The US Department of Energy has promised to distribute $1 billion to help facilitate demand for the hydrogen fuel that hydrogen hubs will produce. Resources for the Future scholars detail various approaches for effective distribution of the funds.
In a previous blog post, we argued that the US Department of Energy (DOE) should rethink its plan to subsidize hydrogen end users (known as offtakers) with another $1 billion in funding. In this blog post, we take that subsidy as a given and offer thoughts on how best to design the subsidy. Both of these blog posts closely track the public comments that we submitted to DOE.
The proposed $1-billion program has three potential goals: provide revenue certainty to producers, enable private-sector financing, and catalyze a clean hydrogen market. These goals are fairly distinct, suggesting that multiple policy instruments might be needed. Revenue certainty requires contracts with offtakers that are tight enough to give producers a reasonable expectation of selling the hydrogen fuel that they produce. Enabling private-sector financing includes working with actors in that sector to convince them that a reasonable return on investment is likely to occur with a manageable and well-understood level of risk. Of course, tight long-term contracts can help with this risk. Catalyzing a clean hydrogen market involves reducing barriers to market creation and would involve multiple hydrogen hubs to get enough “action” to encourage market makers to move from bilateral transactions to price discovery and market activity. Tight long-term contracts could impede market formation, as these contracts would lock up hydrogen within a hub’s producer-offtaker relationships.
When choosing particular producers or offtakers to subsidize, a tension exists between funding the most viable projects (which risks wasting the money on projects that would have succeeded without support) and funding the projects that are most in trouble (which could risk too many failures and waste taxpayer money). Another option is to fund projects that show the most promise of reducing costs, where the additional funding could make the difference between success and failure.
Specific Comments on the Policy Instruments That Are Suggested in the Notice of Intent from the US Department of Energy
Contracts for Differences: This instrument has the advantage of providing price certainty to producers, offtakers, and capital markets, and therefore meets two of the program’s three goals. The difficult issues are setting the strike price (i.e., the price above which the subsidy will be provided) and the implicit lack of targeting to specific uses.
Fixed Price Support: Compared to contracts for differences, fixed price support does not permit a reduction in the subsidy as production costs come down over time and, as such, likely is a more inefficient form of support.
Market Makers: We assume that this instrument refers to an entity like Hintco in Europe that can provide long-term offtake contracts to hydrogen producers, reselling the hydrogen to offtakers on a shorter-term basis. This mechanism can ensure stability for hydrogen producers while giving flexibility to the offtakers who may not want to commit to a long-term contract at a high price. In addition, this mechanism can bundle multiple smaller offtakers that may not, by themselves, be sufficient to provide the offtake that’s needed by a large hub producer. However, by purchasing the hydrogen directly, the market maker takes on substantial risk that it can sell the contracted hydrogen at a price that’s not too much lower than the price it pays producers. If that price gap ends up being substantial, the $1 billion that capitalizes the entity could disappear very quickly. In addition, costs of standing up and monitoring such an entity could be high.
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Reverse Auctions: Under a reverse auction, the lowest bidders receive the funds. Logically, those bidding the lowest have the strongest projects and/or are best able to secure funding—so, these projects likely need the money the least. The outcome with reverse auctions would be inconsistent with the goal of promoting a broader clean hydrogen market and risks “wasting” funding on projects that would proceed in any event.
Proposal-Based Process: Aside from adding another layer to an already bureaucratic process, this instrument defers setting criteria for selection. However, given the advantages of funding not just the lowest bidder, as above, such a process may be unavoidable.
Eligibility-Based Process: This is a “spread-the-money-around” approach that defers discussion about what makes a project eligible or how much subsidy each eligible project should receive. Filling in the needed details about eligibility and other features is a substantial challenge. As DOE’s proposed funding level is relatively small compared to the potential size of a broad hydrogen market, spreading the money over diverse projects risks getting a very low bang for the buck and therefore works against other program goals.
Conclusions
If the intent of this funding is to help the hydrogen hubs, then we suggest that a more effective solution would be to help the hubs directly, by sending more direct funding their way. For example, the DOE could give each winning hub $1.2 billion instead of $1 billion. That money could be dedicated to providing the same sort of support as the mechanisms and instruments described above, but within the context of the contractual relationships between producers and offtakers in the hubs. Creating a separate Hintco-type entity, replete with high transaction costs and potentially complicated and restricted funding mechanisms, risks inefficiencies and delays.
