Notice

HAR2 Cost Challenge: guidance for shortlisted projects on being cost competitive

Published 7 April 2025

Purpose

Low carbon hydrogen will be critical to supporting the UK’s energy security, clean power by 2030, and achieving net zero by 2050, presenting significant economic opportunities for our industrial heartlands and across the UK.

The Hydrogen Allocation Round (HAR) programme is the primary delivery mechanism to support non-CCUS enabled hydrogen production in the UK, allocating Hydrogen Production Business Model contracts to projects.

HAR2 is intended to award a contract to those projects that are considered commercially and technically viable and offer value for money and affordability. As such DESNZ retains the discretion to determine the actual capacity to be awarded, similar to the approach taken in HAR1. This ensures that we support only those projects that are commercially and technically viable, aligned with our strategic objectives, and value-for-money.

Government support will not be given at any cost and HAR2 needs to be affordable with projects delivering value for money. This document sets out a cost-reduction challenge to projects which underscores the Government’s commitment to driving down hydrogen production costs, and ensuring the affordability of hydrogen through the HAR programme.

To support projects moving to the next stage, this document sets out high-level expectations for the next stage of the HAR2 process where HMG expects a significant cost reduction in strike prices to HAR1.

Projects should show clear and measurable plans to achieve as low a hydrogen production cost as possible – taking in to account project configuration - with an aim to achieve lower average hydrogen production costs than seen in HAR1, contributing to DESNZ’s goal of making clean hydrogen a competitive and scalable energy source.

In addition to cost-reductions, some consideration may also be given to how Projects align with broader Government priorities, such as:

1. Supporting Net Zero and clean power goals: Projects may demonstrate how they align with the Government’s Clean Power Mission and contribute to the UK’s net-zero 2050 target by detailing how they will help decarbonise key sectors and reduce reliance on fossil fuels.

2. Promoting industrial growth and economic resilience: Projects may also articulate how they will contribute to the UK’s industrial strategy.

Context

Shortlisted projects will be invited to a phase of due diligence. Being shortlisted and/or progressing to this next phase does not guarantee future contract award.

As part of a competitive allocation round, costs for each project will be assessed by comparing them not only to cost information from other projects in the round, but also to external cost data, ensuring they offer value for money while taking into account each project’s configuration. In addition to the initial submission at the Request for Information stage, there will be an opportunity for projects to submit updated costs during the potential future negotiations phase as they mature, until the Best and Final Offers are requested and the final selection process begins. Broadly, projects will be required to justify their costs across four key components:

1. Capital Expenditure (CAPEX)
2. Non-Electricity Operational Expenditure (Non-Elec OPEX)
3. Electricity Cost
4. Cost of Capital

As a portfolio, the selected HAR1 projects achieved a weighted average strike price of 241 £/MWh H2 (HHV) ^{[footnote 1]}. HMG expects a significant cost reduction in HAR2, with a clear focus on ensuring projects are both value for money and deliverable. This will guide our decision-making process, which we will manage at a portfolio level. To be successful in HAR2 and be considered for contract award, it is essential that strike prices represent value for money and that any cost risk is appropriately balanced between government, project and offtaker. A decision to award LCHAs to successful HAR2 projects will only be made subject to government being comfortable with the application of subsidy control requirements.

Key areas of Cost Challenge

Engineering maturity and cost justification

Based on HAR1 learnings, projects are encouraged to seek greater engineering maturity to enable more effective cost-competitiveness. Greater engineering maturity indicates lower contingency included in the cost estimates, which is then a more accurate reflection of the final strike price – and hence, a more accurate reflection of the VfM that the project can deliver. In practice this means:

• Aiming to progress the project’s engineering design as far as practicable to reduce cost uncertainty, and as a by-product, reduce excess CAPEX contingency in the final strike price, for example completing FEED.
• More mature projects with a greater proportion of costs informed by supplier information rather than estimation, will be in the strongest position to justify their costs, and present a clearer picture for HMG to evaluate.

