The UK's Hydrogen Strategy signals next steps on the road to decarbonisation

The UK government has launched (17 August 2021) its much-anticipated (and much-delayed) Hydrogen Strategy – the first of its kind in the UK – that sets out a broad range of policy and investment commitments and signposts and, according to the government, lays "the foundations of a thriving hydrogen economy".

Hydrogen has an important role to play in the government's plans to decarbonise the UK economy. The analysis detailed in the strategy suggests that 20-35% of the UK’s energy consumption by 2050 could be hydrogen based, and that the hydrogen economy could be worth up to £900 million by 2030 and £13 billion by 2050. Thousands of low-carbon jobs could also be created as a result of this expansion.

How effective will the strategy be in achieving the government's aims of driving hydrogen progress in the 2020s, delivering 5GW of hydrogen production by 2030 and utilising hydrogen to help the government meet its Sixth Carbon Budget and net-zero commitments?

'Twin track' production

The government is proposing, as widely anticipated, a "twin track" approach to hydrogen production and sees both electrolytic "green" hydrogen and carbon capture, utilisation and storage (CCUS) enabled "blue" hydrogen playing an important part in reaching hydrogen and net-zero targets. In adopting this twin-track approach, the government hopes to enable the expansion of hydrogen production at pace and is hedging its bets as to the most effective way of growing hydrogen production capacity, given the uncertainties and variables in the current market.

While the government acknowledges that the proportion of hydrogen that will be supplied in the long term depends on a range of assumptions and the marketability of emerging technologies, there is a clear expectation that blue hydrogen will deliver a greater volume of production in the medium term, as it currently attracts the lowest cost. This will permit "early bird" hydrogen projects to develop rapidly while the costs of producing green hydrogen are predicted to fall – on some predictions becoming cost competitive with blue hydrogen as early as 2025.

The strategy expects that the first movers in the early 2020s are likely to be relatively small electrolytic hydrogen projects (up to 20MW) with production and end use closely linked, for example at a transport depot or industrial site. By the mid-2020s the government expects to see larger (100MW) electrolytic projects and the first CCUS-enabled hydrogen production facilities based in industrial clusters. By the end of the decade, the government expects multiple large CCUS-enabled (500MW plus) production facilities across the UK.

The overall goals are for 1GW of low-carbon hydrogen production by 2025 and 5GW by 2030 compared to very low levels currently.

Hydrogen funding

The strategy includes a funding pipeline for hydrogen projects totalling £961 million. Around one third of this funding is to be allocated towards projects aimed at hydrogen production, and the remainder will be geared toward end-users of hydrogen in the industrial sector.

The strategy's funding commitments include the launch of the £240 million Net-Zero Hydrogen Fund in early 2022 with the aim of de-risking private sector investment in low-carbon hydrogen projects and reducing the lifetime costs of those projects via a set of staggered competitions. This will sit alongside the recently launched £60 million Low Carbon Hydrogen Supply 2 Competition which is intended to encourage innovative low-carbon hydrogen supply solutions, and the £68 million Longer Duration Energy Storage Demonstration Competition. The strategy also contains a commitment to deliver phase two of the £315 million Industrial Energy Transformation Fund, which focusses on fuel switching technologies.

Supportive business model

Alongside the strategy, the government launched a consultation on a low-carbon hydrogen business model that is intended to provide longer-term revenue support to hydrogen producers and bridge the cost gap between low-carbon hydrogen and the currently cheaper higher-carbon alternatives.

The government's current "minded to" position favours the implementation of a variation of the existing Contract for Difference scheme in the hydrogen sector which would use whichever is the higher of the natural gas price or achieved sales price as the reference price (given the current lack of an observable wholesale hydrogen market price). It is expected that contracts would initially be awarded on a bilateral basis with a more competitive auction system to be implemented in the medium term. The government has indicated that it aims to provide a response to the consultation alongside indicative Heads of Terms in the first quarter of 2022, enabling the first contracts to be allocated from the first quarter of 2023.

Market and regulation

The government is expected to provide further clarity on regulatory roles and licensing requirements in order to facilitate the expansion of the hydrogen market and maintain competitive market pressure. It is still unclear whether the National Grid's position as the gas transmission operator will be expanded to cover hydrogen, or if a new regulated entity will be established and if the storage, production and transportation of hydrogen will require a licence.

The government has set out plans to create a Hydrogen Regulators Forum during 2021 which will bring together the Health and Safety Executive, the Environment Agency, Ofgem and others to work through and coordinate the regulation of hydrogen. An update on the hydrogen network review and storage requirements is also promised in early 2022.

The strategy also promises to finalise a low-carbon hydrogen UK standard in 2022, which will assess the carbon intensity of different types of hydrogen production. This will be integral for market participants to determine which projects are able to receive government support. The government has published a consultation alongside the strategy which seeks views on the options for setting and implementing this standard.

The government is also considering numerous demand-side policies to stimulate demand for hydrogen generation, including:

• Sector specific policies via: for industry, the Industrial Energy Transformation Fund; for transport, the Renewable Transport and Fuel Obligation; and, for the power sector, the Capacity Market.
• Carbon pricing through the UK Emissions Trading Scheme and Carbon Price Support.

The strategy sets out that the final demand is likely to comprise industrial processes that require direct firing or high-temperature heat (such as steel and concrete production) and long-distance and heavy-duty transport where electrification is less possible. There will also be a demand in the power sector for the purposes of storing energy and provide flexibility.

The role of hydrogen for heating buildings is less clear cut. The strategy does not expect any significant use of hydrogen for heating before the 2030s but does not close the door completely. The government has committed to publishing a call for evidence on the future of the gas system in 2021 with a final decision to be taken in 2026. We may also have more information on the government's thinking when it publishes its long-awaited Heat and Buildings Strategy expected later in 2021.

Osborne Clarke comment

The publication of this strategy is very welcome and signals an important step in the UK's decarbonisation plans, providing a basis for making long-term investment decisions. We are particularly pleased to see the government start to sketch out what support may look like and recognise the potential application of the contracts for difference model, which is familiar to market participants and has worked successfully to enable the deployment of certain renewable energy technologies, such as offshore wind.

However, in some cases – particularly the hedging between blue and green hydrogen and the role of hydrogen in heat – the government has kicked the can down the road. Time will tell whether that was the right decision or not. What is not in doubt is that hydrogen will have a significant role to play in the UK's net-zero ambitions.