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Is the UK’s hydrogen infrastructure prepared for a CfD-powered future?

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Image by Gerd Altmann from Pixabay

At a glance 

Can UK green hydrogen contract for difference (CfD) match the cost-saving success of renewable electricity? By Rahmatallah Poudineh. Oxford Institute for Energy Studies (OIES), Oct. 15, 2024.

This paper looks at how the United Kingdom is using Contracts for Difference (CfDs), which it has successfully used to support renewable electricity, to boost investment in green hydrogen. It highlights key differences in market characteristics, especially the high operational costs of producing green hydrogen. This is primarily driven by electricity prices and the use of Proton Exchange Membrane (PEM) electrolyzer technology. The paper highlights the outcomes of the U.K.’s first Hydrogen Allocation Round (HAR1), which showed initial market traction but also cost-related barriers. It underscores the need for improved infrastructure and policy adjustments to scale up the production of green hydrogen effectively. It also examines the impact of the second allocation round (HAR2), aimed at adding 875 megawatts (MW) of hydrogen capacity through the Hydrogen Production Business Model (HPBM), on advancing the U.K.’s energy transition goals.

Key findings 

  • Operational vs. capital costs: Green hydrogen production relies heavily on operational expenditures due to electricity price fluctuations, unlike renewable electricity CfDs, which are capital-cost driven.
  • Hydrogen Allocation Rounds: HAR1 granted 11 contracts totaling 125 MW at a £241/MWh strike price, indicating initial interest but highlighting high operational costs.
  • Electricity market volatility: Volatile electricity input prices, driven by dependency on PEM electrolysis, create cost predictability issues for green hydrogen CfDs, complicating long-term investment decisions.
  • Infrastructure requirements: Scaling green hydrogen production is constrained by limited infrastructure, including transportation and storage systems, which may not receive adequate funding through current CfD structures.
  • HAR2 expectations: HAR2 plans to support an additional 875 MW via revenue support under the HPBM, reflecting a policy shift towards supporting operational costs directly rather than solely capital expenditures.

Bigger picture

Contracts for Difference (CfDs) are financial mechanisms designed to reduce investment risks by stabilizing revenue. CfDs play a key role in the U.K.’s renewable energy strategy, initially proving successful with offshore wind. Through CfDs, generators receive a guaranteed “strike price” for electricity. When market prices fall below this, the government compensates the difference. When prices exceed it, producers repay the surplus. This model, which has driven substantial cost reductions in renewable electricity, is now being adapted for green hydrogen through the Hydrogen Allocation Rounds (HARs).

The U.K.’s hydrogen CfD model attempts to leverage the proven benefits of renewable electricity CfDs but must contend with specific challenges unique to hydrogen. The operational costs of hydrogen, particularly through PEM electrolysis, present a complex cost structure that is highly sensitive to electricity market volatility, unlike the more predictable renewable electricity landscape. This paper’s analysis reveals that green hydrogen CfDs cannot directly replicate the success seen in the renewable electricity sector without policy adjustments and complementary strategies. The paper also emphasizes that the limited infrastructure — especially pipelines and storage — poses a barrier to the U.K.’s hydrogen expansion and will likely require targeted investment beyond CfD mechanisms to achieve decarbonization goals.

Globally, interest in hydrogen is growing. The European Union, Japan, and other economies are now examining CfD-like models for green hydrogen, but the paper suggests that fixed-price contracts alone may not be enough to address the volatile cost environment of hydrogen production. The U.K.’s experience with HARs provides a valuable framework that could guide similar international efforts, underscoring the need for multifaceted support structures, including government incentives, tailored contracts, and possibly dynamic pricing models that can absorb market shocks and input variability more effectively.

Challenges and opportunities

Key barriers to progress in green hydrogen deployment include:

  • High electricity cost dependency: Hydrogen production is electricity-intensive, with input costs significantly affecting price stability under CfD models.
  • Infrastructure scarcity: The limited availability of dedicated hydrogen pipelines and storage facilities restricts the scalability of green hydrogen initiatives.
  • Market immaturity and demand risks: Without a robust demand base, green hydrogen CfDs face the risk of overproduction and stranded assets.

To address these challenges, the paper suggests:

  • Infrastructure support: Developing hydrogen-specific pipelines and storage facilities can reduce distribution costs, enhance scalability, and support long-term growth.
  • Policy innovation: Introducing dynamic pricing mechanisms or hybrid CfD structures can help align hydrogen’s operational cost profile with market realities.
  • International policy alignment: Collaboration and shared policy frameworks could harmonize hydrogen market growth and attract broader investment globally.

In their own words

The current high cost of green hydrogen production, primarily due to the cost of renewable electricity and electrolyser technology, creates uncertainty about whether these costs can be reduced sufficiently
to make hydrogen competitive with other energy carriers.

Can the UK Green Hydrogen Contract for Difference (CfD) Match the Cost-Saving Success of Renewable Electricity? By Rahmatallah Poudineh. Oxford Institute for Energy Studies. October 2024.

Final thoughts

This paper outlines the nuanced complexities of implementing CfDs in green hydrogen, primarily due to the sector’s high operational costs and its susceptibility to electricity price volatility. The initial outcomes of HAR1 illustrate both the demand for green hydrogen contracts and the significant cost challenges that remain. As HAR2 moves forward, this paper suggests that the CfD framework will need adjustments to effectively incentivize infrastructure investment and mitigate the risks associated with hydrogen’s evolving market dynamics. The paper also implies that supplementary policies, such as government subsidies and infrastructure support, may be essential to drive the industry toward cost-competitiveness with fossil fuels.

These findings raise critical questions about the broader global applicability of the U.K.’s approach. As more economies consider adopting similar CfD structures, understanding how these models can integrate mechanisms to stabilize cost predictability and absorb demand fluctuations will be crucial. Moving forward, research should delve into optimizing hydrogen CfDs to address infrastructure gaps, input cost variability, and the development of resilient, scalable hydrogen markets that align with global net-zero objectives.


Download the paper originally published by the Oxford Institute for Energy Studies in October 2024.

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