Hydrogen Production Revenue Support (Directions, Eligibility and Counterparty) Regulations 2023

Monday 18th December 2023 Grand Committee

Considered in Grand Committee

16:20

Moved by

[Lord Callanan]

That the Grand Committee do consider the Hydrogen Production Revenue Support (Directions, Eligibility and Counterparty) Regulations 2023.

[The Parliamentary Under-Secretary of State, Department for Energy Security and Net Zero (Lord Callanan) (Con)]

My Lords, these regulations were laid before the House on 8 November this year. On 26 October, the Energy Act 2023 received Royal Assent. The Act provides a legislative framework for hydrogen, including provisions relating to the hydrogen production business model—a funding model to support the production and use of low-carbon hydrogen in the United Kingdom. Delivering this policy will be essential to kick-start the hydrogen economy and move towards the Government’s ambition to have up to 10 gigawatts of low-carbon hydrogen production capacity by 2030, as set out in the British Energy Security Strategy.

Under the business model, projects will be paid a subsidy for the hydrogen produced through a revenue support contract, similar to the highly successful contracts for difference for low-carbon electricity production. The business model, contracts for hydrogen, will be managed by a hydrogen production counterparty. Initial projects are to be selected through allocation rounds run by the Department for Energy Security and Net Zero. To receive business model support, a project must be an

“eligible low carbon hydrogen producer”.

Where such a project is allocated support, the Secretary of State will issue a direction to the hydrogen production counterparty to offer to contract with that project.

I hope noble Lords noticed that, last week, we announced 11 major new electrolytic hydrogen projects across the UK that will be offered support under the hydrogen production business model. This represents the largest number of commercial-scale green-hydrogen production projects announced at once anywhere in Europe. These new projects, stretching all over the country from the south-west of England and south Wales to the Highlands of Scotland, will invest over £400 million up front over the next three years, in a major boost to the UK’s green economy. In addition, CCUS-enabled hydrogen projects have also been shortlisted through the track 1 phase 2 cluster sequencing process.

I turn now to the detail of the regulations and their important role in all this. Fundamentally, the regulations satisfy the duty in Section 66(4) of the Energy Act 2023 by determining the meaning of “eligible” in relation to a low-carbon hydrogen producer. They tell the world who can be eligible for support.

The regulations set out that only new hydrogen production facilities, or existing hydrogen production facilities adding new production capacity, that can demonstrate that their proposal for the production of hydrogen is capable of complying with the UK low-carbon hydrogen standard, will be considered eligible. This will ensure that eligibility keeps pace with how the Government define low-carbon hydrogen. I recall that a number of amendments tabled during the passage of the Energy Act 2023 sought to ensure that regulations on eligibility made reference to the low-carbon hydrogen standard, so I hope that the Committee will welcome these provisions.

The regulations also set out the process by which the Secretary of State may direct a counterparty to offer to contract with an eligible low-carbon hydrogen producer. This follows a similar approach to contracts for difference, with which industry is very familiar. Similarly, the regulations include requirements for a counterparty to publish the full contracts entered into and establish a public register of key information. As noble Lords would expect, such publication is of course subject to redaction of confidential information and personal data. The regulations also set out various requirements in respect of Secretary of State directions to a counterparty. They include the circumstances in which directions cease to have effect and enable the Secretary of State to revoke a direction before it has been accepted.

Furthermore, the regulations require a counterparty to promptly notify the Secretary of State if it is, or considers it likely to be, unable to carry out its functions. Your Lordships may think such a provision sounds familiar, and indeed it is; it is very similar to the approach taken by the Nuclear Regulated Asset Base Model (Revenue Collection) Regulations 2023, which I am sure the Committee is following very closely.

The department has considered the content of these regulations extremely carefully. We carried out a full public consultation earlier this year, seeking views on the principles enshrined in the regulations and satisfying the statutory requirement to consult, as set out in the Energy Act 2023. We received 28 responses from various organisations and members of the public. We carefully considered all of them, although I am pleased that the majority supported our proposals. Accordingly, in our government response, which we published on 30 October, we set out plans to proceed largely as proposed, albeit with some amendments made in response to the feedback that we received.

This secondary legislation represents an essential step for implementing the hydrogen production business model to ensure that we can support the deployment of low-carbon hydrogen projects to achieve those 2030 ambitions, to improve our energy security and to help achieve net zero. I therefore commend these draft regulations to the Committee.

