To support the UK Government’s target of achieving 10GW of low-carbon hydrogen production capacity by 2030, the Net Zero Hydrogen Fund was introduced to provide upfront capital funding, while the Hydrogen Business Model was launched to offer revenue support. Both schemes are currently limited to green hydrogen suppliers to encourage low-carbon hydrogen production projects.
However, as with any emerging market, suppliers are grappling with legal and practical uncertainties, including establishing a supplier-offtaker relationship that can successfully navigate unique scenarios across the hydrogen supply chain.
The hydrogen offtake agreements are being introduced to regulate the sale, purchase, storage and supply of green hydrogen in the absence of widely accepted market practices. While each offtake agreement is likely to initially vary project-to-project at this early stage, broadly we expect to see them deal with the same key issues.
Take or pay
Unlike traditional subsidies granted for production alone, the UK Government has linked subsidies to hydrogen sales through Hydrogen Allocation Rounds (HARs) and Low Carbon Hydrogen Agreements (LCHAs). These agreements depend on the actual sale and use of hydrogen, meaning that suppliers must commercialise hydrogen from the beginning to be effective.
This puts pressure on suppliers to have in place robust, reliable offtake arrangements to benefit from the subsidies. Hydrogen suppliers have responded by insisting on including 'take or pay' obligations on offtakers to ensure that the supplier either offloads the required quantity of hydrogen to meet the subsidy requirements or the offtaker must pay the difference.
Offtakers are likely to resist such strict obligations from the outset. They want to ensure that their purchase obligations are in line with their demand requirements and that the supplier meets minimum supply obligations.
Facilities
Both offtaker and supplier benefit from being bound by commercial terms as early into the project lifecycle as is practicable for a number of reasons, in particular, as each party is required to build facilities to enable them to produce and utilise hydrogen, respectively. The clear tension point that will need to be considered when drafting the offtake agreement is scenarios where the parties have signed the offtake agreement, and their plant or facility is not ready to produce hydrogen.
To mitigate this risk, parties have been discussing, for example, the offtaker keeping their existing gas supply running for a period to allow for any hydrogen shortages. The offtaker has also insisted in some instances that there should be an obligation on the supplier to source alternative hydrogen elsewhere.
If the latter, parties should consider whether the offtaker will accept alternative forms of hydrogen such as blue or grey hydrogen, noting that in doing so, they will lose their 'green' credentials. It will also be difficult for the supplier to source alternative forms of hydrogen when hydrogen is not widely produced.
Conversely, where the offtaker is not ready to accept hydrogen, suppliers are insisting on the take or pay obligations being enforced. However, suppliers might end up holding surplus hydrogen without a ready buyer.
Contract term
Suppliers, eager to secure revenue over the full 15-year LCHA subsidy period, are pushing to bind offtakers for a 15-year period to match the LCHA term, while locking into long-term agreements feels risky for offtakers, when demand for hydrogen is still finding its footing and the technological and regulatory landscape, continues to evolve.
This mismatch between supplier expectations and offtaker readiness reveals a fundamental tension: timing. The timing of hydrogen production and offtaker readiness is a balancing act; if either side isn't ready, it can lead to costly delays, jeopardising the entire supply chain.
Transport and allocation of risk
The UK hydrogen market is still in flux about how best to transport and store hydrogen and that uncertainty will flow into early-stage offtake agreements. While it is the cheaper alternative, pipelines will not form the full solution given that hydrogen is less dense than gas and can escape more easily, it can corrode metal and it will be difficult, costly and take a long time to build a new hydrogen infrastructure.
This has left suppliers considering truck transportation, which is particularly helpful if end users are widely dispersed. Suppliers and offtakers must negotiate who will assume responsibility for the hydrogen and when risk will transfer between them.
Solutions
A framework that allows for adjustments to timelines, quantities or contractual terms in response to changing conditions is crucial for ensuring hydrogen projects can progress to meet the UK’s hydrogen production goals.
A balance might be struck with fluctuating take or pay arrangements or production thresholds with the opportunity to review these thresholds at regular intervals by both parties throughout the term of the contract while tying both parties in for a time period suited to the terms of the LCHA.
Another solution to minimise risk is the adoption of joint venture partners who are also offtakers and are therefore more willing to accept some of the initial risks for the benefit of the overall project.
What is clear is that both parties must be prepared to accept the inherent risks of an emerging market and allocate risk appropriately to develop a solid foundational relationship if the hydrogen market is to flourish.
This article was first published in H2 View—read more here.
