Hydrogen
Hydrogen Purchasing Guide and Considerations
Overview
Hydrogen today is sold by large industrial gas companies and distributors, and the hydrogen economy in the US is set to experience an influx
of subsidies from the Inflation Reduction Act and the Infrastructure and Investment Jobs Act, which are expected (as of mid 2022) to dedicate a
combined $22.5 billion to lower-carbon hydrogen production.
This funding may alter the competitive landscape in the industry, although the key needs procurement professionals must address in terms of
business requirements and physical properties of the hydrogen will remain the same.
The only exception to this is with relation to net zero goals from the organization, which may filter down to CO2 equivalence targets for
hydrogen purchased.
When having a need for hydrogen, an organization must understand both its physical needs in terms of how the hydrogen will be used as well
as its business needs. This Guide identifies some of the key considerations to be aware of when procuring hydrogen for your business.
Primary Considerations
Gas Technical Requirements
Establishing your organization’s respective use case(s) may require technical expertise, but having the right information at hand when
negotiating hydrogen procurement will make the process more efficient and reduce the potential for errors as you move towards a transaction.
These critical technical requirements include:
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Volume – Most industrial gas companies quantify volume in scf (“standard cubic feet”) while low-carbon developers quantify molecule
needs in kilograms. How much hydrogen is needed by the end user typically determines what type of delivery and mode of supply is
appropriate. Hydrogen usage volume levels and their respective supply modes include:
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Lowest volumes – Cylinders or cylinder bundles.
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Moderate volumes – Bulk over the road delivery of gaseous hydrogen or liquid hydrogen via truck into on-site storage tanks or
tubes. Liquid hydrogen tanks store more molecules than gaseous hydrogen tubes but may require additional equipment such
as vaporizers and compressors for gas applications.
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Large volumes - On-site hydrogen generators, on-site reformation plants, or pipeline delivery.
•
Gaseous State - Differing hydrogen usage applications can require different states of matter, that being liquid or gas. Most
applications require hydrogen in gaseous form, but some applications, such as rocket fuel, require that liquid hydrogen is used.
Differing states also require different handling requirements. Liquid hydrogen for example, is cryogenic in nature and requires
special piping and handling.
•
Pressure - Certain hydrogen applications require higher pressures that impact the size of compressors needed on-site or in transit.
•
Usage Pattern – Downstream processing can either be batch or continuous, which could impact equipment and piping sizing. Liquid
hydrogen is subject to evaporation or boil-off that should be considered in tank sizing.
•
Purity – There are specific applications such as fuel cells that require higher purity hydrogen with lower concentrations of certain
compounds including CO, water, and sulfur.
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Hydrogen
Business Needs / Contract Terms
Pricing Terms
When establishing a contractual agreement for the the purchasing of hydrogen, there are a variety of terms that you will likely encounter. In
most cases procurement will benefit from identifying business partners within their organization to help inform the process.
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Escalation Clauses – At a minimum, industrial gas companies will be seeking to increase the price you pay for hydrogen to make up for
increases in the costs of production they incur over time. Hence, they escalate prices in a couple of ways:
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Fixed Escalation – A set percentage increase in price per month, quarter, or year. As this increase is not based upon specific cost
component increases, it represents a risk for both buyer and seller. As a buyer of hydrogen, you may want to check with your treasury
department for any preferences: longer price adjustment periods are generally better for forecasting cash flow of purchasers. A
standard fixed percentage increase can range from 1-3% per year.
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Formula Adjustments – Formula adjustments are favored by industrial gas companies as they track the changes in costs for producing
hydrogen by utilizing indexes. Most of the hydrogen today is produced by reforming natural gas and the main cost drivers of this
process are natural gas and electricity.
Further, hydrogen that is transported over the road has a considerable proportion of cost related to transportation, which may also be
included in the formula. This component can range from 25 to 50% of the total formula.
These formulated adjustments use a base index (such as the Henry Hub natural gas index) tied to a specific time and track changes to
that index over time. Several indexes may be used in varying proportions.
Purchasers should consider the value of the original period index relative to the average of the index. A low original cost relative to
historical average(s) could drive initial pricing increases up quickly. Indexes may also be averaged over a period such as months or
quarters.
The following is an example of formulaic pricing for over the road transported hydrogen:
$/cscf = $/cscf original x (0.4 (HHI (current period)/ HHI (original))
+ 0.3 (ECI (current period)/ECI (original))
+ .3 (DSTEO (current period)/DSTEO(original)))
Where:
HHI = Henry Hub Index
ECI = Electric Utility Index
DSTEO = Diesel Short Term Energy Outlook Index
•
Fixed/Variable Charges – Most industrial gas supply contracts have several components that compromise the purchase price:
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Fixed – These are typically monthly service charges that must be paid regardless of the volume of gas taken, and this portion is called
a “take or pay.” Fixed elements of the price cover the respective gas company’s capital expense(s) for tanks, vaporizers, compressors,
pipelines, or entire plants for the highest volume customers.