[Lord Naseby (Con)]

My Lords, I very much welcome this statutory instrument and congratulate His Majesty’s Government on bringing it forward so speedily. I just wonder whether my noble friend has any idea of how many potential clients there are in the United Kingdom. That would be interesting in itself.

Regulation 2(4), on page 2, defining an

“eligible low carbon hydrogen producer”,

is very sensible and has thankfully been included. Of course, because of the publicity for the domestic trial in the north-east of England, hydrogen is getting a bit of an unfortunate image. I am not sure whether any incentive can be produced to help the local communities—which I would say are getting difficult, but let us say they are being very careful—to do those trials. If there is not, there is not, but this is a negative reaction and not one I welcome.

Finally, it is usual for most statutory instruments, certainly the ones on which I comment, to have a sunset clause for review. I do not see one, unless I have missed it, but that would have helped.

[Lord Teverson (LD)]

My Lords, as always, I thank the Minister for his excellent explanation of this secondary legislation and welcome how we are now moving forward at some pace on the hydrogen front. I also welcome the Government’s announcement that they are moving ahead with the carbon border adjustment mechanism, even though it is one year after the EU has done so. I do not know what has happened in the middle, as far as SME exports and that side is concerned. Their commitment to energy efficiency after the election perhaps raises some questions, but at least there is some intended movement there.

I also welcome the Government finally giving up on the hydrogen villages in England. This was clearly never going to happen or be real, and I am sure the Minister was at the forefront of those talking sense to his Secretary of State on that area, which is excellent.

As background, I read through the hydrogen standard. As it is Christmas, I was going to ask the Minister to explain the formula in there, because I could not understand it either. There is a training video on how to understand it, which I will watch on Boxing Day rather than before.

16:30

I will not go forward with that but I have some serious questions, one of which is on the reason for having a revenue subsidy rather than taking the well-proven contracts for difference approach to this. One of the big challenges around revenue support is that there is no incentive whatever on the producer to be cost effective. They are just given the revenue support, which I presume is the difference between their cost of production and the actual market price for hydrogen.

I may be completely wrong, but that is how revenue subsidies normally work. It means there is absolutely no incentive for those hydrogen producers to be efficient in their production—unlike a contract for difference, which is all around incentivising them to bring down the cost to a strike price, which they are paid, and then there is the difference between the actual market price and the strike price. I understand that it might be too early for this market to have sophisticated contracts for difference, but we manage this in other areas of innovation such as tidal stream, wave energy and geothermal. Why does it not happen with hydrogen? That is a real question which I would be very interested to understand.

I notice that there is a desire for 50% of this scheme, I think, to be from electrolysis production of hydrogen and/or low-carbon hydrogen. Is that still the target? Given what the Minister was saying, I think there will there be a balance between carbon capture—the breakdown of methane and burying the carbon—and electrolysis methods. I would like to understand that a little more.

On the timing, I get the impression that the Government are in a hurry. I was certainly pleased to hear that a number of schemes, which I also read about, were already in the process of early approval. But when there are rounds, as there are in CfDs, I will be interested to understand from the Minister how frequent those will be. I am also interested very much in the question of the noble Lord, Lord Naseby, about markets. In particular, which markets does the Minister expect this hydrogen to go into? There are many areas of industry; it is obviously difficult to decarbonise heavy transport. I am interested to understand that about all those areas. However, is there a budget for this? I presume that the Treasury does not sign these things off without knowing that there is a cap somewhere on how much it is going to cost. I think we would all like to know that as well.

On a personal note, I have decided to stand down at the end of this year as spokesperson on energy and climate change for the Lib Dems. Despite the Minister’s huge admiration for Liberal Democrats, I have very much enjoyed working with him. Over my time in the role, I perceive that he may have become even more dedicated to the subject than he was at the beginning. I have genuinely enjoyed our interactions and I wish him well. I am not retiring from the place and will stay involved in these issues, but not from the Front Bench. It has also been my great pleasure to work with the noble Lord, Lord Lennie, and the noble Baroness, Lady Blake, on legislation in similar areas to this.

[Baroness Blake of Leeds (Lab)]

My goodness. I was not expecting that announcement and have not been party to that information. I am sorry: I was not clear from the noble Lord’s comments whether he meant the end of this year. Perhaps he has secret information about when this Parliament might come to an end.

[Lord Teverson (LD)]

I meant this year.

[Baroness Blake of Leeds (Lab)]

Can I just put on record my appreciation for the incredible contribution that the noble Lord, Lord Teverson, has made in this area? I certainly benefited enormously from our working closely on the Energy Bill, and going forward from that.

