Energy UK response to the DESNZ consultation on Hydrogen to Power: market intervention need and design

Question 1. What are your views on the vision we have set out for hydrogen to power?

Energy UK broadly supports the vision described, with Hydrogen to Power (H2P) having a variety of roles in the power market. These range from a short-term peaking role to providing services to the system operator and longer duration running to cover extended periods of reduced renewable generation. The deployment of H2P alongside other low carbon dispatchable technologies, including power CCS, batteries and long duration electricity storage (LDES) will help to support the decarbonisation of the power sector. The role each technology will play is difficult to predict at this time and there are a range of deployment levels for H2P explained in appendix 1, which are credible. The question is whether the proposed model will or should deliver H2P plant for all these roles, and where H2P plant should be in the merit order. As part of this, further consideration needs to be given to whether hydrogen, as a high value fuel, should mostly be used for a security of supply role or if it should be utilised more widely and provide general decarbonisation benefits.

The ambition to decarbonise the power sector by 2035, subject to security of supply will require further articulation to understand the size and shape of the security of supply element. This will be needed to ensure the policy and market framework is developed towards meeting this ambition. Policymakers will also need to be mindful in the short term of the medium to longer term aim for low carbon technologies to compete to provide power to the market for supply / demand matching and ancillary and flexibility services. Essentially there is a risk that one technology receives more support than another which hinders the development of competition in the services provided – our answer to Question 12 elaborates on our views.

For H2P it will also be essential to understand the interdependencies with other elements of the hydrogen supply chain, including production, transport and storage. There are clearly risks in developing H2P plant where transport and storage infrastructure may not be delivered in the same timescale. These are similar to those for CCS supported hydrogen production. We trust there will be further engagement with industry to enable DESNZ to understand the risks and challenges faced by project developers.
Further clarity needs to be given about the target for 10GW of hydrogen supply by 2030 referred to in the UK Hydrogen Strategy and the Hydrogen Delivery Roadmap. Whist this is a good starting point, there is a lack of detail on how this would be divided for transport, power and industry and there are concerns about whether this target is sufficiently ambitious. In establishing the wider hydrogen economy, consideration will also need to be given to the capability to ramp up production to meet evolving demand at the required pace as well as the capacity target.

Question 2. In your view, what role should hydrogen to power plants be playing in the power system? Please provide details and an explanation of your reasoning.

As noted above H2P plant are technically capable of playing a variety of roles in the power system. Members views vary with the extent hydrogen should be utilised in the power sector or reserved for use in hard to decarbonise sectors. In principle H2P plant should dispatch where it is economically rational for them to do so, but the challenge of this is the numerous support mechanisms which form part of the value chain (production, transport and storage) alongside the support mechanisms for technologies with which H2P will be completing in providing flexibility, supply / demand matching and other roles to the power system.

We note that H2P does not link well to being a key offtaker for a hydrogen producer given that hydrogen generation is expected to be highly intermittent, storage will be a key part of the value chain from the outset. However, if hydrogen is sold at the natural gas price to generators it may be dispatched ahead of unabated gas plant due to it not attracting the carbon price.

Further consideration is needed into the role H2P is to play to ensure support mechanisms deliver the desired outcome.

Question 3. Do you agree with our assessment that less CAPEX-intensive plants and/or plants with ready access to low carbon hydrogen fuel could deploy in the short term without bespoke support? Please provide an explanation of your reasoning.

It is not apparent that any plant will have access to sufficient volume of hydrogen to deploy in the short term, say before 2030. Nor is it likely that such hydrogen supply would be sufficiently reliable for plant to participate in the capacity market, given the risk of non-delivery penalties.

In recent years nearly all, if not all, new investment in gas generating plant has been supported by a capacity market contract, it seems unlikely that hydrogen generation plant whether large or small will be built without some kind of contract.

When future roll out is uncertain and market arrangements are evolving investors are more likely to spend on lower upfront capital projects than commit to high capex projects, so outcomes will be determined by that rational decision.

