Hydrogen transport and storage: Update on proposed business models and UK Hydrogen Strategy

Updates to the UK Hydrogen Strategy

The UK Hydrogen Strategy was updated on 2 August 2023, confirming the launch of a second hydrogen allocation round (“HAR2”) later this year with contract awards of up to 750 MW in 2025, three times the capacity of the initial allocation round.

In March 2023, the government published a shortlist of 20 electrolytic projects totalling 408 MW under a first allocation round (“HAR1”). Awards for around 250 MW are expected in Q4 2023, with first projects aiming to be operational in 2025. Providers will need to move quickly as the Government plans to transition to annual, price-based competitive allocation after HAR2, as they did with the contract for difference (consultation closing on 11 August). Annual, price-based competitive allocation will be run for LCHAs by 2025 for electrolytic projects, and potentially other specified non-carbon capture hydrogen production technologies.

The Government intends to continue developing policy based on recommendations in the Independent Review of Net Zero. This included plans to develop a hydrogen production delivery roadmap as well as plans to publish consultations later this year on hydrogen blending and options for hydrogen-to-power market intervention.

Here we set out some key developments concerning the production of hydrogen (supported through the LCHA) and the transportation and storage of hydrogen.

Low Carbon Hydrogen Agreement

The Low Carbon Hydrogen Agreement, or “LCHA” is currently being developed, with an aim for the final version to be published in Q3 2023. Government still intends for the first contracts to be allocated for electrolytic projects in Q4 2023 however given the low carbon hydrogen guidance and wider dependencies on the Energy Bill which is making its way through Parliament, the timing may be delayed. Please see our earlier comments on the key provisions of the draft LCHA here.

Hydrogen transport and storage proposals

How any hydrogen produced will get from the producer to the customer has been a critical missing piece of the puzzle for UK’s nascent hydrogen sector. The updates to the proposals for hydrogen transport and storage business models are therefore welcome.

Since the UK Government published its hydrogen transport and storage infrastructure (the “Consultation”) (see our previous Law-Now on this here) nearly a year ago, the developments on the production side had had to focus on ‘private connection’ type arrangements and for others, such as storage operators and gas networks have simply had to wait for further clarity. The response from the Department for Energy Security and Net Zero (“DESNZ”)  set out a summary of responses and the government’s ‘minded to positions’ on hydrogen transport and storage business model designs, regulatory arrangements, strategic planning and the role of blending (the “Positions”). In this update, we briefly draw out some of the key points in the Positions.

A key driver for the Consultation had been the Government’s aim of increasing the production capacity of new low carbon hydrogen to 10GW by 2030 for use across the economy. The Consultation considered multiple options for regulating hydrogen storage and infrastructure, including whether models such as RAB based economic regulation, CfD or cap and floor structures would be best suited to attract investment into such projects.

Hydrogen transport infrastructure

The minded to high-level design for the hydrogen transport business model is a Regulated Asset Base (RAB) alongside an external subsidy mechanism, in the form of private law revenue support contracts. UK hydrogen transport and storage networks will therefore be likely be regulated through the same RAB-style price control as gas under the Gas Act 1986. DESNZ proposes implementing a RAB for hydrogen pipelines through gas transporter licences granted under the existing framework of the Gas Act 1986. However, it has not yet made any decisions on the configuration of roles and responsibilities between Ofgem and Government. We would expect the Government to have more of a say in the early developments and then leave more to Ofgem’s regulatory powers once the policy is established.

DESNZ considers that a RAB model is the most suitable model in the long term because a mature hydrogen transport and storage network will face market barriers closely resembling those of other natural monopolies. The RAB framework is familiar to Government, regulators and industry, incentivising investment into complex natural gas, electricity and water infrastructure projects and even gaining ground for new nuclear projects.

Under the RAB model, storage providers/owners and operators of hydrogen pipelines would agree an “allowed revenue” (the amount the provider could recover across a specified period) with a regulator ahead of the price control period. The allowed revenue would be conditional on operational performance targets being met. Users would be charged in accordance with an agreed methodology. Revenues would also be subsidised by an external funding mechanism whilst the hydrogen economy is in its infancy. The risk would be transferred to the external subsidy funder, resulting in a guaranteed regulated return which would provide investors with certainty. This is proposed after stakeholder feedback flagged that an external subsidy mechanism would be required alongside a RAB framework to avoid high upfront costs falling on an initially small user base in a growth phase. We would anticipate that learnings from the CCUS TRI model developments as well as the interconnector regimes will feature heavily in the policy thinking here.

