Briefing: What next for UK Hydrogen?

Executive Summary

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• In response to the Ukraine crisis, the UK has doubled its ambition for domestic low-carbon hydrogen production, now targeting production capacity of 10GW by 2030. The recent Queen’s Speech (which sets out the Government’s legislative programme) confirmed the commitment to creating low carbon hydrogen business models.
• Funding is available for UK hydrogen projects through a number of mechanisms. The two most significant are the Net Zero Hydrogen Fund and the Hydrogen Business Model.
• Political risks and unknowns surrounding the development of hydrogen policy in the UK include:

1. The energy price crisis is making it much harder for government to add costs to energy bills, potentially limiting fiscal support for emerging technologies. Despite this, hydrogen business models are in development.
2. High gas prices are making gas-dependent fuels such as blue hydrogen far less economic. Public policy is not alleviating this pressure.
3. Government is ‘picking winners’. The current Conservative Government has a habit of choosing favoured technologies, although this is also baked into the market design. This links market success to political success. This currently favours hydrogen.
4. A fast-moving regulatory environment is imminent for hydrogen. Ramping up to 10GW over eight years will require very rapid development of a wide range of legislation and regulations. Early movers will be bidding for subsidy contracts two years before the regulatory framework is established.
5. Public perceptions of hydrogen are untested in practice. The public perception of hydrogen is broadly positive, but no one has tested hydrogen-fuelled technologies in consumer markets. Polling often diverges when hypotheticals meet reality.
6. Despite the current relative political stability and broad support for hydrogen, a potential change of government would present political risk for such a regulated and nascent industry.
7. Electricity market reform is on the horizon. Its design will be highly consequential for all participants, whether off-takers (such as electrolysers) or sellers into the grid (such as hydrogen-based power).
8. To become a global commodity (especially one closely tied to international heavy transport), hydrogen will need intergovernmental cooperation to agree standards. Febrile geopolitical conditions do not improve the prospects of such cooperation.

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Introduction

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The UK Government has pledged significant support for hydrogen production and technology development, seeing it as a key fuel for the Net Zero economy. In the UK’s recent Energy Security Strategy - produced in response to the Russia-Ukraine crisis - ambitions for domestic production of hydrogen were doubled. A raft of new policy and funding announcements have given some more indications as to where the UK’s hydrogen sector will develop, but there remain a number of questions to answer.

The UK administration is currently pursuing a twin-track approach to its hydrogen ambitions, leaving space for the development of ‘blue’ and ‘green’ hydrogen simultaneously (see ‘Hydrogen Rainbow’ below).

The recent British Energy Security Strategy raised the UK’s previously stated ambition for low-carbon hydrogen production, from 5GW up to a new target of 10GW by 2030, of which half will come from electrolytic production. The government will be hoping that this delivers even greater benefits than its previous forecast of a hydrogen economy worth £900 million by 2030, and supporting over 9,000 jobs.

Although the previous target was presented as ambitious, it was actually seen as ‘low-ball’ by industry insiders. The new target of 10GW looks more of a stretch, but is still achievable with the right market structures in place.

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“We’re going to produce vastly more hydrogen, which is easy to store, ready to go whenever we need it, and is a low carbon superfuel of the future.”

- UK Prime Minister Boris Johnson, British Energy Security Strategy, 7th April

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The UK is not alone in setting out ambitious plans for the future of Hydrogen production. The European Union is concentrating on developing significant resources of green hydrogen as part of its sweeping ‘Fit for 55’ climate package. If all goes to plan, this will involve:

• Increasing electrolyser capacity from the current 60MW to 6GW by 2024 and to 40GW by 2030
• Retrofitting half of existing fossil-based hydrogen plants with carbon capture and storage
• Commitments to hydrogen transport, distribution, storage and refuelling stations.

Hydrogen offers an impressive array of applications across heat, power, transport, industry and others, though there are many big questions still to be answered, both by industry and policymakers.

On the heat front, the use of hydrogen in the gas grid looks set to compete with electrification, but there are strong signals that government and network companies plan to repurpose the gas grid.

For electricity, the role of hydrogen will likely be in energy storage and transport, though substantial market reforms will be needed.