Anecdotally members report that hydrogen capable engines are more expensive than natural gas equivalents but that H2 ready combined cycle plants are likely to be comparable to natural gas equivalents. Retrofitting of current plant to take a blend will vary by plant type.

It’s worth noting the challenges associated with converting existing plants which will not have envisaged hydrogen operation in their lifetimes (as opposed to new plants that will be building in hydrogen capability). Whilst conversion is feasible technically, the commercial viability will vary among plants.

Question 4. What are your views on our proposal to enable hydrogen to power plants to compete in the Capacity Market as soon as practical?

Energy UK welcomes the proposal to enable hydrogen to power plants to compete in the Capacity Market as soon as practical. We also agree with the consultation document that at present, the CM is not sufficient on its own to kickstart the deployment of hydrogen to power, but that it is nevertheless an important route to market.

Therefore there should be a strong focus from the Government on supporting H2P to participate in the CM as soon as possible by removing barriers to entry and progressing CM reform to minimise the continued need for bespoke support of H2P. More broadly, it is important for the Capacity Market to be able adapt and adjust to new technologies and ensure that new plants, running on new fuel, can provide security of supply.

Energy UK considers that H2P should be able to participate in the CM as long as derating factors are fair, clear and transparent, and as soon as barriers to entry are removed. It’s worth noting that removing barriers to entry depends on efficient operational processes and on Ofgem and the Delivery Body to make appropriate changes to CM rules. There should be renewed efforts from the Government to remove these administrative barriers, so that H2P can participate in CM auctions as soon as possible.

We note that one of the most significant barrier to entry is fuel supply risk. Until there is more certainty in the development of hydrogen transport and storage and more certainty in the reliability of fuel supply, the risk to participate in the CM may be too high given non-delivery penalties. Furthermore, the cost to consumers could also be high as a hydrogen plant would not only factor in capex into their bid, but would also price the risk to fuel supply.

Furthermore, the CM being a viable route for unabated plants converting to H2P also depends on the removal of barriers. Energy UK has previously provided input on decarbonisation pathways for unabated gas assets with CM contracts in the response to the 2023 DESNZ consultation on the CM: strengthening security of supply and alignment with Net Zero[1].

In considering the participation of H2P in the CM, it is also important to keep in mind that the CM exists to deliver security of supply. At present, there is a lack of detail on the definition of security of supply in the context of a decarbonising and decarbonised power system. Energy UK understands that the forthcoming REMA will be providing further detail on this, and a wider vision for the phaseout of unabated gas, so we would encourage the Government to make progress on its publication.

This is particularly important as enabling the participation of H2P in the CM as soon as practical demands more clarity on expected timelines and on the Government’s aims for hydrogen in the short, medium and long term.

Question 5. Are there any additional changes to existing markets which could support the deployment of hydrogen to power? Please provide details and an explanation of your reasoning.

In addition to bespoke support, the successful deployment of hydrogen to power will depend on a positive investment landscape and investor confidence in GB energy markets. Clarity and certainty here is essential, especially given intensifying global competition for investment.

Furthermore, it is important to consider the role that the UK Emissions Trading Scheme (ETS) will play in the deployment of hydrogen to power. A strong carbon price and carbon price support will help hydrogen to dispatch ahead of unabated gas in the merit order.

Question 6. Do you agree with the risks and barriers to hydrogen to power deployment that we have identified? Please provide an explanation of your reasoning.

Energy UK agrees that H2P deployment faces a number of barriers as described. In particular first-of-a-kind (FOAK) risk, T&S risks and availability of hydrogen.

We note that the T&S business models are interlinked through assessment criteria and cohort assessment. Some linkage of this type may be needed to ensure the infrastructure needed for H2P plant is in place when needed. Otherwise H2P investment may be delayed until there is confidence in the rollout of the necessary infrastructure.

