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The regulation of hydrogen – what will it look like?

With no current legislation in place we discuss the future regulation of hydrogen and what contractual frameworks need to be considered?

Introduction

As the UK (and indeed the world) seeks to address the threat of climate change, the role of hydrogen is key. It is clear that, for the UK to achieve its target of net zero emissions by 2050 and as use of fossil fuels is phased out, there is an urgent need to diversify its sources of energy supply. Whilst generation of power from renewable sources such as solar and wind, considered as most cost-effective and sustainable, is the ultimate goal, there remains a heavy reliance on gas (with gas being used to provide up to half of the country’s electricity demand and three quarters of our heating). As we transition to a more diverse energy market which will support economic growth of many industries, including manufacturing and transport, hydrogen is set to play a central role.

Of course, the use of hydrogen in gas networks is nothing new. Prior to the use of North Sea gas in the 1960s, local gas networks supplied “town gas” which in fact contained around 50% hydrogen. However, it is now necessary to develop the use of hydrogen, as a replacement for natural gas, to move to a decarbonised future. Both the Government’s Energy White Paper (Powering our Net Zero Future, December 2020) and the UK Hydrogen Strategy (published in August 2021 by the Department for Business, Energy & Industrial Strategy (“BEIS”)) are clear on the importance of hydrogen to a cleaner, zero carbon future, the detail in relation to regulation of hydrogen has not yet been considered and will no doubt be the subject of industry consultation. So, what might future regulation of hydrogen look like and what regulatory and contractual frameworks need to be considered?.

Legislation

There is no specific legislation in relation to hydrogen and, in the absence of any forthcoming legislation (of which there is currently no sign), hydrogen will be governed by the existing legislation for natural gas, namely the Gas Act 1986 (“Gas Act”), with hydrogen being captured by the definition of “gas” ( “…….any substance in a gaseous state which consists wholly or mainly of- (i) methane, ethane, propane, butane, hydrogen or carbon monoxide; (ii) a mixture of two or more of those gases; or (iii) a combustible mixture of one of more of those gases and air” (Section 48(1) Gas Act 1986)). 

The Gas Act also confers powers on the Gas and Electricity Markets Authority to regulate the UK gas industry, which it does through the Office of Gas and Electricity Markets (“Ofgem”). It follows that Ofgem will be the economic regulator in respect of hydrogen and will issue licences pursuant to the Gas Act to anyone who wishes to engage in the supply, shipping or transportation of gas. Licences would also contain provisions in relation to the safe operation of gas networks transporting hydrogen.

Industry codes and contractual framework

Gas licensees are obliged to comply with various industry codes, principally the Uniform Network Code (“UNC”). The UNC is a complex code which governs gas transportation arrangements between gas transporters and shippers and defines the rights and responsibilities for users of the gas transportation system. In addition, every gas transporter is required to have a network code of its own (incorporating the UNC) to govern the terms on which gas will be transported. As hydrogen is a “gas” pursuant to the Gas Act definition, transportation of hydrogen is likely to be governed by UNC.

Players in the hydrogen market should also consider whether it is necessary to comply with other industry codes, such as The Smart Energy Code (if they are to engage in smart metering) and The Retail Energy Code (which consolidates a number of previous codes and governs the arrangements for consumers to switch their energy suppliers).

In addition to compliance with the Gas Act, anyone intending to become involved in hydrogen projects should consider what commercial contracts it may need to enter into. The necessary commercial agreements could include:-

  • agreements for supply of power and water (for use in the production of hydrogen process)
  • Network Entry Agreements and Network Exit Agreements (under the UNC) for delivery of hydrogen to the gas network and offtake respectively
  • agreements with hauliers in relation to transportation of hydrogen by road (hydrogen is classified as a dangerous good under the Agreement Concerning the International Carriage of Dangerous Goods by Road)
  • any agreements necessary for connection to, and use of, local gas networks
  • agreements to govern the sale of hydrogen
  • funding agreements with investors.