I also echo the Minister’s comments on the progress that has been made; during the passage of the Bill, there were times when we wondered how we were going to get through it. I assure the Minister that the announcement of the first funding round, with its 11 successful green hydrogen projects, has been noted and is welcome. I certainly look forward to hearing about their progress.

I want to make a few comments on the regulations before us. As we have heard, this statutory instrument is one of the first to follow from the 2023 Act and we know that there are more to come. The regulations cover, in particular, the process whereby the hydrogen low-carbon business plan will be implemented during the initial allocation period of contracts for hydrogen producers; all of this goes towards the target of 10 gigawatts of hydrogen production.

As I understand it, schemes will be identified and quality-assured by the Minister, who will then direct the hydrogen counterparty—it is identical in structure to the low-carbon contracts company—to provide contracts for companies that have been deemed eligible. All of that is absolutely fine and the right thing to do, especially when we consider the initial allocation process.

The Explanatory Memorandum states that the initial allocation will give way to a competitive tender process later on. Some more detail on that would be useful as we go forward; perhaps it will be forthcoming. However, at this moment in time, we are considering the initial allocation process, which is to be informed by the centrepiece of the SI: the low-carbon hydrogen standard, which has been outlined for us today. This refers to a detailed document setting out the greenhouse gas emissions and sustainability criteria that programmes applying for an allocation contract should follow.

I note the stringent qualifying criteria for a project’s eligibility. Of course, they require a project not to exceed a certain level of carbon emissions and to measure fugitive hydrogen—that is, the process whereby hydrogen is produced and all the implications around hydrogen—for its duration. It is a system-wide standard for the low-carbon nature of that hydrogen. For a project to get a direction from the Minister, it must comply with the standard when it receives agreement to proceed.

I just want to pick out that point. As we understand it, the standard will evolve. Indeed, the standard to which the SI refers is version 2 of the UK low-carbon hydrogen standard; that evolved from the initial standard, which was produced immediately after the Act was passed. Version 2 has emerged from consultation with the correction of various elements of the initial standard that could have caused difficulties. It has tightened up several matters that were uncertain, difficult or in need of clarification. It is absolutely clear in the documentation and the Explanatory Memorandum that it is intended that the standard will evolve; this means that the department envisages that it will produce further iterations of the standard in future. The low-carbon hydrogen standard as it currently stands is therefore likely to change. Does the Minister think that this will present some difficulties for those companies that have had their contracts approved? Clearly, although they will be signing up under version 2, they may not necessarily comply if we move on to versions 3 or 4—or more. It would be good to get some assurances around what the implications will be for companies in the earlier rounds.

There needs to be a bit of thought about whether those companies could be disadvantaged as we go forward. Will the Minister have some discretion in considering this? Of course, it could go either way, although it is very unlikely that there would be a relaxation of the carbon emission standards, but there is something to pick up there. Is it possible that, with these changes, companies might be put in a place where there are more costs, expense and planning? It would be useful to have more understanding of the methodology that will be used to determine whether companies are continuing to adhere to the standard once it is set in the contract. From the initial comments, I understand that the Minister is satisfied that this will work well. Could he expand on some of the changes that might come along?

During the consultation, some respondents suggested that further information could be published in a contract register, including outturn volumes, CO² capture rates and CO² capture quantity. It is obvious that a balance needs to be struck between transparency and what useful information is kept confidential but, as making this information public seems like it would have a positive impact, is it that the impact is not deemed significant enough to lower confidentiality? Alternatively, is it that there are further drawbacks to publishing this information that have led the Government to proceed with the initial approach? A bit more clarification around that decision-making would be welcome. On the other hand, 10 of the 23 respondents disagreed with information that the Government are proceeding with publishing, primarily due to the financial aspects. Could the Minister please elaborate on the decision-making process there?

I welcome the progress that has been made and look forward with interest to see how we can move forward in the area of hydrogen, which seems to be fairly fraught—I note the comments of the noble Lord, Lord Naseby. I am also interested in the response on the review. It is very noticeable that that is missing, because of the process. But, in such a new departure, a review would be useful and welcome.

[Lord Callanan (Con)]

I thank all noble Lords for their contributions to the debate. Low-carbon hydrogen will be an essential part of our future energy mix, and the hydrogen production business model seeks to address one of the key barriers to its deployment: the higher cost of low-carbon hydrogen, compared to higher-carbon counterfactual fuels. The Government remain committed to delivering on our hydrogen ambitions—first, those to help support energy security, but also our decarbonisation goals.