DESNZ has a key role here as strategic planner, it could provide clarity on where it envisages H2P plant being able to deploy in which timescales.

Question 7. In your view, what should industry’s role be in addressing the barriers that we have identified? Please provide details and an explanation of your reasoning.

Industry has a role in helping government to shape policy and support mechanisms through providing challenge based on its experience of markets and investment drivers.

Industry is happy to engage in discussions with other parts of the value chain, but ultimately, they are separate businesses, with commercial drivers and sensitivities. Co-ordination of the rollout of production, T&S and use needs oversight and direction that the individual parties cannot drive in isolation of strategic planning and vison with appropriate support.

Question 8. Are there any other potential risks and barriers that we should be considering? If so, which ones? Please provide details and an explanation of your reasoning.

Question 9. Do you agree with our assessment that bespoke hydrogen to power market intervention is required to mitigate our identified deployment barriers and accelerate the deployment of hydrogen to power plants, likely those which are more CAPEX-intensive? Please provide an explanation of your reasoning.

Yes, although it is not certain that intervention is only required for more capital-intensive plant. The risks pertaining to infrastructure and supply make early projects too risky to proceed absent market intervention.

Question 10. Have we considered all credible market intervention options for hydrogen to power? Please provide details of any design options you think we may have missed and explain your reasoning.

Yes, Energy UK believes that all credible market intervention options for hydrogen to power have been considered.

However, it is also important to note that carbon pricing will ultimately set the differential between fossil fuel plants and hydrogen plants. A strong carbon price will help to dispatch hydrogen before unabated gas.

Question 11. Do you agree with our shortlisted three market intervention design options? Please provide an explanation of your reasoning.

Yes, Energy UK agrees. The modelling and rationale are both well worked through and the three best options have been presented.

Question 12. Have we accurately identified the benefits and risks of a DPA-style mechanism? If not, are there any further benefits and risks to consider? Please provide details and an explanation for your reasoning.

Energy UK believes that a DPA-style mechanism is the right option to pursue for supporting the early deployment of hydrogen. We agree that it would be effective in incentivising the build out of hydrogen plant and consider that separating capex from opex is an efficient design.

Energy UK believes that one of the risks of the DPA that has not been captured in the consultation document relates to the uncertainty over the future role of hydrogen in the power market, as highlighted in our answers to earlier questions on the Government’s vision for hydrogen to power. The allocation of the DPA may require significant Government steering of the capacity required. Therefore, the design of a mechanism and allocation system needs to be aligned with the specific outcome the Government is seeking, which at present is unclear. Clarity on the role the Government expects hydrogen to power to play in the power market is essential (i.e. whether hydrogen to power will provide a limited peaking role or contribute to decarbonisation on a wider scale).

There are further uncertainties that should be also addressed, including whether the DPA will be available only to high capex projects or all H2P plants, whether it will be competitively awarded, how it would be competitively awarded, and how best value will be determined.

It is also not possible for Energy UK to comment on whether the DPA will work as a stepping stone towards participation in the longer-term technology-wide competitive market being considered by REMA until the REMA consultation is published and further detail is provided. In general, the Government should be mindful to take a whole-system and market-wide view in its approach to bespoke mechanisms, with an overarching objective to deliver a competitive market which supports a range of low-carbon technologies as soon as is feasible.

If a whole-system, market-wide perspective is not taken, we are concerned that there may be risks of market distortion, in particular if hydrogen that has already been subsidised by the Hydrogen Production Business Model is used at scale for H2P, as this could impact the merit order and power prices. Some members have warned that this could have the potential to adversely impact the economics of other low-carbon technologies and other sources of low-carbon flexibility, which could result in an increased need for subsidy to support other technologies thus delaying the transition to a technology-wide competitive market.

There may also be risks with the development of the wider hydrogen market if the relatively limited volumes of hydrogen likely to be available over the next decade are subsidised for use in the power market to the detriment of other uses, including industrial decarbonisation. Therefore a proportionate and balanced approach needs to be taken.

