Hydrogen: who pays? A practical alternative to the hydrogen levy

The UK needs a secure supply of low carbon hydrogen.

Hydrogen will improve energy security by storing intermittent renewable energy and reducing the need for imported gas. It can make British industry more competitive by removing pollution costs through decarbonisation and helping them to access markets which are now placing a premium on greenness. And it can create jobs in deindustrialised parts of the country that have nascent hydrogen clusters, like Teesside and Humberside.

The Government understands the value of hydrogen, and has set a target of 10 gigawatts (GW) of low carbon hydrogen production by 2030.

How much will the 10GW of hydrogen cost?

• We calculate supporting 10GW of low carbon hydrogen production could cost £53 billion over 20 years.
• This would mean financial support for the hydrogen industry will rise to £3.5 billion per year from 2030.
• A levy to pay for this would raise energy bills by around £118 per year for the average dual fuel household.

Funding investment in hydrogen through a new ‘hydrogen levy’ would be bad for business, raise household energy bills, and risk long-term investment by undermining support for net zero.

The Treasury is attempting to avoid the direct costs of supporting a hydrogen industry. This is understandable in a tight fiscal environment. But a levy would be regressive and unfair, especially when households will probably not use the hydrogen to heat their homes.

Onward polling found that 43% of the general public would not be willing to pay a hydrogen levy on their energy bills. A quarter of people would pay up to £10, whereafter support falls sharply.

Asking Members of Parliament to vote for bill rises during the current cost of living crisis risks political support for hydrogen, and the broader net zero agenda. It is also counterproductive to the Government’s ambition to have the lowest energy prices in Europe by 2035 and its efforts to tackle fuel poverty.

There is an alternative to the hydrogen levy. 

By implementing a carbon border adjustment mechanism, the Government can phase out free allowances for carbon pricing under the UK Emissions Trading System from 2026. The revenue raised from phasing out free allowances means the hydrogen levy can be avoided.

In most of the Government’s carbon price scenarios, revenues raised from phasing out free allowances can pay for the 10GW of hydrogen. Even in the worst case, the amount needed is significantly lower, easing the burden on the Treasury or on bill payers.

We have also created three scenarios based on the speed of the phaseout. The first is a slow phaseout of free allowances over the four year period, with full carbon pricing by 2030. The second is a slightly faster phaseout by 2028 and the third is faster still, by 2027. The faster the phaseout of free allowances, the more revenue raised.

Revenue raised from phasing out free allowances by 2030

Revenue raised from phasing out free allowances by 2028

Revenue raised from phasing out free allowances by 2027

Using UK ETS funds was by far the most popular method of funding from our polling (44% support), decisively beating a new levy (12% support).

To reduce the financial cost of supporting the hydrogen industry as much as possible, the Government needs to ensure the investment environment is conducive to lowering strike prices. This means creating a better investment environment for hydrogen through more generous capital allowances and permitting blending to the lower operating costs of hydrogen projects.

Recommendations:

1. Use revenue that would be raised from 2026 by phasing out free allowances in the UK Emissions Trading System (UK ETS) to pay for producing 10GW of hydrogen.
2. More generous capital allowances for the infrastructure that is needed to reach our energy security and net zero targets, like wind and solar farms, electrolysers, and power transmission lines. 
3. Permitting the blending of hydrogen into the gas network to support the development of the market while ensuring selling hydrogen to the grid really is a last resort for producers.

This research note is produced as part of our Getting to Zero research programme.

Getting to Zero