Hydrogen - the Breaking of the Bond: Trends, Risks and Disputes

March.02.2022

Summary

The increased focus on Hydrogen production and exploitation offers investors great opportunities. But like many emerging technical solutions, it can also bear risks. Orrick Energy Disputes Team (along with our projects colleagues) have been tracking trends in Hydrogen and the litigation risks they present to companies. One of the key Hydrogen-related trends we have seen centres on joint venture disputes and the need for an effective dispute resolution exit strategy to be in place. Often joint ventures involve international companies and projects located in unfamiliar jurisdictions. At the outset, companies need to consider wisely the choice of law for their contracts – will it be local law (which in some jurisdictions can be unpredictable) or the more predictable and safer choice of English or New York law? Companies will also need to consider whether, in the event of a dispute, they wish to litigate in unfamiliar and potentially hostile local courts, pursue either litigation elsewhere, or arbitrate. 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 such arbitration). This involves consideration both at the outset of entry into a joint venture, as well as the management of such disputes should they arise. Although companies may not wish to start off a new project thinking about how it might go wrong, these are important topics to discuss and Orrick’s experience working on both arbitrations and litigations across the global energy sector means that we can assist clients upfront to manage risks and reduce/avoid potential pitfalls throughout a project’s lifetime.

Before we dive into the trends we are seeing, it is important to remember why Hydrogen is such a hot topic at the moment in the renewables industry.

Hydrogen at a glance

Hydrogen is very much at the core 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. It is expected that this will reach 40 GW by 2030. Worldwide there is a similar optimism that the Hydrogen market will boom, with capacity reaching almost 100,000 metric tonnes by 2027. The July 2021 amendment to the Renewable Energy Directive supports these aspirations and directs that by 2030, 2.6% of renewable fuels of non-biological origin (“RFNBOs”) consumed in transport should be Hydrogen-based. The amendments even indicated aims for 50% of Hydrogen-based fuels to be used in industry as feedstock and in final energy consumption.

Self-evidently, the aims for increased consumption of Hydrogen require an increase in capacity within Hydrogen production, which in turn has necessitated an increase in the number of projects. In July 2021, the Hydrogen Council stated that there were 359 large-scale projects announced globally (which was a growth of 131 in the first half of 2021). By the end of 2021, it was reported that there were over 225 active Hydrogen projects worldwide.

Hydrogen has various uses including in oil refining (which accounted for almost 40 metric tonnes of global Hydrogen consumption in 2020) and chemical production (primarily ammonia, methanol and steel production which accounted for almost 46 metric tonnes of global Hydrogen consumption in 2020). Hydrogen is also used to produce fertiliser and as part of food processing. In addition to the uses which are all part of daily life, in the future it is anticipated that, amongst other things, Hydrogen will be used as a fuel for transport and electricity generation.

The make-up of the Hydrogen market

The ever-increasing demand for energy and the world’s shift towards using renewable energy sources have introduced many new players into the Hydrogen market, as well as requiring established energy companies to adapt. Such adaptation by oil majors and supermajors has often been in the shape of collaborations – through entry into formal joint ventures, Memoranda of Understanding, and other forms of collaboration.

The interest of oil and gas companies in the Hydrogen market may initially seem counter-intuitive, but there is a reason for this. Firstly, Hydrogen projects form part of the pledge of companies to reduce Carbon emissions, and as Hydrogen is likely to form a large portion of the energy industry going forwards it makes commercial sense to ‘get in at the ground floor’. Secondly, there are also efficiencies from which oil and gas companies can benefit, such as Hydrogen being required to convert heavy petroleum fractions, and efficiencies in terms of transportation of Hydrogen through existing pipeline networks.

The interest in Hydrogen production has not been solely the preserve of new entrants and oil majors looking towards greener projects. The household names in the renewable energy sector have also lined up Hydrogen projects as part of their wider renewable portfolios.

Where do we think the sector is going and what disputes could arise?

As a starting point, it is apparent 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 further declarations of intention to construct Hydrogen projects are made and fulfilled. The increase in Hydrogen production capacity will also result in greater volumes being traded and transported.

Regulatory Issues

In the UK at present there is no well-defined legal framework specifically aimed at Hydrogen projects. It is very likely that a domestic legislative framework will be developed for Hydrogen projects in the UK in the near future – in particular setting out a regime for acceptable practice of Carbon Capture and Storage, as well as legislating on aspects of safety and regulation within the Hydrogen network. It is also plausible that countries will implement incentive regimes to encourage projects for Hydrogen production. Furthermore, we will likely see a move towards setting industry standards on classifications of Hydrogen. This may even lead to a movement away from defining Hydrogen by colour (an industry shorthand for various types of Hydrogen being produced).