Question 13. Do you agree with government’s assessment that a mechanism based on the Dispatchable Power Agreement is the most suitable option for bespoke hydrogen to power market intervention to support the accelerated deployment of hydrogen to power? Please provide an explanation of your reasoning.

Yes, Energy UK agrees that a mechanism based on the DPA is the most suitable option for bespoke hydrogen to power market intervention to support the accelerated deployment of hydrogen to power, provided that the UK ETS remains a strong incentive to dispatch hydrogen plant ahead of carbon-fuel based plant.

Question 14. What are your views on the need for a Variable Payment? Please provide details and an explanation of your reasoning. Hydrogen to Power: Consultation on the Need and Design for Market Intervention.

Energy UK believes that more work is needed to determine whether a Variable Payment is needed and that more clarity is needed on the market failure it would be seeking to address.

There is uncertainty about the availability and the price of hydrogen in the longer term, which cannot be assumed to be at or close to the natural gas price in the longer term subject to changes to the low-carbon hydrogen agreement. There is also uncertainty about where hydrogen plant will run in the merit order and the interaction with the UK ETS.

Energy UK’s members have mixed views on the Variable Payment, with some believing that it is a necessary component given the uncertainty around the cost and availability of hydrogen, while others emphasised that more work was needed to understand whether it is needed, and others noting they did not see a case for it at all given the potential for market distortion as noted in our answer to Question 12.

Overall, Energy UK agrees there is a need for the Government to provide a comprehensive assessment and a clear, detailed articulation of why a Variable Payment is needed, taking into account the uncertainties listed above and how these would interact with a Variable Payment as part of support for H2P plant.

Question 15. Have we accurately identified the benefits and risks of a Split CM? If not, are there any further benefits and risks to consider? Please provide details and an explanation of your reasoning.

Energy UK notes that a Split CM will be considered as part of REMA and in general, we feel that this question is more appropriately addressed by REMA. While the majority of Energy UK members believe that the DPA is the right approach for the deployment of hydrogen to power (agreeing with the consultation that the CM is not suitable for FOAK technology), some members noted that CM reform should be progressed in parallel with the DPA before a final decision is taken.

In general, Energy UK considers that the concerns outlined in our response to Question 4 about risks to H2P participation in the CM would also be relevant for H2P participation in a Split CM.

Question 16. Do you agree with our proposal to discount the Split CM as an option for bespoke hydrogen to power market intervention to support the accelerated deployment of hydrogen to power? Please provide an explanation of your reasoning.

Yes, Energy UK agrees.

Question 17. Have we accurately identified the benefits and risks of a Revenue Cap and Floor? If not, are there any further benefits and risks to consider? Please provide details and an explanation of your reasoning.

Yes, Energy UK believes that the benefits and risks of a Revenue Cap and Floor have been accurately identified.

Question 18. Do you agree with our proposal to discount the Revenue Cap and Floor as an option for bespoke hydrogen to power market intervention to support the accelerated deployment of hydrogen to power? Please provide an explanation of your reasoning.

Yes, Energy UK agrees.

Question 19. What is your view on the need for price-based competitive allocation within/between bespoke business models versus moving assets straight to a technology-wide competitive market? Please provide an explanation of your reasoning.

Energy UK believes that competitive markets deliver innovation, efficiency and best value for consumers. However, as a FOAK technology, hydrogen to power requires bespoke support at this stage. Ultimately, how assets transition from early support to technology-wide competitive markets is a question more appropriately addressed by REMA.

Question 20. How should a bespoke hydrogen to power business model be evolved to promote competition between low carbon flexible technologies? Please provide details and an explanation of your reasoning.

The Government is currently considering the introduction of bespoke support for a number of FOAK technologies to unlock investment and enable these technologies to support the transition to a decarbonised power system and meet system needs.

