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This is part three of our Energy Transition Series, in which we offer our insights on new technologies and their role in driving the energy transition. Part one, 'Five Things to Know about Oil & Gas Electrification', is available here and part two, 'Five Things to Know about Electric Vehicle Infrastructure', is available here.
Green hydrogen is increasingly viewed as the key to decarbonising hard-to-electrify sectors such as transportation and heavy industry. With governments announcing ambitious hydrogen policies as part of their net zero ambitions, and given wider industry and investor focus on ESG profiles, the momentum shows no signs of slowing. However, despite the long-term growth potential of the hydrogen sector, green hydrogen is yet to be proven at scale, causing financiers and investors to tread carefully. Here are five things to know.
The UK has set a target of 10GW (increased from the former 5GW target) of hydrogen production capacity by 2030, at least half of which is to come from green hydrogen. In light of its commitment to achieving net zero by 2050, the UK published the Hydrogen Investor Roadmap in April 2022 with the objective of providing crucial information about the hydrogen sector. The information ranged from providing details about 59 potential hydrogen projects across the UK to details about the government’s 2035 Delivery Plan, outlining critical objectives on the path to developing the UK hydrogen economy. The EU has set equally ambitious targets, with a target of 10 million tonnes of domestic renewable hydrogen production and 10 million tonnes of imports by 2030.
Governments have also started to draw up the financial support mechanisms they will employ to stimulate the growth of the hydrogen sector and create a market demand for green hydrogen. For example, many countries have allocated public funding for small scale demonstration projects, while others have gone further and published detailed revenue support mechanisms. In the UK for example, the UK Government has published its Hydrogen Business Model to help mitigate price risk based on the principles of the Contract for Difference (“CfD”) regime applicable to low carbon power projects.
Private companies are also demonstrating their commitment to the sector. Oil and gas majors, such as ENI, BP, Shell, Total and Repsol, have all committed investments to low-carbon hydrogen projects, and large electrolyser manufacturers are teaming together to meet future demands. For example, Air Liquide and Siemens Energy have formed a joint venture dedicated solely to the production of industrial scale renewable hydrogen electrolysers.
Institutional investors have also become increasingly willing to invest capital into the hydrogen sector. In August 2022, Copenhagen Infrastructure Partners announced that it had closed its CI Energy Transition Fund at its hard cap of EUR 3bn making it “the largest dedicated clean hydrogen fund globally”. The fund will target next-generation renewable energy infrastructure including industrial scale power-to-x projects.
As such, early movers in the sector can take confidence that there is, at least, both public and private ambition to deploy hydrogen technologies on a large scale.
Investors and institutional lenders are becoming increasingly interested in the hydrogen sector. This can be seen in the current make-up of the Hydrogen Council, a CEO-led initiative of companies and banks with a vision for hydrogen to foster the clean energy transition, which now counts leading financial institutions amongst its members. However, whilst lenders are conceptually engaging in the hydrogen sector, only a handful of low-carbon hydrogen project financings have reached financial close to date.
The issue at present, in simple terms, is that the uncertainties relating to future regulations and demand are barriers to a project being able to demonstrate that it can generate sufficient future revenues for it to be bankable. In the absence of government backing in the form of subsidies and tariffs, it is very difficult to predict what the future price of hydrogen may be. Consequently, banks are often unable to devise a financial model with assumptions that are reasoned enough to be bankable.
As such, we expect that in the short term we will continue to see the emergence of smaller projects financed on balance sheet, often via joint venture arrangements or through concessional type governmental loans.
That being said, we only have to look at the trajectory of other renewables, such as solar and wind, which started on a small scale, as an example of how new technologies can flourish with an effective regulatory framework and subsidy regime. Taking UK offshore wind as an example, the first project in the UK was a demonstration project that consisted of two 2MW turbines located only 2km from the Northumberland coast. Twenty years later, the UK is one of the world leaders in offshore wind generation and reports the world’s largest offshore wind capacity and some of the largest offshore wind sites in the world. Project financing for offshore wind projects has become routine and banks and investors alike are extremely keen to invest in the offshore wind space. This demonstrates that, provided the hydrogen sector is given the support it needs in its early stages of development, private investment can be catalysed, which, in turn, will help turn a nascent sector into one that flourishes. The financial support mechanisms mentioned above, particularly those aimed at stimulating an offtake market, are therefore essential.
