Introduction
Introduction of the revenue support business models for both low carbon hydrogen projects and carbon capture and storage (CCS) projects are some of the key measures provided in the Energy Act 20231 (the Act). In this fourth briefing in our Energy Act analysis series, we consider the provisions which are designed to stimulate growth of the hydrogen economy in the UK. We will address CCS separately in a future briefing.
The Act provides a framework for the licensing, operation and provision of funding for the first in a new wave of UK hydrogen projects. Its passing has been hotly anticipated by developers and potential investors in UK hydrogen, particularly those involved in the current Hydrogen Allocation Round (HAR1) – the funding competition for hydrogen production projects, the results of which are due to be announced imminently – and those looking to submit a bid for the next round of funding (HAR2), which is scheduled to open before the end of the year.
Hydrogen Business Models
As well as setting out the broad regulatory framework for the first wave of subsidised low carbon hydrogen projects, the Act gives authority for funds to be allocated via the different business models, and for the Secretary of State for Energy Security and Net Zero (SoS) to permit her nominee (in this case, the Low Carbon Contracts Company (LCCC)) to enter into the relevant business model contracts.
Part 2, Chapter 1 of the Act sets out the types of revenue support contracts covered by the new Act. For hydrogen, this comprises three separate (but likely similar) sets of arrangements covering (i) production; (ii) transport, and (iii) storage of hydrogen. In all cases, the SoS will be able to designate the counterparty for entry into revenue support contracts and authorise any deviations from the published standard terms.
The Act also provides for an "allocation body" to be responsible for administering the competitive allocation process for hydrogen production, which may involve putting in place formal guidance or rules (an "allocation framework") on how the rounds will work. At present, this process is managed by the Department for Energy Security and Net Zero (DESNZ) on behalf of the SoS, but again the real detail on this will be covered in secondary legislation.
Hydrogen Production
The first of the hydrogen business models authorised by the Act is the Hydrogen Production Business Model (HPBM), published in draft form in August 2023 following the publication of, and consultation on, proposed Heads of Terms previously. We understand an updated draft is due to be released by DESNZ imminently.
The HPBM comprises a bespoke Front End Agreement (setting out the key project parameters) and a standard form Low Carbon Hydrogen Agreement (LCHA), and is essentially a revenue support contract to be used for both electrolytic and low carbon hydrogen projects. While HAR1 is limited to bids from electrolytic projects only, with HAR2 intended to be run on the same basis, it is expected that further rounds will be open to projects designed around different feedstocks.
Pipeline transportation
The Act also formalises some of the proposals set out in the government consultation response in respect of the hydrogen transport and storage framework, published this summer2 and which we summarised here. Whilst hydrogen was already defined as a gas within the meaning of the Gas Act 1986, its provisions have now been expressly extended to cover licensing of pipelines for the transport of hydrogen. Developers of hydrogen pipelines will require gas transporter licences for transmission and distribution of the molecules, whereas those arranging the supply (i.e. the owners) will require a gas shipper licence. In reality, the holder of these licenses may be one and the same entity, or separate entities, depending on future development of a core national hydrogen infrastructure network (described as "essential" in the national infrastructure plan3).
The Act allows the SoS to "designate" development of hydrogen pipeline projects, and notify the details of the project, including entities involved, to both the Gas and Electricity Markets Authority (GEMA) and the Health and Safety Executive. Designation triggers the ability for the SoS to use other powers to implement a Regulated Asset Base (RAB) model in respect of the designated entity and project, such as powers to grant, extend and/or modify a gas transporter licence. Further, there has been an attempt to "future proof" the Act with the inclusion of powers to repeal certain provisions when the Government considers intervention is no longer required to support hydrogen pipeline development. From December 2040 onwards, there is a mandatory requirement to give consideration to the need (or not) to repeal these "designation" provisions, recurring at 5 yearly intervals thereafter where provisions remain in force.
Hydrogen storage
As for production and transportation, the Act provides authority to provide revenue support for hydrogen storage projects. It permits the SoS to "designate" suitable entities for the purpose of developing hydrogen storage projects, but the details will be set out in future hydrogen storage regulations. Such regulations will also determine where any specific provisions of the Gas Act should be disapplied or applied with modifications, once consultation with GEMA and other interested parties has been concluded. It should be noted that onshore storage of hydrogen remains subject to a body of existing planning and health and safety law, which is beyond the scope of this briefing.
Hydrogen levy
The Act enables the SoS to appoint a hydrogen levy administrator (Administrator), responsible for raising funds to support the hydrogen business models. In the face of significant consumer opposition to a proposed levy on individual households raised in Parliament when debating the draft provisions during passage into law, the Act delegates the details of how the Administrator will operate to secondary legislation via revenue support regulations.