Energy UK agrees that bespoke support should be a short-term solution for FOAK projects, before re-integrating supporting into a wider market mechanism to compete on a level playing field with other low-carbon flexible technologies.

The decarbonisation of the power sector will require the Government to consider how multiple policy streams will develop and overlap in the course of the transition to ensure both that 1) policy frameworks for hydrogen, and other technologies, are clear and robust to provide confidence to invest, and 2) that a level-playing field can be achieved in the longer-term.

The Government should be mindful of the potential impact of different market interventions and how these interact with one another, taking into account the potential risk of market distortion[2]. More broadly, there is a need for Government and the National Energy System Operator to approach policy and regulation in a coordinated manner and through a whole-system lens, to ensure that, for example, bespoke support for hydrogen to power does not adversely impact other low-carbon technologies or inadvertently divert hydrogen away from other sectors of industry or transport where fewer decarbonisation routes exist.

We understand that the forthcoming REMA consultation will provide further detail on the Government’s view of how these policies will evolve alongside one another. As with our answer to the previous question we believe that this question is more appropriately addressed by REMA.

Question 21. What are your views on the alignment of hydrogen support and policies needed to enable the deployment of hydrogen to power capacity. Please provide details and an explanation of your reasoning.

The development of the hydrogen economy at pace is critically dependent on all the components of the chain progressing in parallel, production, T&S and use are all reliant on each other, although early production may be able to direct production into the distribution networks for blend the opposite is not the case for H2P plant which are ready before there is sufficient production or infrastructure to transport the hydrogen to site. It is essential that H2P build or conversion is protected from these cross chain risks which are beyond its control.

Security of fuel supply to H2P generation will be a consideration for electricity security of supply.

Question 22. Do you have any reflections on the feasibility of hydrogen producers, or qualifying off-takers, to facilitate the volume of storage required for hydrogen to power – for example, regarding sourcing finance/capital? Please provide details.

Energy UK considers that a substantial volume of hydrogen storage will be needed for H2P that would not be feasible to finance as part of production or H2P plant.

A distinct business model is needed for hydrogen storage which will have general benefits to the hydrogen economy beyond support for H2P, including general supply / demand matching, security of supply for all customers and balancing services for the pipeline / network operator.

Question 23. What are your views on the feasibility of developing commercial arrangements between hydrogen producers, storage providers, and electricity generators that meet the Hydrogen Production Business Model (HPBM) requirements relating to Risk Taking Intermediaries (RTIs)?

Risk taking intermediaries can take on roles in the nascent and developing hydrogen economy that they are best placed to manage efficiently, including contracting with producers, storage operators, customers, suppliers (depending on supply licence considerations) and the pipeline operator for transportation and balancing services.

Absent the RTI role there will be many, many bilateral contracts between parties in the supply chain with risk of non-delivery / availability priced in to each one. This would be highly complex and is likely to be inefficient. Parties would also need to take on roles unfamiliar to them in the current gas market and inconsistent with principles of unbundling, e.g. producers agreeing supply contract with customers.

Where long term contracts are agreed these may need to be renegotiated if the regime transitions from non-RTI arrangements to market arrangements permitting or requiring sales to RTIs. We envisage RTIs having a key role in the development of hydrogen trading which we anticipate will grow as the hydrogen economy develops. Any concern with respect the end use of hydrogen supported by the production business model could be managed by adequate record keeping.

Contact

Julie Cox, Senior Policy Advisor
julie.cox@energy-uk.org.uk

Sophie Lethier, Policy Manager
sophie.lethier@energy-uk.org.uk

References

[1] Answers to questions 12 to 18, Energy UK response to DESNZ consultation on the Capacity Market: strengthening security of supply and alignment with Net Zero, March 2023. Additionally, some members have suggested that consideration should be given to CM contract holders with carbon-based fuels to terminate their contract in exchange for a hydrogen based contract, to facilitate a faster transition to non-carbon based fuels.

[2] As outlined in our answer to Question 12.