Japan Implements Contracts for Difference Scheme to Support Low Carbon Hydrogen Production

Japan is taking significant steps to bolster its low-carbon hydrogen industry through the introduction of a Contracts for Difference (CfD) scheme under the newly established hydrogen act. This initiative mandates that hydrogen and its derivatives, such as ammonia and e-fuels, adhere to a specified maximum carbon intensity, reflecting a 70% reduction in CO2 emissions compared to fossil fuel benchmarks. Unlike European standards, which measure carbon intensity at the consumption stage, Japan focuses on production point metrics, allowing for greater flexibility in utilizing carbon capture and storage (CCS) and electrolytic methods for hydrogen production.

The government recognizes that the cost of producing low-carbon hydrogen remains higher than that of traditional grey hydrogen derived from fossil fuels. To address this price disparity, the CfD scheme will provide subsidies to eligible suppliers for up to 15 years, funded by a substantial budget of JPY 3 trillion (approximately USD 19 billion). This financial commitment aims to create a competitive environment for low-carbon fuels in Japan, potentially stimulating industrial-scale demand.

Applications for the CfD scheme are open until March 31, 2025, allowing domestic and imported low-carbon fuels to qualify, provided their business plans receive governmental approval. The scheme's design draws inspiration from the successful UK model for offshore wind support, leveraging the effectiveness of the CfD mechanism in fostering growth within the hydrogen sector.

Under this scheme, rather than offering tax credits based on production volume, the government will compensate suppliers for the cost differential between conventional and low-carbon fuels. Suppliers will receive top-up payments based on a formula that reflects their production costs and profit margins, subject to approval by the Japan Organization for Metals and Energy Security (JOGMEC).

Interestingly, the approved standard price for suppliers will remain fixed for the entire 15-year term, with the potential for downward adjustments only in exceptional circumstances—contrary to typical practices in other hydrogen-consuming markets, where technological advancements generally lead to lower support levels over time. This approach may pose challenges for early-stage projects, which typically face higher production costs.

Overall, the CfD scheme not only aims to support the immediate growth of Japan's low-carbon hydrogen sector but also anticipates that rising carbon pricing will gradually increase the reference price of conventional fuels, leading to a self-sustaining low-carbon fuel industry in Japan. This strategic framework reflects a forward-thinking approach to addressing climate change while bolstering economic opportunities in the hydrogen market.