FEATURE: UK favors variable premium subsidy for hydrogen producers, with nat gas price floor

The UK government closed its consultation on a hydrogen business model Oct. 25, setting out details on its preferred market support mechanism of a producer-focused variable premium subsidy, with natural gas setting a floor price.

The Department for Business, Energy and Industrial Strategy (BEIS) considered a range of support mechanisms in the consultation, setting out its "minded to" position of a variable premium subsidy for producers.

"We propose a producer-focused subsidy with the aim of reducing the cost gap between hydrogen and counterfactual fuels [i.e. fuels that would have been used otherwise]," Neil Atterbury, who works on low-carbon hydrogen policy at BEIS, said in a consultation presentation Oct. 14. "It will be open to different production technologies and project sizes."

The proposed subsidy is similar to Contracts for Difference, but in the absence of an established hydrogen market in the initial phases of support, an alternative price reference point would be needed, BEIS said.

Under the proposed model, the government would pay producers the difference between a strike price for hydrogen and the higher of two reference prices.

One reference price would be the natural gas market, and the second an achieved sales price.

The gas price would set a floor for subsidy support, as support below this risked subsidizing gas production, BEIS said.

Natural gas would set a price floor as "it is the most common fuel from which end users would switch so are likely to be willing to pay at least that price for hydrogen," BEIS said.

The inclusion of an achieved sales price as a reference gave hydrogen producers pricing power to encourage customers to switch, BEIS said.

"When sales occur above the natural gas price, the sales price would prevail" as the reference, BEIS said.

Ceiling on reference price

Hydrogen producers broadly welcomed the variable premium model.

"Whilst we are supportive of the government's proposed reference price there are some concerns in sectors where natural gas is the counterfactual fuel that with very high gas prices (and therefore hydrogen prices), industries may be forced to cease production, if they cannot afford hydrogen," Hydrogen UK Lead and Head of Innovation Clare Jackson told S&P Global Platts Oct. 25.

"Hydrogen UK believe that there needs to be a mechanism to mitigate this risk such as a ceiling on the reference price or a contractual reopener in the situation that natural gas prices hit a certain pre-determined threshold," Jackson said in an email.

In addition, blue and green hydrogen production pathways should be treated differently, Hydrogen UK said, possibly indexing green hydrogen to electricity as well as natural gas prices.

BEIS said it was considering "additional contractual measures to incentivize producers to seek higher priced sales."

The arrangement would be a private law contract between hydrogen producers and a government counterparty, BEIS said.

Hydrogen benchmarks

Longer term, a market benchmark price would best represent the value of low-carbon hydrogen in the market, BEIS said, and indicated it would engage with price reporting agencies such as S&P Global Platts to consider how to develop such a benchmark.

""We are minded to ... integrate a market benchmark into this approach at the earliest opportunity for future projects," BEIS said.

S&P Global Platts assessed the cost of producing hydrogen via alkaline electrolysis in the UK (including capex) at GBP12.53/kg ($17.25/kg) Oct. 22, based on month-ahead feedstock prices, which have risen sharply in recent weeks on tight gas supplies.

PEM electrolysis production was assessed at GBP14.86/kg, while blue hydrogen production by autothermal reforming was GBP4.81/kg (including capex, CCS and carbon).

BEIS considered using a carbon price as the reference, similar to the Dutch SDE++ scheme, but dismissed this model, noting that the carbon price may not perfectly reflect the market value of hydrogen.

The correlation between carbon prices and the market value of hydrogen would likely weaken over time, BEIS said, adding that the level of subsidy received on this model would be independent of the price the producer actually achieved for its sales.

Timelines

BEIS proposes inviting project applications in 2022 for assessment, before bilateral negotiations with selected parties to enable final investment decisions from 2023.

Longer term, BEIS took the view that auctions would be a more appropriate route for allocating contracts.

It noted that a different approach to funding smaller scale projects might be more appropriate for producers who don't have the administrative resources or experience to enter into such contracts.

Siemens Energy's Head of Market Development, Matthew Knight, said the renewable transport fuel obligation provided a good base for small-scale hydrogen uptake in the mobility sector, though the scope for scaling much above 1-MW projects was limited.

However, significant policy gaps remain for hydrogen in heavy transport and industrial uptake in the short term, Knight said Oct. 6 at the Dcarbonise Virtual Sustainability Summit.

"There's the urgent need to build something in the next couple of years to get the supply chain started," Knight said.

Volume risk

BEIS has proposed a sliding scale mechanism to provide volume support in the early days of demand building.

The government would pay a higher per-unit subsidy on initial volumes of hydrogen sold by a producer to cover minimum returns needed.

Hydrogen UK said more should be done to boost demand, removing the need for volume support mechanisms.

The consultation also sought views on indexation of the strike price to account for changing input costs, the length of contracts and scaling of future production volumes.