Hydrogen sales and purchase contracts – high-value issues to keep in mind
With its ample hydropower, developing wind power, and gas reserves, Norway is particularly well placed to produce both green hydrogen and blue hydrogen. Although the potential is obvious and there is a clear will to develop it further, the hydrogen industry is still in early stages. At present, relatively few supply contracts have been entered into and few clear market principles have developed. As such, the hydrogen industry faces similar questions in respect of the contractual regulation as the natural gas industry faced in its early phase.
This article briefly covers some of the high-value issues that typically may become subject to dispute in long-term contracts for the sale and purchase of gaseous fuels and which consequently should be kept in mind when drafting the contract, i.e. the regulation of volume and price and price revision. The issues raised in this article are in particular based on our experience with disputes under long-term natural gas sales contracts.
The development and production costs are significant, and investments in hydrogen production require long-term off-take security. In long-term gas sales contracts, this has been addressed through volume provisions.
The volume provisions generally regulate the seller’s delivery obligation and the buyer’s off-take obligation. Underlying the volume regulation is a two-fold consideration. On the one hand, the seller needs to secure a regular running income to amortise the, often significant, investments in production facilities, and to cover the costs of production itself. On the other hand, the volume provisions should also provide the buyer with flexibility to vary his off-take in accordance with his varying needs.
To strike a balance between these two underlying considerations, it may be prudent to establish a maximum and a minimum volume regulation within a further specified time interval. The minimum volume obligation may be further regulated by implementing an obligation on the buyer to off-take and pay for, or only pay for, the minimum amount of volumes within the relevant time interval (the so-called take-or-pay principle). Such a take-or-pay provision would give the seller the desired guarantee for a regular future income that also may be further capitalized on up-front. The seemingly draconian obligation on the buyer to pay for volumes irrespective of whether the volumes are off-taken or not, has customarily been balanced by an entitlement for the buyer to off-take the paid for but not off-taken volumes at a later point in time (make-up volumes). Without such make-up provisions, take-or-pay provisions are akin to penalty provisions, and as such, most likely unenforceable and subject to review.
Disputes over volume provisions will often include issues of both contract and competition law, including questions regarding the validity of the volume provision(s).
Price and price review provisions
Furthermore, there is no separate, reliable market price for hydrogen. However, there are different pricing principles that may be applied.
Since hydrogen is a product of other energy sources, some of which have liquid and transparent prices, “cost plus” would be a relatively simple and quite transparent price methodology. In the early stages of the natural gas industry in Europe, the indifference principle became a guiding pricing principle. The indifference principle implied (near) cost parity with relevant other alternative fuels and allowed natural gas to gain market share by being priced a fraction below its competitors. The relevant fuels that may be used for (near) cost parity under this pricing principle will depend on the specific project/market. Accordingly, we expect to see a development of different price formulae in different projects/markets, depending on which fuels the to-be purchased hydrogen will compete with in the project/market in question.
When committing to sell or purchase goods over time, it is almost impossible to factor in all future market developments. To ensure that the hydrogen sold and purchased remains marketable and that the producer gets a fair share of any increases in the market value of the hydrogen, it would be prudent to consider the inclusion of a price revision provision in the contract, granting both parties the right to request a revision of the price in case of significant changes in circumstances and/or in the event that the price fails to reflect the market price of hydrogen.
Issues typically in dispute in relation to price are the scope and implications of the changes that have taken place and the level of the relevant market price(s) and its/their relation to the contract price.
Regulation of high-value issues is key
Hydrogen is a fuel for the future, and the technological development and the raised awareness about its potential, make for significant opportunities. However, in light of the financial interests involved, it is important to accurately regulate the high-value issues which otherwise may create disputes at a later stage.