For transport, much of the discussion so far has revolved around hydrogen cars versus electric vehicles, but the future of hydrogen as a transport fuel looks more likely to lie in heavy vehicles or the hard-to-decarbonise sectors of shipping and aviation.

Industry provides an important fourth vector, where the versatility of hydrogen and the need for low-carbon alternatives for important chemical processes could provide the biggest opportunity for hydrogen producers.

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The ‘Hydrogen Rainbow’

Hydrogen can be industrially produced using many methods, each with drastically different cost, climate and usage profiles. The leading methods have been given a generally accepted colour code. These are:

Grey hydrogen: The most common form of current hydrogen production, this uses steam methane reformation to extract hydrogen from natural gas or methane. However, it also produces large amounts of greenhouse gases.

Blue hydrogen: The same as grey hydrogen, but with carbon capture and storage added to the process. This means that the greenhouse gases produced are captured rather than emitted into the atmosphere.

Green hydrogen: Uses clean electricity from surplus renewable energy sources (e.g. wind or solar) to electrolyse water, splitting it into its components of hydrogen and oxygen and producing zero carbon dioxide during production or usage.

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Other colours are more disputed, but the more common are pink (created by electrolysis powered by nuclear energy, also sometimes labelled purple or red), black/brown (powered by black coal or lignite respectively), and turquoise (not yet proven at scale, this involves using methane pyrolysis to produce hydrogen and solid carbon).

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Clean Hydrogen Ladder

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There is currently heated debate amongst industry and the policy community about the merits of various hydrogen use-cases. One notable contribution comes from industry analyst and commentator Michael Liebreich - the ‘Hydrogen Ladder’ (see image).

The Hydrogen Ladder offers a ‘best use’ framework for policymakers and investors to understand the relative merits of different hydrogen applications. Consistent with many other policy commentary in the UK, the Ladder prefers industrial and heavy transport uses above smaller-scale uses and heating.

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Current state of policy

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Overall strategy

The British Energy Security Strategy doubled the UK’s previous target for low-carbon hydrogen production, aiming for 10GW by 2030, of which at least half will come from electrolytic production. This updates the Hydrogen Strategy (2021) and Net Zero Strategy (2021), which set a target of 5GW by 2030.

The UK has decided to pursue a “twin-track” approach to its hydrogen ambitions, simultaneously encouraging the production of green hydrogen from renewable electricity and blue hydrogen from natural gas with carbon capture attached.

In 2020, the UK consumed 0.7 million tonnes (Mt) of hydrogen, with virtually all used as an industrial feedstock in the chemical industry and in oil refineries. By 2050, the government expects that hydrogen will be able to deliver 20-35% of the UK’s energy consumption, with use in sectors ranging from heavy industry to power, and heating to land, air and maritime transport.

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Regulation

There is very little hydrogen-specific legislation and regulation in the UK so far. Currently, hydrogen regulation falls under the Gas Act 1986, with the Office for Gas and Electricity Markets (OFGEM) as the regulatory body and issuer of licences. Under the existing legislative framework, anyone engaging in gas supply, shipping or transportation must have a licence to do so, and also comply with the applicable industry codes (such as the Uniform Network Code, Independent Gas Transporter Uniform Network Code, Supply Point Administration Agreement, Retail Energy Code).

The Government does not expect an initial regulatory framework for hydrogen to be fully in place until 2025 at the earliest.

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Public and private funding for Hydrogen

The UK Government has announced various funding mechanisms for hydrogen-related projects, with the two most important being the Net Zero Hydrogen Fund and the Hydrogen Business Model. The May 2022 Queen’s Speech committed the Government to bringing forward legislation on low-carbon hydrogen business models.

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Net Zero Hydrogen Fund:

• £240 million available between 2022 and 2025. Further funding may be made available beyond 2025, subject to review.
• Split into four separate strands based on project readiness. Each strand will have different funding rounds and requirements.
• To be eligible, projects must comply with the new Low Carbon Hydrogen Standard.