As an asset class, we would usually expect low-carbon or green hydrogen projects to fall within the same class as infrastructure or renewable assets. As such, investors and lenders are likely to require longer tenure offtake structures, ideally with some form of government price support.
In relation to government price support, see our commentary above. In terms of offtake, there are several issues.
Firstly, there is no real merchant market for hydrogen. Whilst this is expected to develop over time in certain key geographies, investors and financiers will be looking for long-term offtake arrangements in the absence of such market, most likely in the form of corporate power purchase agreement-type arrangements (‘hydrogen purchase agreements’).
Secondly, offtakers will be unwilling in the short term to sign up to long-term fixed-price offtake agreements for green hydrogen. This is in part due to the uncertainties posed by the absence of a merchant market but is also driven by existing offtake structures in target sectors. In the transport sector, for example, offtake structures do not typically exceed 10 years and, similarly, long-term offtake arrangements are uncommon in the chemical refinery industry. This poses a challenge for lenders and investors who would expect offtake arrangements to align with the tenure of the debt at least.
Thirdly, regulation is currently absent in terms of the standards required for “green” hydrogen. Whilst the UK government has recently published the UK Low Carbon Hydrogen Standard, which sets out useful guidance in relation to UK government schemes and policies, exactly how such standards are applied in practice will remain somewhat unknown until the various schemes and subsidy regimes are launched. In turn, contractors may require termination or other rights to mitigate the risk of a project losing its green status under new rules, leading to further lender and investor uncertainty.
The multi-project nature of a hydrogen project means that managing the interface risk between projects (i.e., the renewable facility and the hydrogen facility), but also the various construction packages of each project, will be key to a successful hydrogen project.
A low-carbon hydrogen facility will most likely be dependent on the successful deployment of a renewable energy facility as well as storage and/or offtake facilities.
Given the different nature of the facilities of a hydrogen project, no large-scale energy project is likely to be developed on a true turnkey EPC basis (i.e., where one contractor delivers the whole project under a single contract). The cost to the developer of that approach is likely to be prohibitively expensive given the premium that a contractor would require to absorb the level of risk assumed by it (a risk which is unlikely to be commercially attractive to any contractor on the market, as seen, for example, in offshore wind).
Nevertheless, multi-project and construction package risk has not put off financiers and investors in other sectors. Analogies can be drawn with LNG-power projects which have multiple upstream, midstream and downstream components and separate EPCs for each of these elements and also large renewable projects, such as offshore wind, which have long been contracted on a multi-package basis. Lenders are now well aware of the risks associated with multi-contracting and have typically become comfortable where key technical interfaces are aligned, where the contracts contain robust coordination obligations and sufficient mechanisms for delay and non-performance and where there is an experienced construction manager overseeing the interfaces. We cover this in more detail in our recent article on contracting structures in green and blue hydrogen projects available here.
Further, additional protections seen in LNG projects could also be applied to low-carbon hydrogen. For example, structural protections by way of bundling multiple projects into the same project vehicle can ensure that the project vehicle retains greater control over the development and timetable (i.e., in relation to a low-carbon hydrogen project by bundling the renewable project and electrolyser together). Likewise, appropriate financial guarantees from developers and strong creditworthiness of suppliers and offtakers alike will further enhance investor and lender confidence.
As discussed above, governments are engaging in green hydrogen, but the current uncertainty in terms of the regulatory landscape serves as a barrier to investment, with investors and lenders looking for some of the uncertainties in relation to demand, price and offtake to be de-risked through government investment and legislative intervention. Currently, large-scale hydrogen projects are at the very early stages of development and there is a gap between targets and mobilising the means to achieve them. Further, paths to transition away from small-scale or demonstration projects to larger ones need to be developed in order for the hydrogen sector to grow. That being said, government intentions and commitments in relation to green hydrogen are clear, and with government price support (and in some cases, volume support) expected, we would expect the sector to grow at a fast pace as soon as a robust regulatory pathway is created.
 See the UK’s Energy Security Strategy (April 2022)
 See the European Commission’s REPower EU Plan (May 2022)
 See the UK Government's Hydrogen Business Model (July 2022)
 For example, Hornsea One (1.2GW), Walney extension (660MW) and London Array (630 MW). See here for more information.