The message from the 2023 progress report from the Climate Change Committee was the need to deliver policies to enable deployment at scale of new industries such as hydrogen. I think that sentiment is widely recognised across this House and by industry. Last week’s announcement represents a major step forward in helping producers to deliver a fuel of the future today, backing some of our fantastic businesses here in the UK to go greener. These regulations are vital to enable those contracts to be awarded, so that projects can take the investment decisions that will kick-start the deployment of low-carbon production in all parts of the United Kingdom. But we are not stopping there. A new second round of funding is already available for producers to apply for, so that they can develop the next round of projects and then subsequent ones that help to build on that success. I will deal with some of this in more detail as I go through the questions raised by noble Lords.

16:45

First, in answer to my noble friend Lord Naseby, the number of future projects is of course slightly uncertain—it depends who comes forward. Many of the existing projects that have already been awarded in hydrogen allocation round 1 funding may well choose to add extra bits on to their production plans, if it proves successful, and bid in future rounds. Nevertheless, separate to that, we are aware of a large pool of hydrogen projects that may seek support in future allocation rounds. Indeed, some projects that were not successful in this round might well hope to sharpen their pencils and bid in future rounds. Such is the nature of a competitive bidding process. We need to kick-start the hydrogen economy that we all want to see, but we also must ensure that we get appropriate value for money for the taxpayer and the bill payer; I hope all Members of the Committee support that.

Building on the success of this HAR1 round, which has announced the intention to support 125 megawatts of low-carbon hydrogen production capacity—across 11 different projects all over the UK, as I said—we have already launched hydrogen allocation round 2. Our aim in HAR2 is to provide up to an extra 875 megawatts to take the total up to 1 gigawatt by the end of next year. That is an ambitious target and it will depend on utilisation, delivery and value for money, but there is certainly no shortage of potential bidders; many have already approached us and we wish them all the best of luck with their bids.

My noble friend also raised an issue not connected with the SI at all: the proposed hydrogen village trial in Redcar. It was clear that the trial could not go ahead as designed, as the main source of hydrogen supply on which it relied would not be available by 2026. The leader of the local council also wrote to inform us that there was an increasing level of public opposition to the trial. We had always said that we would not proceed unless the public in the area concerned were behind the trial. Those two factors together resulted in the decision not to proceed. There is still a much smaller trial going ahead in Fife, however. We will of course look at the evidence that it brings forward to take a decision in 2026, as we always said we would, on whether hydrogen will ever contribute to domestic heating decarbonisation—and if so, how.

I will respond to some of the points raised by the noble Lord, Lord Teverson. I think that he is slightly wrong on his first point about having revenue support or CfD. This provides the opportunity for the level of subsidy to reduce as the market price for hydrogen increases. In my view, that is like contracts for difference rather than revenue support. In this case, a revenue support contract is effectively a contract for difference, because it is a variable premium paying the difference between a strike price, which represents the cost of producing hydrogen, and a reference price representing the market value of hydrogen. That of course provides the opportunity for the level of subsidy to reduce as the market price for hydrogen increases.

Our Government remain committed to driving cost reductions in future allocation rounds, and we hope that future projects will be able to benefit from the learnings and experiences of the first rounds. Growing our hydrogen economy must continue in the context of being affordable and delivering value for money across the economy.It is undoubtedly the case that the first allocation round is relatively expensive, but for HAR2 we have increased our focus on delivery and cost reductions by increasing our weighting of cost assessment in the application process and including cost reductions as a key objective of delivering HAR2.

With regard to future round frequency, I can tell the noble Lord, Lord Teverson, that we are aiming to run annual allocation rounds of the hydrogen production business model from 2025 through to 2030. We have further ambitious capacity aims of up to 1.5 gigawatts of hydrogen through hydrogen allocation rounds 3 and 4. He also asked about the budget to help to give producers the certainty they need for the years ahead. The Government are providing more than £2 billion-worth of revenue support over the 15-year contract lifespan, ensuring that there is a guaranteed price for the clean hydrogen that those projects provide.

In response to the questions asked by the noble Baroness, Lady Blake, first, with regard to competitive allocation, earlier this year we published a call for evidence on price-based competitive allocation for low-carbon hydrogen. This sought views and evidence from the industry on the market conditions required to eventually transition to price-based competitive allocation for the hydrogen production business model. The call for evidence summary document summarised the responses received to that call, which, alongside our own evidence-gathering, have been used to inform the development of the future policy framework for the hydrogen allocation rounds. The hydrogen production delivery road map, which was also published alongside last week’s announcement, sets out our plans for future hydrogen allocation rounds, including plans to move to annual allocation rounds out to 2030.