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Variable – This is a monthly charge per unit of gas delivered and is measured via flowmeter. It can be constant rate or can vary via a
scale for different tiers of volume.
•
Surcharges – In addition to fixed and variable charges, most gas companies require a contract provision that allows charges to be added
monthly to cover unexpected costs. Recently these provisions have included an energy surcharge and a health and safety surcharge for
covid-related costs. Buyers can negotiate for these surcharges to be removed or limited.
•
Bundling Options – If other industrial gases such as argon, oxygen, nitrogen, helium, or carbon dioxide are being procured, a joint
purchasing agreement may be negotiated for multiple products, resulting in a discount.
For large hydrogen plants that are on the site of industrial users, credits may be applied for electric power or water, which are often
supplied by the buyer.
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Hydrogen
Other Contracting Considerations
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Term Length – The majority of hydrogen sales are done via contract purchases. These contracts range from 1 year for over the road
transported hydrogen, to 20+ years for hydrogen plants that are built on the site of a hydrogen consumer. Contracts for larger volumes
usually require a year’s notice period before termination. The longer the contract term, the lower the pricing.
•
Service Level Availability/Reliability – Many hydrogen end-users require a constant supply of hydrogen to keep their manufacturing
processes running, and service uptime is critical to their operations. In these cases, buyers may choose to have a constant supply of
backup hydrogen on-site and size tanks accordingly. They may also choose to pick a gas company with a strong regional presence,
meaning they have multiple sources of hydrogen in the region.
Service level agreements can take two forms:
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On-Stream Time – Many large volume contracts require on-stream time to be tracked by the gas company relative to a specific target
and the plant performance can result in either a bonus or penalty for the gas company.
For large, reliability-sensitive customers, a baseline on-stream time of 95% may be used. Exceeding this percentage could result in
a bonus, while having lower uptime would result in a penalty for the molecule producer. For larger refinery customers, the bonus or
penalty can easily reach 6 figures annually.
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Allocations – Some contracts specify how molecules will be allocated when a hydrogen plant or network of plants is not operating at
capacity. Some consuming companies may choose to pay a premium in backup product price (generally up to 10% more) to obtain
preferential hydrogen allocations relative to other customers.
•
Force Majeures – These provisions allow gas providers to cease delivery and limited their service obligation risk in extraordinary cases.
Contract language may or may not include equipment breakdown. All verbiage can be negotiated.
•
Equipment Ownership – Industrial gas companies generally will offer options for the buying company to either lease equipment on the
property of the buyer associated with hydrogen storage or to buy it outright. This equipment can include tanks, vaporizers, compressors,
manifolds, and pressure vessels.
Purchasing the equipment requires that the buying company handle maintenance and upkeep of that equipment. Leasing the equipment
requires no upkeep on the part of the purchasing organization but would require removal and a “hassle factor” for the company if they
choose to eventually switch gas suppliers.
•
Sale of Gas vs. Sale of Equipment
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Sale of Gas - For the largest on-site plants and generators, buying companies can choose to sign a long-term gas contract with an
industrial gas company that entails the gas company owning and operating the hydrogen facility in a sale of gas arrangement.
Having the hydrogen asset co-located with the buying company would make switching, even at the end of a contract, difficult for
the buying company as a new company would need to come in and build a new asset and have competitive pricing compared to an
incumbent asset that is already fully depreciated.
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Sale of Equipment – The buying company can choose to have an industrial gas company build a plant and sell the entire plant to the
hydrogen purchasing company. In this instance, called a sale of equipment, the purchasing company would be required to operate
and maintain the entire hydrogen facility, which many companies choose not to do as it is not their core competence.
An upside of this arrangement is that the buying company is not tied to a long-term contract for its hydrogen needs.
•
CO2 Emissions – As of mid 2022, there are no credit schemes in place for purchasing lower-carbon hydrogen outside of California. As net zero
goals prompt companies to re-evaluate purchasing habits, it is possible that the CO2 equivalence of hydrogen becomes a purchasing factor.
Subsidies in this space will make lower-carbon hydrogen such as green and blue hydrogen more competitive with traditionally produced
gray hydrogen but all proposed credits are currently on the production of the hydrogen. For buyers to benefit from these credits,
producers will need to pass through some of the cost savings.
Final Note
Contracts between industrial gas companies and hydrogen offtakers can be complex, particularly when new assets for production are being built.
Gas companies may be purposely vague about the components that go into each pricing category. For sufficiently large contracts, purchasing
companies may wish to model the proposed pricing with financial models to determine tradeoffs in contract length vs. price discounts and to
model expected escalations. Getting bids from multiple gas companies is always recommended to check complex contract pricing and terms.
For questions or comments, contact bmcauliff@bloomberg.net.
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