Hydrogen storage infrastructure

Government favours a 15 year private law revenue support contract between a storage provider and a government-appointed counterparty for the hydrogen storage business model design. These contracts would have a minimum revenue floor and would be negotiated bilaterally according to allocation criteria to be published later this year. Although not considering a price competitive process yet due to the relatively small number of storage projects they expect to come forward, the details of how the storage contracts would be awarded is not yet clear. The Government anticipates the initial focus for support to be geological storage, though they are minded to retain optionality to support above-ground storage where it faces similar market barriers. Precisely how this will interface with pipeline regulation for transport and ensure appropriate risk allocation between production and hydrogen customers (especially given the Government’s position on not permitting sales through intermediaries under the LCHA) is not yet known.

Strategic planning

Government is yet to decide where hydrogen pipelines and storage facilities can be built in the UK. While there may be elements of market-led development for certain infrastructure based on scale, flexibility, location or third-party access, the Government considers that build-out of larger scale or systemically important assets should be guided by centrally coordinated, locally sensitive, strategic planning that is integrated across energy and other relevant systems. A market-led plan would be less conducive to a regulated model like RAB, but DESNZ is “mindful that strategic planning should avoid being so prescriptive as to deter otherwise viable projects from coming forward when encouraged by market signals.”  This will be welcome news if it can fit into a wider plan that facilitates a more efficient planning process for such works.

Until the Future System Operator (FSO) takes on a central strategic planning role following its establishment, a ‘hydrogen networks pathway’ will elaborate the Government’s vision for the development of hydrogen transport and storage infrastructure in the UK.

Regulatory framework

In addition to proposed business models to support hydrogen infrastructure, the Government has also consulted on the suitability of the existing non-economic regulatory framework for planning, health and safety, environment, and concerns in the onshore and offshore contexts.

In April 2023, the Government published the Offshore Hydrogen Regulation Consultation, requiring secondary legislation for oversight of offshore hydrogen pipelines and storage facilities whilst ensuring the environmental impacts of early hydrogen projects are duly considered. The consultation is closed and the Government’s response is now anticipated in Q3 2023.

Blending

A decision on blending is outstanding. The Government is aiming to reach a policy decision in 2023 on whether to support the blending of up to 20% hydrogen by volume into the GB gas distribution networks -  a consultation is expected later this year. The Government sees hydrogen blending as a potentially effective way to manage volume risk and de-risk investments in the early stages of the development of hydrogen transport and infrastructure in the UK. In what seems to be a limited way of looking at the opportunity, the Government considers that blending could act as a reserve offtaker, absorbing excess volumes of hydrogen where there are no alternative routes to market. This can manage volume risk in situations where producers may have been unable to sell enough volume to cover their costs, which may incentivise the development of additional capacity in low-carbon hydrogen. Furthermore, this ‘reserve offtaker’ can bridge the gap in demand while transport and storage infrastructure develops and can manage volume risk even when an offtaker exists. Ultimately, blending hydrogen with methane remains an opportunity for greater management of the gas system in the UK.

Next steps

The Government is continuing to develop policy at pace to deliver on the UK’s ambitions on hydrogen, including taking forward recommendations from the Independent Review of Net Zero. Whilst this recognition of additional work is welcome, critics point out the lack of detail in the Hydrogen Strategy especially around establishing a certification scheme for low-carbon hydrogen, to ensure transparency and consistency in the market and aligning it with the EU's delegated acts. What’s more, there is little in the strategy about the role that hydrogen will play in the transport sector – for example how it could better interface with the Renewable Transport Fuel Obligation. The strategy also lacks detail on how to incentivise the development and integration of renewable energy sources such as offshore wind and solar which can provide the electricity needed for green hydrogen production, and how to enable the coupling and flexibility of the power and hydrogen sectors.

Government plans to continue working with industry and regulatory bodies to consider the issues, suggestions and final business model design for hydrogen transport and storage infrastructure. In terms of other hydrogen developments, later this year, we can expect:

• The closure of the consultation regarding the UK’s transition to price-based competitive allocation for low carbon hydrogen production
• New consultations on design options for hydrogen to power market intervention, hydrogen blending, IETF Phase 3 design and NRMM decarbonisation
• The Government’s response to the Offshore Hydrogen Regulation Consultation
• The policy decision on whether to support the blending of up to 20% hydrogen into gas distribution networks
• The hydrogen networks pathway setting out early strategic planning, details on how the hydrogen storage contract will be allocated and further updates on transport and storage business model design