Hydrogen Business Model (HBM):

• Similar to a CfD, the subsidy will be the difference between a “strike price” (cost of production) and a “reference price” (reflecting market value of hydrogen) 
• HBM will be finalised in 2022 and first allocation of contracts will take place in 2023
• The first allocation round will be open only to electrolytic projects. The Energy Security Strategy set out an aim to run yearly electrolytic allocation rounds.
• The technologies in scope in later allocation rounds will be guided by the UK Hydrogen Strategy.
• Allocation will initially be done through bilateral agreements, later moving to competitive auction as market conditions and legislation allow.
• Will be funded by a levy from 2025. First projects will be funded by general taxation if levy is not yet in force.
• CCUS retrofit of grey hydrogen will not be supported.

Industrial Decarbonisation and Hydrogen Revenue Support scheme:

• Up to £140 million available to fund new hydrogen and industrial carbon capture clusters.
• Includes £100 million to award contracts in 2023 of up to 250MW of electrolytic hydrogen production capacity, with further allocation in 2024.

Additional funding:

• UKRI funding for specific projects: in Mar 2021, the government’s R&D body, UK Research and Innovation, awarded £171 million of funding across nine hydrogen projects.
• Industrial Hydrogen Accelerator Programme: £26 million funding for innovation projects that can demonstrate end-to-end industrial fuel switching to hydrogen.
• Net Zero Innovation Portfolio: £1 billion distributed through different schemes (e.g. Low Carbon Hydrogen Supply competitions 1 and 2), aiming to accelerate the commercialisation of innovative clean energy technologies and processes through the 2020s and 2030s

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In addition to public funding commitments, the Government is looking to ‘crowd in’ private capital. As part of the Hydrogen Investment Package released in April 2022, BEIS published a Hydrogen Investor Roadmap offering guidance and support for private investment in hydrogen.

BEIS has acknowledged that further policy work and analysis is needed in a number of areas, including: determining and indexing the reference and strike prices for the subsidy mechanism, designing the sliding scale for volume support, and designing a fair and workable long-term funding model for hydrogen support.

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Defining “low-carbon” hydrogen

Immediately following the Energy Security Strategy, the Government set out detailed guidance on what it means by “low-carbon hydrogen” in its response to the Low Carbon Hydrogen Standard consultation. Hydrogen projects must comply with the Standard in order to be eligible for support. The proposed policy design includes decisions on: thresholds for GHG emissions, scope of the standard, consideration of different primary energy inputs and feedstock emissions, further GHG methodology / calculation considerations, and delivery and administration of the standard.

The Government expects to tighten the Standard over time in line with the pathway to Net Zero.

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Clusters and CCUS

The UK is pursuing a cluster approach to its CCUS and hydrogen policy, hoping to leverage the network and agglomeration effects of different industries located side-by-side to spur investment. Hydrogen is a crucial part of these plans, but until recently the more detailed policy work has come in the CCUS space, funded most notably by the £1 billion CCS Infrastructure Fund.

BEIS aims to identify two CCUS clusters for deployment by the mid-2020s, with a target of four by 2030. The East Coast Cluster and the HyNet North West cluster are currently proceeding through Track 1 of the process, with the Scottish Cluster in reserve. This reserve status has raised significant political consternation in Scotland.

Jobs in a much-expanded hydrogen economy will likely be concentrated in these cluster regions, with accompanying political benefits for the Government’s ‘Levelling Up’ (regional development) narratives. The UK Hydrogen Strategy estimates that the UK’s hydrogen sector will support over 9,000 jobs by 2030, increasing to a potential 100,000 jobs by 2050. If the Government’s new ambitions in the British Energy Security Strategy are realised, these numbers may be even higher.

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Timetable

In April 2022, the Government published a Hydrogen Investor Roadmap, seeking to encourage private investment into the UK hydrogen economy. The Roadmap sets out the Government’s Delivery Plan to 2035 - reproduced below:

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Eight key political risks for hydrogen in the UK

Hydrogen-related policy and regulatory frameworks are in relatively early stages of development. There are several strands of policy under deliberation, and the wider energy market is also in flux. Along with the geopolitical threats arising from the Russian invasion to Ukraine, this means that there are several “unknowns” and political risks in relation to hydrogen-related policy. We highlight some of these below.

