 19.10 also provide calculations for the UK ETS Allowance Price and the UK ETS Allowance Reference Price respectively. Condition 19.11 also states that these calculations may be amended, supplemented or replaced in accordance with an annex to the LCHA.

Under Condition 34, the Producer provides a warranty to the LCHA Counterparty that at the Start Date, no UK ETS Free Allowances have been applied for, or received. The Producer also provides and an undertaking that it will not apply for or receive UK ETS Free Allowances. Failure to comply with this undertaking is deemed to be a termination event under the LCHA.

Interplay with RTFO

The LCHA permits Producers to participate in the RTFO scheme, however, claiming under both schemes in respect of the same volumes of hydrogen will not be permitted.
To this effect, the LCHA includes a third party claim prohibition, which means Producers will be required to use all reasonable endeavours to ensure that volumes subsidised by the LCHA are not subsequently claimed under the RTFO scheme by a third party.

A new “Pre-Start Date Subsidy Notice” is required where a Producer intends to claim subsidy under the RTFO between the agreement date and the Start Date of the LCHA.

Condition 33.20 sets out circumstances where the Producer is not required to pay a RTFO Volume Clawback Amount, despite a breach of the RTFO Compliance Obligation, i.e. where the Producer (i) made all due and careful enquiries in respect of the Offtaker’s compliance, and (ii) included a compliance provision in the relevant offtake agreement.

Condition 33.21 also provides the circumstances where a Producer’s breach of the RTFO Compliance Obligation (i.e. double recovery under RTFO and LCHA) will be deemed a termination event. In simple terms this is if the breach has been intentional, reckless or repeated.

Interplay with LCHS

Volumes of hydrogen produced must be compliant with the LCHS to be a “Qualifying Volume” and therefore be eligible for support under the LCHA. Annex 6 of the Standard Terms and Conditions contains data collection and monitoring provisions in relation to compliance with the LCHS, and Annex 10 contains provisions in relation to the Producer’s participation in the scheme itself.

DESNZ is considering the position that Producers should be required to estimate emissions using pre-approved methodologies (e.g. default values from the LCHS), failing which the LCHA Counterparty will determine the emissions. In the case of missing data or supporting information, the LCCC will have the right to deem that the relevant consignments are not compliant with the LCHS and therefore suspend payment under the LCHA.

No material changes to the principles of compliance. Annex 6 has been updated to include:

• Additional detail on PPAs used for the purchase of green electricity;
• Further detail required from Producers in relation to the content of the LCHS compliance audit reports;
• The inclusion of the “Materiality Threshold” from the LCHS into the LCHA.
• The ability for the Producer to dispute a notice of LCHS non-compliance from LCCC; and
• Termination for Misleading LCHS Report Data only where 3 such failures have occurred (across the life of the LCHA).