The Energy Bill – Key Points for Hydrogen and CCUS Business

UPDATE: As foreshadowed in our earlier alert (below), Jacob Rees Mogg, the new secretary of state for business, energy and industrial strategy, has now indicated that the Bill will be paused or discarded altogether to reflect the new government’s priorities. However, it is reported that reforms contained in the Bill could be inserted in the “levelling up and regeneration bill” or other pieces of legislation. It is also possible that certain elements could be taken up by the Treasury, as new Chancellor Kwasi Kwarteng had launched a consultation on how to reform the electricity market in July in his capacity as then business secretary. We will continue monitoring developments.

Among soaring temperatures and political rifts, the U.K. government introduced its Energy Bill on 6 July 2022. The Bill is currently at committee stage in the House of Lords and the government has called it “the most significant piece of energy legislation in a decade.” Its main aim is to mobilise £100 billion of private investment by 2030 to drive the next phase of the energy transition and contribute to energy security. As part of the British Energy Security Strategy, the government stated that it plans to accelerate the deployment of wind, new nuclear, solar and hydrogen, whilst supporting the production of domestic oil and gas in the nearer term – which could see 95 percent of electricity by 2030 being low carbon.

There is a lot to unpack in the Bill’s 243 clauses and 19 schedules, but we have picked out the highlights below. It is worth noting that the appointment of new Business and Energy Secretary Jacob Rees-Mogg, given his previously expressed positions on the energy sector[1] is likely to affect parts of the Bill. In addition, new Prime Minister Liz Truss is planning a fundamental market reform that will ask renewable and nuclear generators take up long-term contracts at fixed prices below current rates.[2] She also announced there would be support for energy bills for consumers, which would include a cap on bills at £2,500 a year.[3] We anticipate the overall commitment in respect of the net zero target will remain intact, but we will monitor developments as they unfold.

1. CO2 Transport and Storage Infrastructure

The Bill introduces licensing and regulatory requirements for hydrogen and CO2 transport and storage infrastructure. Ofgem will be the economic regulator of CO2 transport and storage; it will have powers to grant, modify and enforce relevant licences. A licence will determine the allowed revenue that a transport and storage operator may receive, which should reflect its efficient costs and a reasonable return on its capital investment. The Bill will also establish funded decommissioning programs in respect of CO2 storage and transport assets and a special administration regime and step in rights for the secretary of state.

1. Hydrogen and CCUS Business Models

The Bill provides the secretary of state with U.K.-wide powers to financially support the establishment of carbon capture, usage and storage (“CCUS”) and low-carbon hydrogen production. The secretary of state will also be able to designate and direct counterparties to support the managing of contracts under the low carbon hydrogen and CCUS business models. The Bill also establishes an allocation process for these contracts and empowers the secretary of state to appoint an allocation body, as well as issue regulations (that will, for example, introduce standard terms and conditions in respect of hydrogen production revenue support contracts and carbon capture revenue support contracts), and establish a hydrogen production levy.

1. Low Carbon Hydrogen Agreement

These measures should be read in conjunction with the package released by BEIS on 8 April 2022 in response to the consultation on the business model for low-carbon hydrogen initiated in August 2021, particularly the indicative Heads of Terms for the Low Carbon Hydrogen Agreement (“LCHA”). BEIS has a goal to finalise the form of the LCHA by the end of 2022 and award the first contracts in 2023.

Many issues remain to be finalised in the LCHA, including the means of allocation; the identity of the Hydrogen counterparty; the consequences of default and producer termination rights; treatment of change of law risk; the interface between the LCHA and the Low Carbon Hydrogen Standard; and limited recourse arrangements from 2025. But several key directions seem clear:

1. Duration – 10-15 years from the start date of hydrogen production;
2. Application – LCHAs will not be available for hydrogen exports. Hydrogen supply to affiliates to be used as self-consumption and to feedstock users will qualify for LCHAs;
3. Form of Support – The producer will be paid a premium based on the difference between the strike price and the reference price. The payment is intended to provide the producer with price certainty and works like a contract for differences (“CFD”) based on the existing CFD model for low carbon energy in the U.K. Payments will be made on a £ per MWh basis (higher heating value basis). Payment will be two-way with the producer paying the hydrogen counterparty if the reference price exceeds the strike price. Payments will be made on a sliding scale and will increase if sales volumes decrease. The commitment is to pay increased amounts for production value rather than to offtake.
4. Calculation of Strike Price – (Expressed in £ per MWh) is intended to reflect the costs of production of hydrogen and an allowed return on investment. It is to be determined which method of allocation will determine the strike price – auction or negotiation.
5. Calculation of Reference Price – (Expressed in £ per MWh) is intended to reflect the market price received by the producer for low-carbon hydrogen. For initial projects this will be the higher of the producer’s achieved sales price and the price floor (the lower of the natural gas price and the strike price).

