A peek at the (UK hydrogen) pipeline: market, policies and opportunities

As the world continues to look for progress with the energy transition process, hydrogen’s contribution is needed to hit global net zero targets: the IEA’s models show a six-fold increase in hydrogen use is required to meet 10% of total final energy consumption for net zero by 2050. Hydrogen, and in particular green hydrogen, has a versatile use-case potential and has catalysed many recent technologically-exciting projects. (The National Grid’s quick explanation of the 'hydrogen colour spectrum' is linked here.)

This blog, focussing on the UK, provides an overview of the hydrogen project opportunities for investors, as well as a snapshot of the status of the market in the UK and its close interaction with policy - in particular the Net Zero Hydrogen Fund and the Hydrogen Business Models. It is worth noting that despite the selective focus here on the role of hydrogen in decarbonisation policies, hydrogen is also an important part of the British Energy Security Strategy and the Chancellor’s Growth Plan presented to Parliament on 23 September 2022.

What opportunities are there?

The hydrogen industry is full of opportunities for investors across the value chain. As well as a variety of green hydrogen production technology (mainly steam reformers and electrolysis), there is a wide range of ways in which the hydrogen produced could be used. These include:

• industrial use such as in oil refining, ammonia production, steel making, methanol production; 
• transport, such as fuel to drive cars (replacing fossil fuels), trucks, ships and airplanes; and
• power generation or possibly heat, including by blending hydrogen into existing natural gas networks or for use in storing low-cost excess renewable electricity.

Key risks for industry players include construction risk and cost overrun. The ambitious timeline proposed as an eligibility criterion for the Net Zero Hydrogen Fund and the Hydrogen Business Model (see below) will add another layer to this challenge.

In addition, the technology risk for hydrogen projects is linked to a tension between the supply and demand market (see Freshfields’ previous blog post including this topic here). Similarly, the requirement for any applicants for the Net Zero Hydrogen Fund and the Hydrogen Business Model to have already identified at least one offtaker will prompt careful consideration.

Greenfield hydrogen-related transaction activity over the last couple of years has included hydrogen production facilities (green and blue hydrogen), hydrogen power stations, storage facilities, distribution facilities, electrolysers and turbines with a related M&A market and debt provision from corporate financings, refinancings and asset financings. At this stage, the main role for brownfield investors might mostly be through venture or growth funds, but as the projects scale up, more opportunities may open.

Investor opportunities may be anywhere within the value chain (i.e. at production, distribution, or delivery to end users) and there are also considerations as to whether to be involved either upstream or downstream, in green hydrogen compared to blue hydrogen, and in different types of projects such as repurposing existing assets rather than building new infrastructure. The UK Government publication has published a useful guide showing the wide variety of investment opportunities in this space.

Any investment in the hydrogen industry could help to:

• increase the scale of project deployment;
• establish demand and/or reduce costs; and
• increase capital expenditure, including in order to build or upgrade any necessary infrastructure.

As suggested above, growth of investment in the hydrogen industry could increase M&A and financing opportunities for brownfield investors too.

Where are we now?

Our snapshot of the developing hydrogen market in the UK shows, especially at this point in time, a synergy with the Government’s policy initiatives. The UK is targeting 10 GW of low carbon hydrogen production capacity by 2030 with over half of this from electrolytic hydrogen.

The key ongoing initiatives in the UK Hydrogen Strategy aiming to deliver these key goals are:

• the Net Zero Hydrogen Fund - funding of £240 million which will be delivered via four strands and grant requests of up to £80,000 each
• the Hydrogen Business Model - design of an allocation round for electrolytic hydrogen projects, with a market engagement exercise where up to £100 million for initial electrolytic H2 projects may be awarded.

Earlier this year, stakeholders provided comments on some of the issues raised in BEIS’s proposals for these initiatives, following which a government response publication was released and clarificatory questions are ongoing.

Some of the main issues provoking discussion (both in the consultation process and in the follow-up clarificatory questions) include:

• The requirement for eligible projects to reach commercial operations date by the end of 2025 at the latest, as this would mean that projects would need a positive final investment decision ideally before the end of this calendar year
• a minimum capacity threshold for projects to be eligible of 5MW, as it has been suggested this may not aid market development and learning, or increase competition
• a criterion that producers aiming to apply should have identified at least one offtaker for hydrogen (where such offtaker should also meet certain qualifications and will be referred to throughout the application, for example within the ‘project risk register’ submitted)
• compliance with the Low Carbon Hydrogen Standard - 20g per megajoule
• the weighting of the project’s ‘deliverability’ score, calculated based on the project’s performance against BEIS’ three key factors.

Applications for strands one and two of the Net Zero Hydrogen Fund, which provides for development expenditure for front end engineering design (FEED), post-FEED activities and capital expenditure support have already closed. Currently applications for strand three - the ‘first electrolytic allocation round’ - are open. Strand 4 will focus on capital expenditure support for carbon capture usage and storage (CCUS) enabled projects that require a hydrogen specific business model and are part of the Phase 2 cluster sequencing process.

What comes next?

The outcome of the allocations under the Net Zero Hydrogen Fund and the Hydrogen Business Model could affect the viability of proposed hydrogen projects – failing to obtain grant funding could cause hydrogen projects to either be scaled down or be delayed, although alternative external investment may be available.

The winning projects will still be working to a very ambitious timeline in order to be operating before the end of 2025 and so such projects may still benefit from additional external support. The timeline proposed would mean that, in order to robustly protect against the key construction and cost overrun risks, all contracts including offtake contracts will need to be agreed by July 2023. Further, concurrent development of the necessary infrastructure for operational hydrogen projects should take place – notably transportation (i.e. either the building or repurposing of pipeline networks, or robust hydrogen compression in order to transport the product by road) and storage.

 Finally, international investors will also have an eye on other hydrogen policy developments outside of the UK. The EU’s “Hydrogen Accelerator” for example is expected to trigger significant interest from investors and overall such incentives are bound to add further colour to the development of hydrogen investment opportunities.

This blog is part of a series with a paticularised focus for financial sponsors and infrastructure investors (see previous posts here, here and here). See also our collection of posts exploring the potential impacts of energy transition and climate change on global projects here.