Four things to consider in a green Hydrogen Purchase Agreement

Hydrogen is arguably the energy sector’s rising star commodity. The hydrogen market is developing rapidly, and industry is seeking to identify key terms for offtake contracts called hydrogen purchase agreements (HPA). The HPA is the commercial heart of any hydrogen project. A HPA is crucial to obtain financing at an early stage and decisive for bankability in the longer run. 

However, the EU’s regulatory framework is in flux and market standards have yet to be established. While certain contractual elements can be drawn from the LNG market, others do not transfer readily to hydrogen, a major aspect being the certification of hydrogen as ‘green’. Against this background, we point out the major elements of marketing green hydrogen. So here are four things to consider in a (green) HPA.

Choose your model

Being a gaseous source of energy, trading hydrogen can to an extent be compared to LNG. This suggests two types of HPA: a tolling model or a sale-and-purchase model.

Under a sale-and-purchase contract the operator of the hydrogen generating facility (H2-operator) provides all raw materials (ie water and electricity) and produces hydrogen that is sold to the customer. The H2-operator may produce the electricity itself with a renewable energy plant or procure electricity from a third party by entering into a corporate Power-Purchase-Agreement (PPA). By contrast, under the tolling model, the customer supplies electricity (and perhaps water) to the H2-operator, which is only paid for processing the electrolysis and thereby converting the water into hydrogen and oxygen. 

Whether a tolling or a sale-and-purchase model is preferable depends on the parties’ market positioning and respective capabilities. For instance, if the customer is in a better position to negotiate a PPA than the H2-operator (for example because the customer has more market power or a higher credit rating), a tolling model may be advantageous.

Similarly, some customers may opt for a tolling model because they operate a renewable energy plant themselves or through a subsidiary/joint venture and can thus readily provide electricity. In other cases, the H2-operator may have developed a hydrogen generating plant together with a renewable power plant as a combined project. This H2-operator will arguably prefer a sale-and-purchase contract. 

Colour matters

International policies such as the EU’s ‘Fit for 55’ regulatory package will sharply increase costs for the emission of GHG and thus drive demand for low carbon hydrogen as source of energy. Despite being in fact a colourless gas, hydrogen is traded as ‘grey’, ‘blue’ or ‘green’ depending on the level of GHG emissions associated with its production. Grey and blue hydrogen are made of fossil fuels and their production emits high levels of CO2 which is reduced in the case of blue hydrogen through the addition of carbon capture techniques.

Green hydrogen, however, is produced by splitting water into oxygen and hydrogen (electrolysis) with the help of renewable energy. This process has zero GHG emissions. Green hydrogen is, therefore, an important clean source of energy for sectors that are expected to rely on gaseous and liquid fuels in the long term, such as maritime and aviation.

The parties of the HPA will seek to ensure that the hydrogen indeed certifies as ‘green’. For instance, transport fuel suppliers will need to ensure that the hydrogen qualifies as renewable fuel and thus counts to their obligation to ensure a minimum share of renewable energy under the EU’s Renewable Energy Directive 2018/2001 (REDII) which is currently being revised. A proposal published on 14 July 2021 by the European Commission looks to raise the EU’s renewable energy targets. For hydrogen, besides an increase in targets for its use in transport, new language has been added to extend its application to other sectors such as heating and cooling of buildings. The Commission is also expected to adopt a delegated act in April 2022 setting out a methodology for assessing GHG savings from fuels like hydrogen and to ensure the electricity used in production is renewable.

While this may be readily fulfilled if the electrolyser is directly connected to a renewable energy plant, things are not as straightforward where power is taken from the grid. Especially four requirements are being discussed:

1. electricity for hydrogen production must come from renewable sources;
2. to incentivise the building of renewable energy plants, the electricity used must, in principle, be obtained from a new plant (‘additionality’);
3. the production of renewable electricity and the production of green hydrogen must be related in time (‘temporal correlation’); and
4. hydrogen production should take place in geographical proximity to power generation (‘geographical correlation’).

The HPA may need to include warranties as to the adherence to these four requirements. However, we note that the definition of these criteria is still subject to legislative debate. Furthermore, a proposal for an EU directive on common rules for the internal markets in renewable and natural gases and in hydrogen was published on 15 December 2021, giving clearer definition on green hydrogen. These legislative developments will need to be considered and where appropriate be reflected in the HPA.

Ensure predictable revenue stream

Financiers of hydrogen projects will demand HPAs that ensure a predictable revenue stream. The HPA will therefore need to provide a long-term offtake commitment (eg a period of 10 to 15 years). However, European competition law requires that offtake agreements do not create barriers to entry for potential competitors. While the European Commission has recently emphasised this point regarding long-term LNG contracts, it may be less stringent concerning HPA given the nascent nature of the market and the need to promote green hydrogen to achieve climate neutrality.

Another aspect of ensuring a predictable revenue stream will be stipulations on offtake quantities. Negotiating a take-or-pay clause may be instructive. Take-or-pay means that the customer has the obligation of either taking a specified quantity of green hydrogen on a periodic basis or pay a penalty. The penalty may be designed in such a way that the customer does not take but pays for the quantity and can claim delivery later.

Conversely, offtake schemes on demand will likely not be prevalent. All the more so as the PPA corresponding to the hydrogen project will probably also stipulate a constant obligation to offtake electricity, thereby generating fixed costs that can potentially not be amortised under an on-demand scheme.

As there are no spot prices for hydrogen yet, early HPAs will likely include a price formula based on fixed costs plus variable costs. Most green hydrogen projects will also benefit from a subsidy that will be reflected in the price. As the market will evolve rapidly, the HPA should include a robust change-in-law clause that also allows review of pricing.

Allocate risks 

The parties of an HPA should carefully consider the appropriate risk allocation. The HPA will likely contain a specific date for delivery to start. Where this is delayed – for instance due to delay of completion of the hydrogen generating facility or the renewable energy power plant – provisions on damages and termination rights should be stipulated.

As regards the risk of failure of electricity and water supply, the HPA should ideally include a stipulation that is designed back-to-back with the PPA (and the contract for the supply of water) so that risks are coordinated along the supply chain. Also, a carefully drafted force-majeure clause is vital to limit liability risks.

If you are seeking to develop, trade or invest in hydrogen, feel free to reach out to us for further counsel.