Hydrogen – Disputes on the Horizon?

Introduction

The race is on for net zero. With countries seeking to achieve varying degrees of decarbonisation of their energy industries by 2030 and 2050, many are looking to hydrogen (and in particular low-carbon hydrogen) to play a significant role in the energy mix of the future. Hydrogen is the most abundant chemical element in the universe, and in certain applications produces only water at its point of use.

Despite being a colourless fuel, hydrogen is often described in terms of colours, depending on how it is produced. Black, brown and grey hydrogen is produced from coal or natural gas (with grey hydrogen currently being the most common type of hydrogen produced)¹. Blue hydrogen is also produced from natural gas, but this production is combined with carbon capture and storage technologies to produce a more "carbon neutral" form of hydrogen. Green hydrogen, on the other hand, uses renewable energy (such as solar or wind) to split water molecules through electrolysis. Because of this use of power as an input, green hydrogen forms part of the "power-to-x" world of technologies and applications which are attracting significant investment. Green and blue hydrogen together are generally referred to as "low-carbon hydrogen".

A related area showing promise is the area of green (and blue) ammonia. Produced using low-carbon hydrogen, low-carbon ammonia is proposed as a tool for decarbonising industry (such as the fertiliser industry), and can be used as a combustion fuel for shipping vessels. Hydrogen can also be transported over long distances in the form of ammonia, which can then be converted back into hydrogen prior to use.²

Despite commercial demand for hydrogen having fallen below expectations to date, governments are implementing efforts to stimulate growth in low-carbon hydrogen, and ambitious targets (such as the EU's REPowerEU Strategy, under which the EU is targeting 10% of its energy needs to be met by green hydrogen by 2050 )³ continue to be set. The number of announced low-carbon hydrogen projects that have reached a final investment decision has also doubled in the past year, evenly split between blue and green projects.⁴  However, overall production of low-carbon hydrogen remains low, coming in at less than 1Mt in 2023.⁵

The increasing scale of the hydrogen industry, together with more advanced progress on the current early-stage projects (being the first of their kind), may give rise to disputes. This has been seen in the past in the energy industry, as the transition to new technologies such as those used in renewable energy produced (and continues to produce) its share of litigation and arbitration.⁶ Given the limited level of low-carbon hydrogen production so far, and the early stage of the majority of the projects in the pipeline, what can be learned from disputes in other sectors to anticipate potential hydrogen disputes?

We draw on experience of disputes elsewhere in the energy industry to highlight seven areas:

1. Shareholder disputes

A large number of low-carbon hydrogen projects are currently being undertaken by way of joint venture.

As with any joint venture (and even more so when the technology is new and developing, and is being shaped to meet a still-evolving regulatory framework), the partners may disagree as to the proper management of the joint venture, the amount of investment to be made in the joint venture, and how to manage delays arising from the refinement of the design of the facilities. In particular, where the joint venture comprises a financial investor pairing with an operating or industrial investor, the mismatch of interests (with the financial investor keen to turn a profit, and the technical investor keen to develop the technology, retain IP rights and build expertise) may provide scope for disputes to arise. This may particularly be the case where, despite the stated aim of various government policies and targets, the long-term prospects for commercial hydrogen production at scale remain unclear, and where technological innovation may challenge the early movers in the hydrogen sphere.

The mitigant against this is a carefully drafted shareholder agreement, with provisions addressing areas ripe for dispute such as expenditure and deadlocks and mechanisms for resolving such disputes.

2. Certification disputes

As at the time of writing, a number of jurisdictions (including the UK, the US and the EU) are developing certification programmes for low-carbon hydrogen. In the absence of consensus between states resulting in an overarching unified scheme, the different (but overlapping) standards regimes could lead to disputes as to how low-carbon hydrogen is marketed and sold across borders. Producers and off-takers may also find themselves in dispute as to how obligations under these schemes apply, and who owns the rights to benefit from incentives put forward by governments, such as renewable energy certificate schemes.

To take one example, the EU⁷  currently requires both additionality and temporal requirements to be met in order to classify hydrogen as a "renewable fuel of non-biological origin".⁸  The additionality requirement means that the renewable energy used to produce green hydrogen must come from newly constructed facilities (so as to avoid green hydrogen production diverting electricity from existing renewable energy resources). The temporal requirement requires the hydrogen fuel to be produced in the same calendar month as the renewable energy produced to power the hydrogen production facility, and from 1 January 2030, this requirement is set to change to require the renewable energy to be produced within the same one-hour period as the hydrogen fuel.⁹  Power purchase agreements, hydrogen supply contracts and offtake agreements may all contain warranties and representations regarding compliance with such standards, with failures to comply potentially resulting in claims under these contracts.

Relatedly, disparities between certification systems may lead to greenwashing claims by purchasers or consumers, where hydrogen produced in one jurisdiction is marketed abroad as being low-carbon, but fails to meet the certification standard for one or more applicable jurisdiction. A well thought out offtake strategy which takes into consideration any jurisdictional differences in the approach to certification can mitigate this risk. Greenwashing claims may also arise where production shortages of low-carbon hydrogen lead to otherwise green facilities using hydrogen as a fuel being forced to rely on grey or other non-low-carbon options.