The Administrator will be able to make provision, via secondary legislation, for "relevant market participants" to make payments to it. Relevant market participants are GB and NI gas shippers holding a licence under the Gas Act 1986 or the Gas (Northern Ireland) Order 1996 (as the case may be). These payments can be used for funding payments by the LCCC (or other designated government counterparty) under the hydrogen business models, but could also be used to cover the costs of the Administrator, to build up reserves, or to cover losses in the case of insolvency or default of a relevant market participant. Relevant market participants may also be required to provide financial collateral.
It is also envisaged that the revenue support regulations will include directions for treatment of any other payments received by the Administrator or the LCCC under a revenue support contract, and specify enforcement powers, dispute resolution procedure and remedies. There also remains a concern that consumers could be indirectly impacted as those entities subject to the levy look to ultimately recover higher costs from end users. A further consultation should flush these issues out before regulations are enacted.
Hydrogen village trial
Although unlikely to be a popular decision, the Act makes provision for the delivery of the "hydrogen heat village" trial (that is, a closed gas network converted to run on hydrogen to be evaluated as part of a large scale feasibility study on using hydrogen for domestic heating and cooking in place of gas). The current SoS, Claire Coutinho, has indicated a wish to push ahead with the trial regardless of local objections. The Act allows the entity running the trial to enter private properties to (a) carry out any essential works for the purposes of the trial, including safety measures such as replacing appliances and installing and testing safety valves; (b) undertake inspections and tests for the trial such as safety checks; and (c) disconnect the gas supply in a property. The SoS is empowered to make further regulations governing how the details of the trial will be communicated and managed with residents.
Hydrogen Production Regulations
The Hydrogen Production Revenue Support (Directions, Eligibility and Counterparty) Regulations 2023 (the Hydrogen Production Regulations) is the first piece of secondary legislation arising from the Act. Laid before Parliament on 8 November 2023, and subsequently considered by the Delegated Legislation Committee on 12 December, it is intended that they will come into force shortly. Time is somewhat of the essence – the Hydrogen Production Regulations need to be put in place swiftly so as not to halt the progress of HAR1 projects, and to give further regulatory certainty to new entrants considering a bid at the HAR2 stage.
The Hydrogen Production Regulations specify that, in order to qualify for revenue support, hydrogen must be produced in accordance with the Low Carbon Hydrogen Standard (LCHS) and meet an additionality requirement. They also authorise the SoS to specify the terms of the revenue support arrangements (in practice, this will be the finalised drafts of contracts which make up the HPBM). The hydrogen production counterparty (the LCCC) cannot amend the terms of the HPMB documents without the express consent of the SoS.
We note that the Act itself defines a "low carbon hydrogen producer" at s65(7) as "a person who produces hydrogen which in the opinion of the Secretary of State will contribute to a reduction in emissions of greenhouse gases4" and doesn't peg the definition to the LCHS, for reasons which are unclear. Instead, the Hydrogen Production Regulations refer to the LCHS in the context of eligibility for funding – low carbon hydrogen producers must produce hydrogen which meets the LCHS when bidding for funding via the HPBM. Producers must also ensure that the hydrogen is "new"; that is, not produced by diverting existing renewables but by creating additional renewable capacity. What is unclear from the Hydrogen Production Regulations is whether the addition of carbon capture facilities to existing "grey" hydrogen production would qualify under paragraph 5, which sets out the additionality requirement:
"But a low carbon hydrogen producer is not to be regarded as an eligible low carbon hydrogen producer if its proposal to produce standard compliant hydrogen involves the use of existing facilities without the carrying out of works to increase the capacity of those facilities to produce such hydrogen."
It appears from the current drafting that a capacity increase is limited to an increase in production capacity only, not an increase in the overall plant size by virtue of the addition of carbon capture technology.
Conclusion
Although the Act is the biggest piece of energy legislation in over a decade, it requires secondary legislation to provide for much of the practical detail. Whilst the swift introduction of the Hydrogen Production Regulations is to be welcomed, it will be essential for the Government to maintain the pace on the regulatory framework for hydrogen generally – first, to prevent a disconnect between industrial decarbonisation aims and delivery of the molecules; secondly, to ensure storage of hydrogen for energy security reasons; and thirdly, to help the UK keep pace with developments elsewhere. A clear and transparent regulatory framework will give that much needed certainty on bankability if many of the proposed projects are to become a reality, and decarbonisation goals are to be achieved.
This is the fourth briefing in our series on the Energy Act 2023. Our previous briefings have covered:
- Offshore oil and gas regime
- Merger control and competition law changes
- Environmental commitments for offshore wind
We will be turning our attention to CCUS, electricity storage and market reform for future briefings – keep an eye on our energy hub here for further updates.
Footnotes
1. https://www.legislation.gov.uk/ukpga/2023/52/contents/enacted
3. The Second National Infrastructure Assessment, October 2023
4. Greenhouse gas as defined in s92(1) of the Climate Change Act 2008
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