In terms of industry legislative and regulatory considerations, there does appear to be a strong case for a “least change” route, with minimal amendments to existing legislation and regulation to afford future use of hydrogen to be regulated in a very similar way to the existing natural gas networks, and by the same regulatory body.

In relation to pricing regulation, it seems feasible that Ofgem could achieve this as an adjunct to the RIIO price control mechanism and this will no doubt be subject to industry consultation, with network operators perhaps wishing to see distinct rules in relation to the old (natural gas), new (pure hydrogen) and hybrid (blended hydrogen with natural gas). It also remains to be seen what methodology for the pricing of hydrogen will be introduced – this could range from a guaranteed unit price (which could be an incentive to invest in hydrogen production plants for hydrogen producers at scale) to a contract for difference model.

Other regulatory considerations

Health and safety

Hydrogen, as with other gases, is regulated from a health and safety perspective by The Health and Safety Executive (“HSE”). Transporters of hydrogen will need to comply with the Gas Safety (Management) Regulations 1996 (which govern the flow of gas through a pipe network) and must have in place a safety case, which will be audited by the HSE, to document the systems that are in place to ensure safety controls in relation to transportation of hydrogen.

Similarly, from an operational perspective, the Pipeline Safety Regulations 1996, governing the design, construction, installation, operation and maintenance of pipelines to ensure their integrity, must be complied with.

Further regulations in respect of hydrogen’s classification as a hazardous substance will also require strict compliance.

Planning

As for any project in the UK, consideration needs to be given to planning and consenting issues. Larger hydrogen projects are likely to be nationally significant infrastructure projects and will, pursuant to the Planning Act 2008, require a development consent order. Smaller projects will likely be regulated by the Town and Country planning Act.

The UK Hydrogen Strategy

The UK Hydrogen Strategy seemed to be a long time coming. Generally, there has been support for the strategy, but it has been acknowledged that the various consultations arising from it are crucial. However, the Hydrogen Strategy does not shed much light on the regulatory piece. It acknowledges that the regulatory framework as it relates to hydrogen is broad and complex. It acknowledges that while early projects can be expected to operate within the existing regulatory regime, new rules and regulations may be required.

Crucially, the Government is considering and addressing four overarching and interdependent regulatory issues for the hydrogen economy:

  1. Addressing regulatory barriers facing first-of-a-kind hydrogen projects.
  2. Using regulation to unlock access to new markets for hydrogen.
  3. Identifying who should regulate an evolving future market for low carbon hydrogen, and how and when.
  4. Ensuring that the potential role for hydrogen is considered in broader reviews of regulation.

Part of the Government’s plans include engagement through the creation of a Hydrogen Regulators Forum, with representatives across the relevant regulatory areas (including environmental, safety, markets, competition and planning).

Conclusion

The time for talking is over and the time for consulting needs to be fast tracked. We have been engaging with lenders over the last couple of years to discuss the numerous opportunities within the hydrogen economy. As to be expected a common theme has been the lack of regulatory certainty. It is difficult to model for a financial outcome on any particular investment where there is regulatory uncertainty without making wide-ranging assumptions.

The interest in hydrogen and the opportunities that we are seeing in terms of both projects to be developed and funders keen to invest is huge. It can lead to the UK becoming a technology leader and an exporter of knowledge, creating thousands of jobs. However, so much depends on the regulatory pieces falling into place, and quickly.   

It is difficult to anticipate what regulation of hydrogen will look like and much will depend on industry consultation and the outcome of current demonstration projects. However, Ofgem’s primary concern will be addressing the needs of customers and seeking to minimise disruption. We believe it is entirely feasible that Ofgem, working closely with BEIS and other industry stakeholders, will adopt a pragmatic, “least change” approach to regulation, using the existing natural gas framework as much as is possible to facilitate efficient, timely implementation.

If you need advice or further information then get in touch with our energy and utilities solicitors

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