Paula Kidd, energy partner at CMS, looks at the Gas Shipper Obligation and hydrogen production funding.
The Energy Act 2023 laid the foundations for various measures to stimulate the UK hydrogen sector, including the Hydrogen Production Business Model (HPBM) revenue support regime for hydrogen producers.
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On 16 January 2025, the Department for Energy, Security and Net Zero (DESNZ) published a consultation on the design of the Gas Shipper Obligation (GSO), a levy on natural gas shippers, being one of the two potential sources of funding the HPBM (the other being general taxation). The consultation seeks input on the potential scope, impact, operation, and administration of the GSO. Here we consider the main characteristics of the GSO and some of the key aspects raised in the consultation.
Background
The HPBM is a revenue support regime similar to that offered to other generators in the UK, such as the Contracts for Difference (CfD) scheme for renewable electricity generators and the Dispatchable Power Agreement (DPA) scheme for carbon-capture-enabled power generators. It is designed to give supported hydrogen producers revenue certainty by “topping up” their revenues where the price at which they can sell hydrogen falls below a contractual “strike price,” particularly while their costs are greater than those of longer-established competitors. Each supported hydrogen producer will enter into a Low Carbon Hydrogen Agreement (LCHA) with a designated independent market administrator, currently envisaged to be the Low Carbon Contracts Company (LCCC), under which LCCC will be required to pay the relevant revenue top-up payments.
Key features
Who will bear the costs: The GSO will operate by way of a statutory obligation on natural gas shippers to pay their share of the amounts that LCCC will need to meet its payment obligations under LCHAs. However, unlike in the CfD and DPA contexts, the costs of the GSO will ultimately be borne by natural gas consumers rather than electricity consumers. DESNZ assumes that the gas shippers and gas suppliers will pass through all of these costs to their customers (though it is testing that assumption with stakeholders), such that GSO will ultimately increase gas bills for consumers.
To help gas shippers plan for their obligations under the regime when setting prices, DESNZ proposes to publish an annual Signal Forecast regarding the extent of the total costs to be recovered under the GSO.
What will be funded: The consultation confirms DESNZ’s intent for the LCHAs for at least the first Hydrogen Allocation Round (HAR1) to be funded via the GSO once it comes into effect, which is expected to be in 2027. Until then, LCHAs will be funded via general taxation.
Design of GSO: Alongside the central purpose of the GSO (to ensure that LCCC has enough money to make all payments that hydrogen producers are entitled to under their LCHAs) DESNZ has also stated that key features of the design of the GSO should be:
- simplicity;
- affordability for consumers;
- avoiding unintended consequences (e.g. impacting fuel poverty, or destabilising the market);
- scalability;
- alignment with industry precedent; and
- flexibility to accommodate future change.
Stakeholder input: there are a number of areas on which DESNZ is seeking input on the design of the GSO regime. These include (i) how the amount will be calculated (e.g. whether contingency headroom should be initially collected or recovered separately), (ii) how a shipper’s market share will be determined (e.g. whether any volumes should be exempted), and (iii) mitigation against the risk of under-recovery (e.g. whether shippers should provide a form of credit support).
Conclusion
This consultation, which is due to close on April 9 2025, is a critical step in ensuring the financial viability of the HPBM and supporting the growth of the UK hydrogen sector. By establishing a clear and sustainable funding mechanism, the GSO aims to provide the necessary revenue certainty for hydrogen producers, thereby fostering investment and innovation in this emerging industry.
For more visit the CMS McKenna website.
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