3. Pricing disputes

With the market for hydrogen still at very early stages and likely to contain an element of volatility, hydrogen supply contracts may include price review clauses, depending on how price risk is borne. Disputes similar to those seen in the gas pricing sphere may therefore follow, and where these supply contracts contain take-or-pay clauses, these may similarly lead to familiar territory. A clearly drafted price review mechanism would assist in mitigating the risk of pricing disputes.

A key consideration here will be the governing law of the relevant contract, with some legal systems (such as those of civil law jurisdictions) potentially providing greater latitude to parties to "adjust" the price paid under the contract.

4. Construction disputes

For the current pipeline of hydrogen projects to be fully realised, there will need to be an "unprecedented compound annual growth rate of over 90% from 2024 until 2030", which the IEA notes is "well above the growth experienced by solar PV during its fastest expansion phases".¹⁰  Further, to meet the demand for low-carbon hydrogen and to fulfil the additionality requirements of jurisdictions such as the EU and the UK¹¹ , additional renewable energy power sources will need to be built to feed the hydrogen production facilities. The global deadlines to reduce reliance on carbon-powered energy sources by 2030 and/or 2050 further heighten the impetus to get projects built and up and running quickly, as do the risk of withdrawal or changing of government subsidies and incentive schemes.

As investors in construction projects will be very much aware, with tight deadlines and new technology comes disputes, whether it be over delays to construction programmes, cost blowouts as designs are refined, or claims in relation to alleged defects (either in the technology or in the works themselves). There may be warranty claims regarding generic terms such as "good industry practice", which are also likely to be hotly contested. Claims regarding shortfalls in performance caused by defects or the renewable power source not producing as well as expected (due to factors such as less solar irradiation for solar PV plants or less wind for wind turbines) are also likely to arise, particularly where the underlying contracts are not clear as to the allocation of risk and responsibility.

5. Interface disputes

With low-carbon hydrogen facilities requiring bespoke renewable power generation under the additionality requirements in jurisdictions such as the EU, the interface between the separate elements of the project (in respect of development, construction and operation) is likely to be an area where disputes arise. For instance, where different contractors are brought in to construct different elements of the plant, delays caused in one aspect of the project may lead to delays in other aspects, which may be challenging to untangle among the various contractors.

As with other power generation facilities, the time after takeover is likely to also be fertile ground for disputes. This may be particularly acute where construction and operation and maintenance (O&M) services are procured from different parties. We anticipate disputes involving the O&M contractor seeking to blame construction defects or defects in the technology for poor performance, whereas the construction contractors equally seek to shift the blame to the O&M contractor for poor maintenance of the plant. Well drafted interface agreements between the Owners, EPC contractors and O&M contractor may help to mitigate the risks of such disputes arising.

6. Import/trade disputes

Given the current prevalence of grey hydrogen in the market, the EU have included hydrogen in its carbon border adjustment mechanism (CBAM).¹²  The aim is to ensure that hydrogen produced from carbon-intensive sources outside the bloc is subject to a charge on import into the EU to avoid undermining low-carbon hydrogen. The practical effect is that importers will be required to purchase and surrender CBAM certificates (representing the embedded emissions less a reduction corresponding to the carbon price paid in the country of origin (if any)) at the current EU emissions trading system market price. The UK is slated to introduce its own CBAM by 2027, and hydrogen is also to be included.¹³

As with the above certification disputes, improper reporting of the carbon emissions embedded in hydrogen or management of CBAM certificates at the relevant stages of the supply chain as hydrogen is imported into the EU or the UK (or any other jurisdiction that implements a similar system) may lead to disputes as to liability up and down the supply chain.

7. Environmental, Social and Governance (ESG) and investment disputes

One of the key ingredients in the production of green hydrogen is water. It is used not only as a feedstock (with green hydrogen generally being produced using electrolysis, where water molecules are split into their constituent hydrogen and oxygen atoms¹⁴), but also as a cooling medium.¹⁵  As hydrogen production ramps up, this means that water will be in ever increasing demand to fuel this growth.

However, water is growing ever scarcer. The Environment Agency estimates that, by 2050, England alone will require an additional supply of almost 5 billion litres of water each day to support the population, food production and protect the environment.¹⁶  Many countries already suffer dire water shortages, struggling to meet current demands, let alone the demands of an expanded hydrogen industry.

Hydrogen projects may therefore find themselves caught up in environmental claims (such as judicial review proceedings, as has been seen with a number of energy projects in recent years) brought by citizens concerned about the use of natural resources in the production of hydrogen.

Relatedly, international investors may find scope for investment arbitration claims, be it on the basis of the shifting regulatory framework or (for example) in relation to expectations (such as in relation to the supply of water or affordable green power¹⁷) not being met. Investors in the hydrogen space will have a keen eye on applicable bilateral and multilateral investment treaties as these projects go forward.

Conclusion

The commercial hydrogen market remains in its infancy. But by reflecting on the causes, and resolution, of disputes in analogous sectors, participants in the hydrogen industry may anticipate some of the challenges they may face in the future. There is much that can be done to mitigate the risk of the issues identified in this article as projects are developed, and contracts negotiated and concluded.