With more news and discussion every day on the threat of climate change and the need for society to transition from carbon-emitting fossil fuels to cleaner, renewable energy, most attention has been focused on the same solutions for several years: wind, solar, and hydroelectric power generation, electric cars and (in some circles) nuclear power. Hydrogen, though less well-understood, has recently gained considerable traction and may prove to be the future-friendliest fuel. Hydrogen projects are becoming more common across Canada, but their increasing prominence is particularly notable in Alberta, given the historical importance of the oil and gas industry, and a stereotype suggesting resistance to cleaner, greener ways. That image may be set to change, considering Alberta’s natural advantages in establishing a hydrogen industry and an enthusiasm in the provincial government that might surprise many.
Rainbow fuel
Hydrogen as a fuel is produced by a process of electrolysis, essentially using an electric current to split water into its component elements of hydrogen and oxygen. There is, however, more than one way to skin a water molecule: hydrogen is usually classified according to an ad hoc colour scheme that differentiates between the sources of power used to achieve electrolysis, and therefore the relative eco-friendliness of each.
“Grey hydrogen” is currently the most common form. Electrolysis is powered by the combustion of fossil fuels (typically, natural gas and methane; however, coal or lignite might also be used, in which case the hydrogen might be classified as “black” or “brown hydrogen”). This method is, understandably, not viewed as the most ecologically attractive, given the carbon emissions required in production. “Blue hydrogen” likewise uses fossil fuel combustion to generate power for electrolysis, but with the addition of carbon capture and storage technology to trap the carbon emitted. Blue hydrogen is notionally much more environmentally friendly than grey (or black or brown) and is particularly attractive in a place like Alberta where a repurposing and recharacterization of fossil fuels as a necessary factor in climate change solutions has resonated.[1]
“Green hydrogen” uses renewable resources (e.g. wind or solar power) to generate power for electrolysis.[2] The value of utilizing non-polluting inputs makes the environmental advantages of green hydrogen self-evident; however, this process is not without its own challenges.
Preferred types
One major challenge to green hydrogen, as opposed to blue, black or brown, is the prohibitive cost. It is cheaper to produce hydrogen from fossil fuels than from wind or water.[3] Another is the availability of large scale electrolyzers, which are not exactly in abundance.[4] Research has suggested that to generate sufficient green hydrogen to meet just “a quarter of our energy needs would take more electricity than the world generates today from all sources combined, and an investment of $11 trillion in production, storage and transportation infrastructure.”[5] The availability and accessibility of renewable electricity for these purposes will need to increase dramatically, and the cost thereof decline correspondingly, to scale up the production of green hydrogen.
In Alberta currently, blue hydrogen seems the best fit,[6] owing among other things to the availability of natural gas reserves, existing pipelines and infrastructure, the skilled labour and human capital of the existing oil and gas industry, and the “ideal sequestration geology.”[7] Further, Alberta already has carbon capture and storage legislation in place, which governs things like pore ownership, long-term stewardship and injection, and regulation for the construction, operation, and abandonment of injection wells.[8] These rules and regulations can be found in legislation such as the Mines and Minerals Act,[9] and the Carbon Sequestration Tenure Regulation.[10] The availability of inputs in various jurisdictions – for example very windy or very sunny places – will impact the feasibility of green hydrogen as compared to its less-glamourous, other-coloured counterparts.
A recognized imperative
Canada has implemented the “Hydrogen Strategy for Canada: Seizing the Opportunities for Hydrogen, A Call to Action” (December 2020), and Alberta itself promotes hydrogen development in its Alberta Natural Gas Strategy – “Getting Alberta Back to Work: Natural Gas Vision and Strategy.”[11] Hydrogen development is also key to meeting Canada’s greenhouse gas reduction targets under the international Paris Accord.[12]
Hurdles to clear
In the context of a broader global need for “clean” energy, the technical challenges identified above must be addressed concurrently with establishing the required legal and regulatory groundwork to facilitate hydrogen production, storage, and distribution. Hydrogen producers need to consider:
- Land Acquisition
- Zoning
- Permits
- Regulatory hurdles
- Production and transport
- Buyers
- Offtake Agreements
- Other Contracts
- Risk Allocation
Land Acquisition:
A hydrogen project first requires a physical location, which means acquiring land or an interest in land, most often by way of lease. Legal counsel can assist in the negotiation of contracts for the purchase and lease of target properties.