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1. Energy price crisis and impact on bills - Rocketing energy prices mean that there is strong pressure not to add any further ‘green levies’ on consumers’ bills. This could place future funding plans (i.e. the levy to support the Hydrogen Business Model from 2025) in doubt, and have knock-on effects on Treasury decisions for hydrogen-related support schemes. As a nascent technology hydrogen might also not appear as cost competitive or ‘value for money’ in officials’ assessments, compared with other more advanced technologies - which could also result in less political backing in the short term.

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2. Pressure on gas supply - The global gas crisis is placing heavy pressure - both in market fundamentals and in public policy - on gas supplies. This could mean reduced support for “blue hydrogen,” which is derived from natural gas through steam methane reformation. The short-term winner could be green hydrogen, or other forms of dispatchable energy generation or storage. On the other hand, gas supply chains are being mobilised to respond to the crisis, which may leave excess supplies in the medium-term, thereby benefiting blue hydrogen so long as policies are in place to allow developers to capitalise on a gas price slump.

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3. ‘Picking winners’ - In sectors with a high political profile, the current Government has a tendency to pick technology winners. The Government’s response to the Hydrogen Business Model consultation indicated that it is focusing on hydrogen in “hard-to-abate” sectors, particularly industry, heavy transport and power generation, with implications for support in other areas, notably hydrogen blending. 

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4. Regulatory explosion - The energy market is heavily regulated. Hydrogen-related regulation could well mirror that in place for electricity and gas - several thousands of pages of legislation, regulations, industry codes and licence text. Investors and developers need to keep abreast with the key developments to ensure their projects consistently comply in a fast-moving compliance environment. However, over time this regulatory development should bring stability to the hydrogen market.

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5. Managing safety perceptions and communications - Hydrogen is a new technology and associated in the public consciousness with its flammable nature (e.g. the Hindenburg). In addition to strong regulatory engagement, hydrogen projects must invest in public acceptability. A clear area of public acceptability challenge might be in hydrogen-fuelled aeroplanes.
   
   It is easy to see how any safety concerns, even minor ones, could raise alarm with politicians, local authorities or regulators. Fracking in the UK and nuclear power in Germany have both provided recent lessons for investors. In addition to government and public engagement on safety, it is vital that project teams have prepared a crisis plan in the event of any safety issues being raised. This should include dealing with political and other key stakeholders.

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6. Change of government - The current Government has a large majority, but it also shows signs of instability. A possible change of governing party, or a new Conservative administration, could create risks. The Labour Party is publicly supportive of hydrogen and has called for further investment in the UK’s “world-leading” hydrogen industry, but has not offered much more detail. Given its closer association with environmental NGOs, it is possible that a Labour-led administration may be more wary of CCUS and the ‘twin-track’ approach, with implications for blue hydrogen projects.
   
   A change from Boris Johnson to another Conservative leader is arguably more risky: Johnson has made Net Zero a flagship policy and a new leader may abandon it. Frontrunners Liz Truss and Rishi Sunak are known to have mixed views on the green agenda.

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7. REMA / Electricity Market Reform - The use of hydrogen in the power sector (most likely as a form of energy storage) will depend heavily on the contents of the upcoming “comprehensive” Review of Electricity Market Arrangements (REMA) promised in the Energy Security Strategy. REMA may provide the long-awaited ‘Electricity Market Reform 2.0’ that many policy specialists have called for. Using excess electricity generation for hydrogen production will require a market structure that can support investment. This will be increasingly important as more and more intermittent renewable capacity comes online.

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8. Trade and competition - Low-carbon hydrogen production will be particularly exposed to green trade considerations. Cross-border industry supply chains will be affected if early-stage proposals for a Carbon Border Adjustment Mechanism (CBAM) based on the EU Green Taxonomy are adopted by the European Union.
   
   Other sectors will be dependent on intergovernmental cooperation. International transport faces a ‘chicken and egg’ dilemma for refuelling infrastructure, because such infrastructure needs to be present throughout a transport network for hydrogen ships and planes to be viable. However, if an interoperable regulatory standard reaches critical mass, it will benefit from significant network effects. This makes large regulatory players such as the EU extremely important.

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