3 ways to accelerate financing for clean hydrogen projects

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Jorgen Sandstrom, Head of Energy, Materials, Infrastructure Programme, Industrial Transformation, World Economic Forum, Derek Baraldi, Head of the Banking Industry, World Economic Forum, Noam Boussidan, Manager, Transforming Industrial Ecosystems, World Economic Forum, Manuela Stefania Fulga, Platform Curator, Banking and Capital Markets, World Economic Forum

• Clean hydrogen can contribute to industrial decarbonization, power generation and energy security.
• Despite progress at COP27, and new initiatives and projects, finance is still not flowing at the scale needed.
• The World Economic Forum has identified key ways to accelerate financial flows towards clean hydrogen projects.

Clean hydrogen is pegged as a cornerstone of the transition to a net-zero future, with the ability to contribute to industrial decarbonization, power generation, energy security and transfer of renewable energy from sources of production to end use.

COP27 further propelled clean hydrogen into popular discourse, with multiple announcements of new initiatives and projects to develop the renewable hydrogen industry and trade. However, despite undeniable momentum on the policy and business fronts, capital is not flowing in at the scale needed, with only 4% of announced clean hydrogen projects under construction or having reached a final investment decision (FID).

Why is that? A combination of factors account for this, including the lack of visibility on demand, unclear regulation, and supply chain constraints. From a financial perspective, risk appetites vary significantly across financial institutions, and clean hydrogen projects often carry significant technology and offtake risks that cause concern to private investors and financial institutions.

Structures and arrangements to de-risk investment in these projects are not widely available today. This includes access to long-term renewable energy secured via a Power Purchase Agreement (PPA), robust offtake agreements for end-use applications that carry low technology risk, the availability of Engineering, Procurement and Construction (EPC) wraps, and performance guarantees for equipment that do not yet have a long performance track record.

As a result, most of the projects at FID today are financed on balance sheets by large incumbent gas or energy producers, who are the only institutions capable of assessing, managing, and taking on such risks as it stands.

To alleviate this apprehension and find the right way to mobilise the finance community, the Accelerating Clean Hydrogen Initiative and the Financing the Transition initiative identified concrete approaches that could help solve the challenge of access to finance for clean hydrogen projects in the current environment. Three key examples are highlighted below:

1. Projects led by credible industrial sponsors and developers

Financiers want to invest and there is an increasing appetite for financing clean hydrogen projects, but there remains a lack of understanding as to the fundamentals of these projects. To give investors confidence in the market, many questions covering different fields (not limited to technology) need to be answered:

• What is a hydrogen project and how do they operate?
• What technology should I choose, and how reliable are the manufacturers and suppliers of the technology?
• Are companies that are more vertically integrated (e.g. owns or manufactures their own electrolysers) more attractive?

Therefore, the “developer model” is becoming a front-running approach to hydrogen financing: don’t pick a winning technology, but instead, pick a credible industrial sponsor or developer for investments. At this initial stage of commercialisation, the credibility and creditworthiness of the sponsors involved are critical. Investors and financial institutions can rely on a sponsor’s knowledge of the industry, ways to mitigate technology risks, and ability to identify off-takers and ship the end product.

An example of such a model can be seen with H2 Energy, a developer based in Switzerland that has been working on renewable hydrogen projects since 2014. Investors in H2 Energy can gain exposure to the burgeoning sector while relying on the company’s expertise, and extensive network of strategic partners and co-investors for projects across Europe. This approach gives institutional investors exposure to the nascent sector, taps into the expertise of existing scale-ups and pre-IPO companies, and helps investors develop their own internal capabilities to take on more complex investments in the future.

Discover

How is the World Economic Forum driving the energy transition?

The World Economic Forum’s Platform for Shaping the Future of Energy, Materials and Infrastructure works across six industries: electricity, oil and gas, mining and metals, chemicals and advanced materials, engineering and construction, and advanced energy solutions. It enables government and business to work together to accelerate the transformation of energy, materials and infrastructure systems.

• In collaboration with Accenture, the Forum is implementing a toolbox of solutions and city sprints to boost sustainability and reduce emissions in urban settings, through the Net Zero Carbon Cities programme.
• The Fostering Effective Energy Transition report summarizes insights from the Energy Transition Index in an effort to assist the world in readiness for energy transition.
• The Mobilizing Investment for Clean Energy in Emerging Economies initiative enables collaborative actions to scale clean energy finance in emerging and developing markets.

Contact us for more information on how to get involved.

2. Investments into parent companies, with optionality for project-level co-investment

While the macro-economic context has decreased the overall market appetite for risky investments, capital is still flowing to clean hydrogen, although with more caution and less scale than before. For larger investments into the sector, preference for a similar approach to the above (projects led by credible industrial sponsors and developers) has emerged, with many investors favouring investments into industrial incumbents at the parent company level. These investments are typically structured as preferred equity or convertible bonds and come with pre-agreed rights to co-invest at the asset level simultaneously or at a later point.

This can be seen in the strategic partnership between Fortescue Future Industries (FFI) and Tree Energy Solutions (TES). The €130 million investment by FFI comprised of an equity stake in TES, as well as a direct investment into the construction of the TES Green Energy Hub and terminal in Wilhelmshaven, Germany. The partners will jointly identify, develop, and invest in further assets over the next few years, to give FFI a pathway for access to critical clean hydrogen infrastructure to execute its decarbonization strategy.

Prebaking the ability to co-invest at the asset level as the portfolio of projects develops gives investors further flexibility while also securing access to a pipeline of high-quality projects, helping investors balance between first-mover risk and reward.

3. Contracts for difference

Uncertainty around a hydrogen project’s future revenues, due to the non-existence of a liquid market for clean hydrogen today, remains a big hurdle to bankability. While financial institutions prefer long-term, credible, offtake contracts as a starting point, off-takers today are generally unwilling to enter into long-term agreements at the current high prices for green hydrogen – even though it’s possible to secure hydrogen offtakes.

This is where the public sector can step in to underwrite these risks. Long-tenor contracts for difference (CFDs) have been an effective tool used by governments to help bridge the green premium that exists between low- or no-emission products and their grey or brown alternatives. In Europe, this approach was included in the 2022 RePowerEU Plan.

To support hydrogen uptake and electrification in industry, the European Commission is expected to roll out carbon CFDs, enabling a full switch of the existing hydrogen production from natural gas to renewables and the transition to hydrogen-based production processes in industrial sectors such as steel production.

Furthermore, when used in conjunction with financing instruments to blend public and private capital, e.g. the Connecting Europe Facility, which disburses grants for the construction of hydrogen refuelling infrastructure that is conditional on additional financing from a financial intermediary, the reduced risk can help boost investor confidence and spur project financing.

Unlocking the market for clean hydrogen

There is reason for optimism in the future of the hydrogen market. Currently, ministers and CEOs from across the world are gathered at the Davos Annual Meeting 2023. Together they must mobilise, implement and drive hydrogen commitment and address regional challenges.

There is scope for clean hydrogen projects to become “business as usual”, but first we must solve bottlenecks, establish policy frameworks and enable measures that will build the confidence needed to unlock the market for clean hydrogen and help fulfil its role in achieving a net-zero future.