In Short : “Contracts for Difference” (CfDs) could be a key tool in scaling up green hydrogen production. CfDs provide price stability by covering the gap between the market price and the agreed strike price for green hydrogen. This mechanism encourages investment by reducing financial risk, making it more feasible to develop large-scale green hydrogen projects and accelerate the transition to clean energy.
In Detail : Under a CfD, the government and the hydrogen producer enter into an agreement. The agreement typically includes terms such as a guaranteed price for the green hydrogen produced
The government is implementing the National Green Hydrogen Mission, with an initial outlay of ₹19,744 crore. The overarching objective of the Mission is to make India the Global Hub for production, usage and export of green hydrogen and its derivatives.
The large-scale use of hydrogen faces several challenges and barriers, both technical and economic. One of the significant challenges is the cost of producing hydrogen. Currently, the vast majority of hydrogen is produced from fossil fuels such as natural gas and coal to make what is known as “grey” hydrogen. The cost of producing green hydrogen is much higher than grey hydrogen. Reducing the cost of hydrogen production is crucial for its widespread adoption.
In addition to that, establishing a comprehensive infrastructure for hydrogen production, storage, transportation and distribution is a considerable barrier. Hydrogen has a low energy density by volume, which poses challenges for storage and transportation.
Large-scale hydrogen use is important to follow low emission pathways for hard-to-abate sectors of the economy. Some countries, like Great Britain, Japan, Germany, Australia, Canada, etc. for example, are embarking on major policy initiatives to try to kick start a large-scale hydrogen value chain. Much of the current debate surrounds the potential use of Contracts-for Difference (CfDs) to support the development of a hydrogen value chain. France has decided to launch €4 billion contracts-for difference programme to support clean hydrogen production.
Guaranteed price
Under a CfD, the government and the hydrogen producer enter into an agreement. The agreement typically includes terms such as a guaranteed price for the green hydrogen produced. This price is often higher than the market price for conventionally produced hydrogen. The guaranteed price provided by the CfD increases the amount of affordable debt the project can take while ensuring regular revenue streams in times of market price slowdown.
The application for CfDs has been in the policy pipeline for quite some time and it has seen its association with other renewable energy projects in Europe, For eg. Carbon Contracts for Difference (CCfD) was announced in Germany to incentivise energy intensive industries for reducing CO2 emissions with payments linked to Emission Trading System (ETS) carbon prices. CCfD rewards industries, which invests in abatement technologies, while simultaneously reducing upfront subsidy burden on the government.
Under the Green Hydrogen Mission, the government has rolled out production-based subsidy over three years from the beginning of production and supply (₹50/Kg, ₹40/kg, and ₹30/kg, respectively during first, second, and third year) along with mix of support for derivative products, electrolyser subsidy as well as waiver on inter-State transmission fee as part of Strategic Interventions for Green Hydrogen Transition (SIGHT) programme. While present support is a step in right direction, the extent of its stride to plug the present shortfall between cost of grey and green hydrogen is the big question.
The incentive payout for successful bidders will be calculated by incentive quoted for that year in Rs/kg times the allocated capacity or actual production (whichever is lower). However, the production-based subsidy guidelines include a clause on payment where allocated capacity (for payout) will remain constant over a period of three years. This may create two hurdles, first this sets a cap on maximum incentive which also eventually declines over three years in turn discouraging companies to achieve economies of scale, and secondly missing link to price of grey hydrogen.
Rising cost
Consider a case of supply shock, where due to rising cost of inputs like semiconductors, batteries or even electrolysers, the cost of producing green hydrogen increases. In the absence of subsidy support being linked to difference in prices of grey and green hydrogen, even a ₹50/kg subsidy may not be sufficient for producers. This may lead to diversion towards grey hydrogen resources. Additionally, the three-year limit on handholding poses concerns for ventures, potentially leading to asset-liability mismatches due to the need for long-term capital support versus the subsidy’s short duration.
Contracts for difference with some limitations can address these issues. The first advantage being the linkage to price of fossilized hydrogen, secondly its inherent design of long-term contracts. CfDs as a demand side intervention can channelise green hydrogen offtake as the present support to green hydrogen industry is mainly limited to supply side.
As already disclaimed, application of CfDs have their own challenges, particularly in terms of bringing parties to mutually acceptable current price for future goods. Delivering on the agreed upon standards for long term is another uncertainty. Effectiveness and scalability of CfD could come up only with proper design and implementation. For this to realise, industry wide extensive consultations may be required, along with adopting standards that are harmonised and accessible to manufacturers. Studies have pointed to cost saving benefits for government in CfD compared to price floors or other direct subsidies. But the larger benefit over and above the economic angle is the inherent commitment of realising actual production. This could kick start the adoption of green hydrogen-based clean energy at industry wide level.
