Hydrogen – breaking the link: trends, risks and disputes | Orrick, Herrington & Sutcliffe LLP

Summary

The increased focus on hydrogen production and exploitation offers investors great opportunities. But like many emerging technical solutions, it can also carry risks. The Orrick Energy Disputes team (along with our project colleagues) has been tracking hydrogen trends and the litigation risks they present for businesses. One of the key hydrogen-related trends we’ve seen relates to joint venture disputes and the need to have an effective exit strategy in place for dispute resolution. Often joint ventures involve international companies and projects located in unfamiliar jurisdictions. From the outset, companies need to think carefully about the choice of law applicable to their contracts: will it be local law (which in some jurisdictions can be unpredictable) or the more predictable and secure choice of English or New York law? Companies will also need to consider whether, in the event of a dispute, they want to sue in unfamiliar and potentially hostile local courts, sue elsewhere, or resort to arbitration. For arbitrations, this will also involve practical considerations, such as the seat of the arbitration – where the parties wish the arbitration to be located (and the procedural rules governing that arbitration). This involves consideration both at the outset of entering into a joint venture, as well as managing such conflicts should they arise. While companies may not want to start a new project thinking about how it could go wrong, these are important topics to discuss and Orrick’s experience in arbitrations and litigation in the industry Energy Global means we can help clients from the start to manage risk and reduce/avoid potential pitfalls throughout the life of a project.

Before we dive into the trends we’re seeing, it’s important to remember why hydrogen is such a hot topic right now in the renewable energy industry.

Hydrogen at a glance

Hydrogen is at the heart of the push towards “Net Zero”. In the shorter term, by 2024, the EU aims to have up to 6 GW of installed renewable Hydrogen production capacity. This is expected to reach 40 GW by 2030. Around the world, there is similar optimism about the boom in the hydrogen market, with capacity reaching nearly 100,000 metric tons of hydrogen. here 2027. July 2021 amendment to the Renewable Energy Directive supports these aspirations and directs that by 2030, 2.6% renewable fuels of non-biological origin (“RFNBO”) consumed in transport should be hydrogen-based. The amendments even indicated targets for 50% of hydrogen-based fuels to be used in industry as a raw material and in final energy consumption.

Clearly, targets for increasing hydrogen consumption necessitate an increase in hydrogen production capacity, which in turn necessitated an increase in the number of projects. In July 2021, the Hydrogen Council said there were 359 large-scale projects announced globally (a growth of 131 in the first half of 2021). At the end of 2021, it was reported that there were over 225 active hydrogen projects worldwide.

Hydrogen has a variety of uses, including in petroleum refining (which accounted for nearly 40 metric tons of global hydrogen consumption in 2020) and chemical production (primarily the production of ammonia, methanol and steel which accounted for nearly 46 metric tons of global hydrogen consumption in 2020). Hydrogen is also used to produce fertilizers and in food processing. In addition to the uses that are all part of everyday life, it is expected that in the future, among other things, hydrogen will be used as a fuel for transport and electricity generation.

The composition of the hydrogen market

The ever-increasing demand for energy and the global shift towards the use of renewable energy sources have introduced many new players to the hydrogen market, while forcing established energy companies to adapt. Such adaptation by oil majors and supermajors has often taken the form of collaborations – through entering into formal joint ventures, memorandums of understanding and other forms of collaboration.

The interest of oil and gas companies in the hydrogen market may seem counterintuitive at first glance, but there is a reason for it. First, hydrogen projects are part of companies’ commitment to reducing carbon emissions, and as hydrogen is likely to form a large part of the energy industry in the future, it is commercially logical to “put yourself on the ground floor”. Second, there are also efficiencies that oil and gas companies can benefit from, such as the hydrogen needed to convert heavy oil fractions, and efficiencies in terms of transporting hydrogen through existing pipelines.

Interest in hydrogen production has not only been the prerogative of new entrants and oil majors looking for greener projects. Big names in the renewable energy sector have also lined up hydrogen projects as part of their broader renewable energy portfolios.

Where do we see the industry going and what conflicts might arise?