Changes to the legislative and regulatory framework will expose companies to various risks. The present approach to categorise Hydrogen by colour risks a party being mis-sold Hydrogen on the basis that the Hydrogen it purchases is actually a different colour (for example, a company purchases what it believes to be Green Hydrogen but is in fact sold and receives Grey Hydrogen). Such issues may well lead to companies facing exposure in terms of receiving a less environmentally friendly cargo and give rise to various contractual and potential misrepresentation claims, including further claims up the chain.

Furthermore, with developments to the legislative and regulatory landscape, our experience suggests that this will lead to instances where a contract may no longer conform with the relevant legislative and regulatory framework. This can put a company at risk of non-compliance with laws and regulations and requires legal advice on change of law provisions to mitigate such issues.

Additionally, whilst the introduction of any incentive schemes for Hydrogen production will present great opportunities, it will also bring potential risks to project owners in terms of meeting thresholds to benefit from such incentives. As we have seen with previous incentive schemes, compliance with such thresholds is ripe for legal challenge (and changes to the regulations) and benefitting from incentives can heavily influence the viability of a project. Similarly, as the solar sector has demonstrated across multiple countries, the grant of incentives, and then their withdrawal, can lead to dozens of multi-million disputes under investment stability agreements/treaties.

Corporate issues

Such is the promise of the Hydrogen market, we are seeing a lot of joint ventures and other forms of collaboration emerging. These collaborations represent opportunities to dilute exposure and share expertise. However, they also contain an inherent risk of the parties falling out and creating stalemates at board level, especially if one of the partners disagrees with the strategy and approach of its partner. A dispute resolution exit strategy (as discussed at the start of the article) is key to navigating such thorny issues.

Construction

During the construction and commissioning phases of a project, clients potentially face the risk of what could be termed ‘traditional construction’ issues, such as issues in terms of delays in the construction of a project and allocation of risk under contracts (such as EPCs). Such projects may also involve defects (a basic example being if the storage facilities constructed at a project have a crack in them). Additionally, it is likely that breach of contract issues could arise (for example if the steam methane reforming technology purchased is found not to be fit for purpose). Similar construction issues may also arise on complimentary projects, for example pipelines constructed to transport Hydrogen, or berths constructed to facilitate vessels transporting Hydrogen.

Transport

As Hydrogen becomes more mainstream, larger volumes will be transported and traded. As posited above, this will lead to the construction of complimentary projects including those to transport the Hydrogen produced. In some cases, it is possible for oil and gas pipelines to be repurposed to allow for Hydrogen to be transported. In other cases, it will be necessary to install new pipelines. The installation or re-purposing of pipelines to transport Hydrogen will trigger many of the construction risks set out above. It is also possible that joint venture partners could disagree as to the appropriate approaches to take to pipelines – especially if it involves one partner re-purposing their existing network for the benefit of the joint venture.

In many cases pipelines will not be feasible. Africa, Australia, the Middle East and Chile are amongst the geographic areas with the largest potential for Hydrogen production (given the significant levels of renewable energy sources and land availability to facilitate such production). Yet they are significant distances from a number of the key importing markets (such as Europe, Japan and South Korea). Therefore, it will be necessary for many Hydrogen cargoes to be shipped. Logically, the larger the number of Hydrogen cargoes shipped, the greater the number of disputes which will arise – for example, collisions, contractual breaches and insurance to name but a few.

How can we help?

Our arbitration team has significant experience in dealing with high-value, multi-jurisdictional and large-scale disputes across the globe in a variety of industries. Amongst other things, our team has significant experience, both in the English courts and before arbitral tribunals around the globe, in the conduct of large-scale and international energy disputes including joint venture disputes, construction issues, questions on the quality and specification of products, and issues with regard to energy tariffs and incentives.

The dynamic team at Orrick can draw on its expertise on both the transactional side and the contentious side to work with our clients as they adapt to changes in their business and manage the risks and potential disputes that arise along the way. Any project should be established with the benefit of advice from the start to reduce risks and ensure that if the project does go south, there is an exit strategy in place to minimise damage.

If you have any questions about disputes and potential issues in the Hydrogen sphere or wish to discuss a matter further with us, please contact Mark BeeleySarah Stockley or Ben Stafford.