The LCHA and the statutory basis being given to the low-carbon hydrogen business model are to be welcomed by hydrogen producers and other participants in the hydrogen economy. Once the LCHA launches in 2023, sponsors of hydrogen production projects will have the benefit of a long-term and bankable hydrogen contract on which they can base their investment decisions and obtaining long-term financing on reasonable terms.

1. Battery Storage

Developers of battery-based projects will welcome the clarification in the Bill that storage constitutes a distinct subset of generators under the Electricity Act 1989. The government has stated that this definition will “allow flexibility for treating storage differently to other forms of generation where it is appropriate to do so.”

1. Future System Operator Established

The Bill establishes the Future System Operator (referred to as the “Independent System Operator” or “ISOP”), a new independent body that will have strategic oversight across electricity and gas systems and interpreting existing networks with new technologies such as hydrogen. Existing capabilities and functions of NGESO and, where appropriate, National Grid Gas, carried out by other entities, including NGESO, will be transferred to the ISOP. Among the new body’s objectives will be a duty to carry out its functions in a way that promotes the net-zero objective.

1. Ofgem as Heat Regulator

The Bill appoints Ofgem as heat networks regulator and introduces an authorisation and licensing regime for this market.

1. Consumer Features – Extension of Price Cap / EV Infrastructure / Smart Meters

The Bill introduces consumer-facing measures, including extending the price cap for consumers beyond 2023 if certain conditions are met, and increasing the pace of the roll out of energy transaction infrastructure such as EV chargepoints and smart heat pumps. The secretary of state’s powers to regulate and amend codes for smart meters has been extended to 1 November 2028.

1. Changes to North Sea Change of Control Regime

Notably for the oil and gas industry, the secretary of state will, under the Bill, be able to charge for certain regulatory functions of Ofgem. Crucially, the Bill will allow the North Sea Transition Authority (“NSTA”) to prevent undesirable changes of control of petroleum licences and for potential revocation of the licence for change of control without NSTA’s prior consent. Licence conditions relating to change of control will be amended.

1. New CMA Function in Energy Mergers

The Bill will amend the Enterprise Act 2022 to require the Competition and Markets Authority (“CMA”) to, in certain circumstances, assess whether a merger between energy network companies substantially prejudices Ofgem’s ability to carry out its functions if it compares data from the companies to set price controls.

1. Nuclear Fusion Regulation – A Divergence From Nuclear Fission Regulation

The Bill will amend the Nuclear Installations Act 1965 to confirm that fusion energy facilities will not be subject to nuclear site licensing requirements and will not be regulated the same way as nuclear fission. Fusion facilities will be regulated by the Health and Safety Executive and Environment Agency. This approach makes the U.K. a leader in fusion regulation and sets it apart from jurisdictions such as the U.S. and Canada.

1. Enabling Accession to Convention on Supplementary Compensation for Nuclear Damage

The Bill will enable the U.K. to accede to the Convention on Supplemental Compensation. This is seen as an important step in facilitating the continued growth of the nuclear sector in the U.K.

1. Final Stages of Nuclear Decommissioning

The Bill will enable nuclear sites post decommissioning to be de-licensed from the nuclear licensing regime by the ONR earlier than at present.

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We will continue to monitor the Bill’s progress. For any questions in connection with this alert, please reach out to your usual contacts.

[1] https://www.bloomberg.com/news/articles/2022-09-07/britain-s-new-energy-minister-wants-to-drill-every-last-drop#xj4y7vzkg

[2] https://www.bbc.co.uk/news/science-environment-62832029

[3] https://www.theguardian.com/politics/2022/sep/08/liz-truss-to-freeze-energy-bills-price-at-2500-a-year-funded-by-borrowing