As a starting point, it is obvious that there will be an increase in the number of active Hydrogen projects involving different types of Hydrogen. This trend is likely to increase in the future as new declarations of intent to build hydrogen projects are made and realized. The increase in hydrogen production capacity will also result in an increase in the volumes exchanged and transported.

Regulatory issues

In the UK, there is currently no well-defined legal framework specifically for hydrogen projects. It is very likely that a national legislative framework will be developed for hydrogen projects in the UK in the near future – in particular setting out a regime for acceptable carbon capture and storage practice, as well as legislating on safety and regulatory aspects within the Hydrogen Network. It is also plausible that countries will put in place incentive schemes to encourage hydrogen production projects. Additionally, we are likely to see a move towards establishing industry standards on hydrogen classifications. It may even lead to moving away from the definition of hydrogen by color (an industry shorthand for the different types of hydrogen produced).

Changes in the legislative and regulatory framework will expose companies to various risks. The current approach of categorizing hydrogen by color risks that some will mis-sell hydrogen on the basis that the hydrogen they buy is actually a different color (e.g. a company buys what she thinks is green hydrogen but is actually sold and receives gray hydrogen). Such issues could well expose companies to receiving less environmentally friendly cargo and give rise to various contractual and potential misrepresentation claims, including other claims up the chain.

Additionally, as the legislative and regulatory landscape evolves, our experience suggests that this will lead to instances where a contract may no longer comply with the relevant legislative and regulatory framework. This can expose a business to the risk of non-compliance with laws and regulations and requires legal advice on changing legislative provisions to mitigate these issues.

Furthermore, while the introduction of any hydrogen production incentive program will present great opportunities, it will also entail potential risks for project owners in terms of meeting the thresholds to benefit from these incentives. As we have seen with previous incentive programs, meeting these thresholds is ripe for legal challenge (and regulatory changes) and receiving incentives can strongly influence the viability of a business. project. Similarly, as the solar sector has demonstrated in several countries, granting incentives and then withdrawing them can lead to tens of millions of disputes under investment stability agreements/treaties.

Business issues

Such is the promise of the hydrogen market, we see a lot of joint ventures and other forms of collaboration emerging. These collaborations represent opportunities to dilute exposure and share expertise. However, they also carry an inherent risk of falling out and deadlock at board level, particularly if one partner disagrees with their partner’s strategy and approach. A dispute resolution exit strategy (as discussed at the beginning of the article) is key to navigating these thorny issues.

Construction

During the construction and commissioning phases of a project, clients potentially face the risk of what might be termed “traditional construction” issues, such as problems in terms of construction delays. of a project and the allocation of risks within the framework of contracts (such as EPCs) . Such projects can also involve defects (a basic example being if the storage facilities built on a project have a crack). In addition, it is likely that breach of contract issues could arise (for example, if the purchased steam methane reforming technology proves unsuitable for the purpose). Similar construction problems can also arise on complementary projects, for example pipelines built to transport hydrogen or berths built to facilitate the transport of ships.

Transport

As hydrogen becomes more common, larger volumes will be transported and traded. As indicated above, this will lead to the construction of complementary projects, including those for transporting the hydrogen produced. In some cases, oil and gas pipelines may be repurposed to transport hydrogen. In other cases, it will be necessary to install new pipes. Installing or repurposing pipelines to transport hydrogen will introduce many of the construction risks described above. It is also possible that the joint venture partners will disagree on the appropriate approaches to pipelines – particularly if this involves a partner re-purposing its existing network to benefit the joint venture.

In many cases, pipelines will not be feasible. Africa, Australia, the Middle East and Chile are among the geographies with the greatest potential for hydrogen production (given the significant levels of renewable energy sources and the availability of land to facilitate this production). Yet they are significant distances from a number of key import markets (such as Europe, Japan and South Korea). Therefore, it will be necessary for many hydrogen cargoes to be shipped. Logically, the greater the number of hydrogen cargoes shipped, the greater the number of disputes that will arise – for example, collisions, breach of contract and insurance to name but a few.