Zoning:
Due diligence on any purchase or lease transaction will include the need to identify and resolve potential zoning issues. In Canada, land use planning is governed by provincial legislation (such as Ontario’s Planning Act or Alberta’s Municipal Government Act). Municipal councils adopt land use plans and enact zoning bylaws to regulate land use, planning and development within their jurisdiction.
Land Use Bylaws typically divide land into “use districts” or “zones.” Depending on the permitted or discretionary uses allowed in each district, different types of development will be allowed. Each Land Use Bylaw is different and may have different zoning definitions, restrictions, and allowances. What is considered “industrial” in one municipality’s Land Use Bylaw may not be considered “Industrial” in another’s; therefore, it will be necessary to review and understand each such bylaw on its own terms. Knowing generally what such bylaws do and typically contain is not, by itself, enough to protect a would-be hydrogen producer.
If the Land Use Bylaw does not allow a specific type of development, it may be possible to request an amendment; negotiation and/or consultation with the municipality will likely be necessary, particularly if the desired use is considered “discretionary” (i.e., allowed if the municipality decides to permit it) or if the desired use would require an amendment of the applicable Land Use Bylaw, or other legislation or regulation.
Permits:
Even if the target property is zoned appropriately, further permits will be required and will vary from one jurisdiction to another.
In Ontario, depending on the location and nature of the project, producers may require approvals, permits and/or authorizations from ministries and approving bodies including the Ministry of Natural Resources and Forestry, the Ministry of Transportation, the Niagara Escarpment Commission, the applicable municipality (which, in addition to zoning considerations, must also issue development and building permits), electric system operators and local distribution companies, and, in some cases, federal government agencies. Projects in Alberta would be subject to similar requirements; for example, power plant applications must be submitted to the Alberta Utilities Commission.
Regulations:
A number of different regulatory hurdles may arise during the application process for required permits, and applicants may need to navigate a complex web of regulators. Alberta applicants may need to deal with some or all of Alberta Municipal Affairs, the Safety Codes Council, the Alberta Boilers Safety Association, the Rural Utilities Branch, Alberta Environment and Parks, the Alberta Energy Regulator, the Alberta Utility Commission, various distribution utilities, and the Canadian Standards Association and American Society of Mechanical Engineers. In Ontario, the Ontario Energy Board (OEB) has regulatory responsibility for all pipeline systems located entirely within the province, however the Canada Energy Regulator (CER, formerly the National Energy Board), an independent federal agency, regulates pipelines that cross interprovincial and international borders – and such pipelines will likewise be subject to applicable legislation and regulations in each provincial or national jurisdiction in which they are located or partially located. Though probably not by design, Canada currently lacks a comprehensive, long-term policy and regulatory framework regarding hydrogen. Alberta is seeking to make its own process easier by amending the Gas Utilities Act and the Gas Distribution Act, which would expand many existing regulations to cover hydrogen in like manner as the fossil fuels to which they originally pertained. Such efforts are welcome; steps to streamline applications and approvals would improve the efficiency and attractiveness of hydrogen projects.
Transportation:
Hydrogen can be transported by vehicle, pipeline, train or ship. Existing natural gas pipeline infrastructure could be utilized to transport hydrogen but this would likely involve changes to the pipelines themselves, as differences between hydrogen and natural gas can impact the gas’ properties, safety systems, metering equipment, end-use equipment and appliances. Standards would need to be updated if hydrogen blending (with natural gas) for transportation through pipelines is to be attempted. Transportation also requires hydrogen compression, which is an expensive and potentially dangerous process.
It is safe to assume that hydrogen production will be limited by storage and transportation capacities, which themselves will be affected by market demand, contracts (including offtake agreements) and risk allocation.
Buyers:
In order to make the production of hydrogen profitable, there must be market demand for the product. Existing and emerging uses for hydrogen include:
- Oil refining
- Ammonia, methanol, and steel production
- Specialty vehicles
- Heavy transport
- Industrial heating
- Mining
- Replacement gas for residential and commercial heating
Offtake Agreements:
Once buyers have been identified, offtake agreements to contract for the purchase of the produced hydrogen must follow. There are currently two prevailing models for such agreements:
- The Tolling Model, pursuant to which a customer effectively pays for the inputs and outputs. The customer purchases electricity to be used at the electrolysis plant (and may possibly supply the water as well), then pays the owner of the electrolyzer to convert the water into its components of oxygen and hydrogen.