• Costs will be benchmarked, and projects will be required to justify higher costs based on evidence. This includes evidencing that project design choices and configuration are VfM. Examples of such evidence accompanying RFI submissions may include, but are not limited to:

  • Equipment – e.g. specifications, firm quotations, offers, or draft agreements,
  • Services (e.g. FEED/EPC) – e.g. tender bids, offers, or draft agreements,
  • Electricity – e.g. PPA quotation, signed draft PPA agreement/ terms sheet, accepted grid connection offer with a breakdown of contestable and non-contestable works,
  • Design/ operational philosophy – e.g. completed FEED deliverables such as design summary report, mass and energy balances, equipment/ utility lists, specifications, PFDs, site plots, production/ supply/ demand profiles

Outside cost implications, a greater level of project maturity (e.g. higher levels of progress engaging with their supply chain, planning authority, landowner, utility supplier, as well as offtaker engagement on areas such as credible plans for cost sharing on transport and storage) will increase DESNZ’s confidence in project deliverability., increasing the likelihood of passing in due diligence.

Construction schedule

It is expected that developers demonstrate they are moving as fast as practical to deliver their project. This includes demonstrating proactive measures to accelerate their schedule, including:

• Early supplier engagement and procurement for critical long lead equipment (e.g. electrolyser, compressors and HV equipment),
• Leveraging standardisation of design while developing multiple projects of common configuration,
• Early engagement with relevant local planning authorities and submission of planning applications,
• Engagement with HSE and the Environmental Agency at the earliest opportunity,
• Engagement with and securing of connection offers from relevant DNOs at the earliest opportunity.

Economies of scale

Developers of larger projects, or multiple projects should capitalise on economies of scale to drive down costs – DESNZ expects to see evidence of cost benefits from economies of scale in these instances. By purchasing equipment in larger quantities, developers can negotiate better pricing, reduce per-unit costs, and secure more favourable terms from suppliers. Additionally, standardising design and contracting processes across multiple projects can significantly streamline operations and reduce overheads.

Optimising electrolyser selection

Projects must justify their choice of electrolyser supplier and model by demonstrating a clear alignment with DESNZ’s expectations on performance, cost-effectiveness, and long-term reliability. While it is acknowledged that the electrolyser market is evolving, DESNZ expects projects to aim for high performance and reliability, with appropriate trade-offs between CAPEX, efficiency, and longevity. Projects should present a compelling case that demonstrates competitive procurement processes have been followed, ensuring that suppliers are facing the appropriate pressures to reduce costs and deliver value. The expectation is that any procurement strategy will reflect the principles of competition, and sole sourcing would require a robust justification. Projects should evaluate and compare electrolyser models on total cost of ownership over the contract lifespan, including efficiency gains, reduced maintenance costs, and maximized uptime, to clearly demonstrate why their price is competitive in relation to the performance offered. Clear ambition with respect to performance is a baseline, and projects will need to justify their pricing within that context.

Competitive electricity pricing

Developers should explore different energy sources, and negotiate competitive electricity rates, recognising that pricing may vary based on project requirements and energy needs. It is worth noting that at this stage, 25% of projects that passed the deliverability assessment reported weighted average wholesale/generation electricity prices not exceeding £66/MWh. These projects also reported total weighted average electricity prices below £82/MWh ^{[footnote 2]}, ^{[footnote 3]}. We expect projects, where possible, to secure additional offtake that would help them increase capital efficiency without a significant negative impact on electricity costs.

Maximise electrolyser utilisation

Projects should aim to increase electrolyser utilisation to the highest practical level, balancing electricity price, in order to minimise the levelized cost of hydrogen (LCOH). This could involve optimising production schedules and integrating storage solutions where appropriate to manage variable electricity supply/price and meet offtake demand. The focus should be on reducing LCOH as much as possible by leveraging strategies that align electricity prices with production needs.

Balance risk with cost of capital

Developers should assess and manage risks carefully, particularly concerning the assumed cost of capital, to optimise project financial performance, and Strike Prices. This might include stress-testing financial models, securing long-term offtake agreements, or exploring innovative financing mechanisms to mitigate risk. The goal is to achieve an optimal balance between risk and reward, ensuring the project’s financial structure supports cost-effective hydrogen production.

1. In 2023 real prices. Comparisons between HAR1 and HAR2 in this document will be made in these terms. ↩

2. Includes network costs, supplier margins and REGOs; ↩

3. Prices are based on data submitted by projects in April 2024 and do not reflect market prices at the time of the publication. ↩