The noble Baroness is right that we intend to go to a more competitive allocation process in future, but for that to work effectively there would need to be a transportation and distribution system around the whole of the UK. At the moment, the off-takers for hydrogen production are located fairly close to producers, geographically, but it is our objective in the medium term to get a transportation and storage system around the whole country which would enable the distribution of hydrogen and a much more competitive process, in that businesses would then have a choice of which producer they use to supply their low-carbon hydrogen.

The noble Baroness also asked about updates to the low-carbon hydrogen standard. Projects seeking support under the hydrogen production business model are required to evidence that the project is capable of meeting the low-carbon hydrogen standard as part of the application for revenue support. With regard to her question about the standard evolving over time, Regulation 2(6) makes it clear that once a producer is deemed eligible under the regulations, it would be unfair to subsequently render it ineligible merely on account of the publication of a new version of the low-carbon hydrogen standard. In other words, it would not be retrospective. Future projects will need to take account of updates to it, but existing projects that have already been approved meet the standards that were applicable at the time. That reflects various other parts of energy efficiency and clean heat policy, where we have adopted a very similar approach.

I say to the noble Baroness that is important to be able to update the standard, because the fantastic thing about this area is that the technology is evolving all the time with new methods of hydrogen production coming on stream. For instance, we have had to update the standard to take account of some innovative companies that are using a process called pyrolysis, which can produce hydrogen from natural gas while producing a by-product of solid carbon only, not gaseous carbon dioxide. Again, that will not necessarily be at a commercial scale any time soon but there are exciting technologies for the future, developed by some really innovative UK companies.

However, a direction issued by the Secretary of State, pursuant to Section 66(1) of the Energy Act, may require a hydrogen production revenue support contract to be offered on terms that require compliance with a later version of the standard. To provide certainty for investors, we intend for any review of and updates to the standard to occur in advance of allocation rounds rather than during them. Where it is considered necessary to introduce updates during an allocation round, which is the period between the launch of the application window and the awarding of contracts, we will aim to provide plenty of notice to projects of any potential changes as part of the allocation or negotiations process.

We have proposed that review points for the low-carbon hydrogen standard coincide with future contract awards through the hydrogen production business model. We would not expect any changes to be applied retrospectively to contracts that have already been awarded through these schemes. The hydrogen production business model contract will not require producers to comply with any future amendments to the low-carbon hydrogen standard after the date on which the contract is signed. Again, that is to provide confidence to producers that the rules they will need to comply with for the purpose of receiving support under the contract will not be changed retrospectively. That is only fair. Subject to the final contract terms and conditions, we expect that producers will be able to follow future changes to the low-carbon hydrogen standard, where relevant, should they choose to do so. The counterparty will be responsible for monitoring compliance with the low-carbon hydrogen standard.

Stakeholders raised other information that should be included on the register, such as CO₂ capture rates and the carbon intensity of low-carbon hydrogen produced. Understanding how to include such metrics requires further consideration, and we will keep them under review.

My noble friend Lord Naseby and the noble Baroness, Lady Blake, raised the point that this instrument does not include a statutory review clause, in line with exemptions under Section 28(3) of the Small Business, Enterprise and Employment Act 2015. The duty to review regularly provisions in secondary legislation is exempt where the power or the duty is exercised to make or amend provisions in secondary legislation in connection with the giving of grants or other financial assistance by or on behalf of a public authority.

I think I have answered all the questions that I was asked. Before I conclude, I say what a great loss the noble Lord, Lord Teverson, will be to these Grand Committee discussions on statutory instruments, often late in the afternoon with few observers. He is right that I am not necessarily a huge fan of all Liberal Democrats but, like all hard and fast rules, there are always exceptions to be made—and he is by no means the worst of them.

[Noble Lords]

Oh!

[Lord Callanan (Con)]

Damned by faint praise. We have always had an excellent relationship and I am sure we can look forward to many exchanges from the Back Benches when he has left the Front Bench of Liberal Democrat politics and joined the real world of politics that the rest of us take part in. I am joking—it has been a pleasure to work with him. On so many issues we generally agree and see eye to eye. It has been fun working with him, and I am sure we will have lots of contact in the future. I thank him for all the work that he has done contributing to these discussions and many of the legislative discussions we have had in the Chamber. With that, I commend these regulations to the Committee.

Motion agreed.