- The Sale-and-Purchase Model, under which the developer/producer is responsible for providing the electricity and water. The electrolyzing facility would procure electricity from a third party, or produce its own. The buyer would simply buy the finished hydrogen product. Subtypes of Sale-and-Purchase Model include:
- Take-or-Pay: the buyer and seller agree up-front on a specified contractual quantity of hydrogen to be delivered on a periodic basis. The buyer must either take the delivery of the specified quantity (and pay), or pay the seller for any amount not taken. If the buyer fails to take (but pays) for the full contract quantity of hydrogen, they may be entitled to a make-up amount in the future.
- Take-and-Pay: the buyer must take the agreed contractual quantity of hydrogen and pay for it. A failure to accept the delivery will entitle the seller to remedies for breach of contract. The risk in a take-and-pay contract is that, unless the contract specifies liquidated damages, seeking recovery for the breach will be time-consuming, expensive, and likely require the seller to demonstrate both actual loss and its efforts to mitigate that loss.
Generally, the Sale-and-Purchase Models are preferred. Lenders want to see a predictable revenue stream; moreover, as there is no current merchant market for hydrogen, it will be difficult to sell hydrogen that is not taken and paid for. Early green hydrogen projects will likely not be able to decrease the electricity they purchase, meaning there will be relatively consistent input costs and producers need the assurance of a reliable purchaser for the output.
Other Contracts:
Hydrogen developers must conclude various ancillary agreements as well, including to purchase the requisite inputs (water, electricity, electrolyzers) and, as described above, to lease or purchase land Proxy generation power purchase agreements are popular vehicles for purchasing renewable energy to produce green hydrogen.
Risk Allocation:
When negotiating hydrogen contracts, risk allocation is a key component and possible point of contention. Unless the buyer and seller are interested in complex future litigation, it is important to properly determine who bears the various types of risk that can arise, including (but certainly not limited to):
- Disruption to a project’s ability to obtain required inputs (such as water or electricity)
- Effect of potential delays
- Changes in law and/or regulations
- When the product is deemed transferred or delivered, and which party bears risk of loss or liability during storage and transport
Conclusion
Hydrogen is a key component of the world’s future energy mix and Canada is well-positioned to be a key contributor and beneficiary, if it plays its cards right. Canadian producers are poised to reap great potential rewards from a “green gold rush”, so to speak, but to the extent hydrogen is a solution to carbon emission and climate change concerns, literally everyone on Earth benefits.
Miller Thomson is able to advise on all aspects of a project, from due diligence to legal and regulatory analysis, to advocacy with relevant authorities, to financing, to contract negotiation and drafting. Please reach out to our national ESG and Carbon Finance group with any questions or to discuss how we can best assist.
[1] Mike Scott, “Green Hydrogen, The Fuel Of The Future, Set For 50-Fold Expansion” (14 December 2020), online: Forbes .
[2] Anmar Frangoul, “Canada is set to have one of the world’s biggest green hydrogen plants” (19 January 2021), online: CNBC .
[3] Sharon J. Riley, “‘Hydrogen fervour’: the technology breathing hope into Alberta’s industrial heartland” (13 April 2021), online: The Narwhal .
[4] Jason Deign, “So, What Exactly Is Green Hydrogen?” (29 June 2020), online: Green Tech Media .
[5] Magdalena Petrova, “Green hydrogen is gaining traction, but still has massive hurdles to overcome” (4 December 2020), online: CNBC .
[6] Riley, supra note 3.
[7] “Pores, pipes and politics: The keys to blue hydrogen in Western Canada” (21 January 2021), online: BLG .
[8] Ibid.
[9] RSA 2000, c M-17.
[10] Alta Reg 68/2011.
[11] Canada’s Minister of Natural Resources, “Hydrogen Strategy for Canada: Seizing the Opportunities for Hydrogen, A Call to Action” (December 2020); Alberta Natural Gas Strategy – Getting Alberta Back to Work: Natural Gas Vision and Strategy.
[12] Alberta Natural Gas Strategy – Getting Alberta Back to Work: Natural Gas Vision and Strategy, ibid at 23.
