The Problem with the UK Hydrogen CFD

 

The principle of a Contract-for-Difference or CFD is to provide pricing stability (or at least visibility) on the hydrogen being produced and sold. The government is typically the counterparty on CFDs.

The producer of the electricity or hydrogen negotiates and agrees a "strike price" with the government under the CFD. When the producer sells hydrogen below this agreed strike price, the government will top it up to the strike price. Conversely when the producer sells hydrogen above the agreed strike price, it must pay the excess to the government. This way, the producer will always receive the strike price for the duration of the CFD.

However the problem with the UK's Hydrogen CFD will not always top up a producer to the strike price because it imposes a floor on how low the hydrogen sale price is, below which the government will no longer top the producer up to the strike price. The floor is set at the natural gas price on a GBP/MWh basis.

Hence if hydrogen is sold below the natural gas price, the CFD payment will only be the difference between the natural gas price and the strike price. The producer does not receive any top-up for the difference between the hydrogen sale price and the natural gas price.

One further issue is that the natural gas price is variable - this introduces another risk to the producer. Even if a producer has locked in the hydrogen sale price, and therefore the difference between the sale price and strike price is fixed, the subsidy under the CFD can be variable if the natural gas price moves. The highest risk occurs when natural gas prices are high and rises to a level above the hydrogen sale price. In this case the subsidy would begin to shrink and the combined producer's hydrogen sale price plus the subsidy would end up being below the strike price.

It should be noted that the regime has been designed to incentivise producers to sell the hydrogen above the natural gas price, by paying 10% of the difference to the producer. Industry feedback has been that a 10% share is not generous enough to sufficiently incentivise produers to seek higher pricing with hydrogen buyers. This also perversely does not help drive down hydrogen pricing which is necessary for more broader base adoption.