For all the buzz surrounding green and blue hydrogen, few low-carbon hydrogen project financing deals have been closed. Financing low-carbon hydrogen projects will require cataloguing and allocating risks in a manner that is familiar to project financiers—but it will require them to pull tools from disparate toolkits.

Existing use cases

There is no merchant market for hydrogen. To be financeable, a hydrogen project must have a bankable offtake scheme. Existing use cases for hydrogen—which today rely almost exclusively on grey hydrogen—may be among the first green or blue hydrogen opportunities to be financeable, because the offtake picture is already clear and will be easier to model.

Ammonia is one such area. A market already exists for ammonia, and several green ammonia projects have been proposed or are in early stages of development.

Petroleum refining is another area where bankable early green or blue hydrogen projects are likely to emerge. Refineries are among the largest users of hydrogen as a fuel stock, and early-stage hydrogen projects may contract with refineries as offtakers. Several pilot projects are also being developed in this sector.

A third area showing early promise is fuel for specialty vehicles. Hydrogen is already being used to power fuel cells. Fuel cells are used in specialty vehicles such as forklifts and by energy consumers to complement electricity from the grid, to smooth energy costs and to ensure reliability.

Emerging offtake structures

Offtake structures in sectors for which hydrogen is not currently used at scale may be more challenging to finance initially, although pilot projects designed around these use cases have already emerged.

The emerging use case that has generated the most publicity is heavy transport. Fuel cells have advantages over batteries for powering heavy transport: hydrogen refuelling is generally much quicker than recharging batteries, and fuel cells are lighter than batteries. In the mobility sector, public transport projects present the most compelling model for project financing. The amount of hydrogen needed and the locations for refuelling buses and trains are predetermined, so their operators can foreseeably constitute stable offtakers that may serve as the backbone for project financing in the transport sector.

Hydrogen for long-haul trucking is a more difficult model to finance because it will rely on a more dispersed refuelling network. Project financing, if feasible in this area, will probably become viable only once infrastructure plans have been established with government input and support to mitigate the chicken-and-egg problem related to the development of fuel-cell trucks and hydrogen refuelling infrastructure.

Electricity generation is another nascent use case. Existing offtake structures can be readily applied to hydrogen in the power sector. In areas with high renewables penetration, hydrogen projects may be particularly appealing as a way to avoid curtailment of renewable electricity plants and to supplement intermittent power generation. Batteries will likely remain more efficient for short-term storage, but hydrogen can be used for long-duration storage, allowing unused energy from renewables plants to be deployed in different seasons of the year. Several projects are underway in the US to use hydrogen in existing natural gas plants.

Offtake structures in sectors for which hydrogen is not currently used at scale may be more challenging to finance initially

Hydrogen for industrial processes holds promise because major, creditworthy manufacturers of industrial products such as steel or concrete could be counterparties in bankable offtake arrangements. In some regions, project developers may be able to develop multi-project facilities combining large renewable generation projects and electrolysers onsite or near major industrial producers or clusters of industrial producers.

Mining companies often operate in environments where other energy sources may be expensive, carbon-intensive and subject to disruption, making them another important potential category of offtaker. Several pilot projects to power heavy-duty mining vehicles are underway.

Hydrogen also has potential as a replacement for natural gas for residential and commercial heating. In this market, prices are generally based on the spot market, making offtake structures more difficult to finance for early-stage hydrogen projects.

Financing risks

The gold standard for project financing is a long-term, fixed-price offtake contract with a utility or other public or quasi-public purchaser. The power and public transportation sectors may provide the best early opportunities for hydrogen project developers to sign such contracts. However, many offtake structures will depend on corporate offtakers. Corporate counterparty credit risk will be most significant where the electrolyser is located onsite or adjacent to the customer that the hydrogen project is designed to serve.

Financiers will also be focused on technology risk. Although electrolysis technology has existed for some time, given the limited track records in electrolyser deployment, financiers will carefully examine manufacturer and EPC warranties.

While some very large companies have entered the sector and partnerships are being announced at an accelerating pace, several of the principal technology suppliers in the market do not have very large balance sheets. Major maintenance reserves may be required by lenders, and manufacturer warranties may need to be backed by insurance or other financial instruments to provide credit support. Such security will likely be expensive for first-mover projects.

Multi-project issues

An electrolyser used to make green hydrogen is of no use without a sufficient source of water and renewable energy as feedstock, a way to store and transport the output, and an offtaker to buy and use the output. Lenders to any part of the chain will have to ensure that all the linked elements will be developed as intended and on time to ensure debt repayment. At the same time, to find financing under a project finance model, hydrogen projects will have to demonstrate a sufficiently discrete revenue stream against which financing can be raised, with a collateral package comprised of assets in which the special-purpose entity owning the project has an indivisible ownership or other property interest that can serve as security for the financing.

In some scenarios, end-to-end financing will be most appealing. An example of a relatively self-contained project is an electrolyser together with a fleet of buses that will use the hydrogen fuel produced. More complexity arises when the power source and transportation of hydrogen are considered separately.

Financiers trying to evaluate and manage multi-project risk can look to knowledge developed through structuring other complex projects containing multiple elements. For example, in LNG-to-power projects, the regasification, port infrastructure, pipeline and power plant components may be financed with the same debt package, or separate special-purpose vehicles may be established for the separate financing of the power plant and the regasification facility.

The gold standard for project financing is a long-term, fixed-price offtake contract with a utility or other public or quasi-public purchaser

Another useful analogy is to the financing of mining-related infrastructure. In some instances, a mining company may choose to develop a mine and related infrastructure (e.g. rail, port, power, water and communication-related infrastructure) under a single or related EPC contract, to be financed as a package. Alternatively, this infrastructure may be financed separately, developed through a public-private partnership or shared with other mining companies in the same region.

Where there are linkages between several projects, careful attention will need to be paid by technical advisers to timelines and the allocation of responsibility, by legal advisers to inter-creditor and security-sharing issues, and by both to the wrapping of construction contracts. As in other sectors, the more completely a contractor is required to wrap all elements of construction, the more costly the contract will be.

Creating a market

Government support will be essential to get the green hydrogen market off the ground. Support for electrolyser deployment will be necessary but likely insufficient by itself for the development of a hydrogen market.

The demand side of the equation is less clear for the hydrogen market than it was for renewables at the beginning of the wind and solar revolution. Hydrogen is not a broadly traded commodity and is today often produced onsite by its users. Governments have begun to tackle the need for the creation of a market by providing support to projects using green hydrogen in industry and elsewhere.

Governments will also need to play a role in the development of hydrogen transportation infrastructure, both through economic incentives and by providing clear and appropriate standards and regulation applicable to the transportation of hydrogen by pipeline, truck and ship.

Catching the green financing wave

The wave of green and ESG-linked liquidity that has overtaken the power industry has largely passed by the heavy transport, mining and industrial production sectors. Financiers and project developers targeting these sectors that can find answers to the challenges described in this article will be well positioned to catch this wave.

Hydrogen as an asset class defies current classifications in most banks. As early hydrogen projects are financed, developers and financiers will need to consider the credit story to tell about each project, including on which desk it should land within a financial institution.

In each case, financiers and their advisers will do well to take a multi-disciplinary approach by drawing on institutional experience in financing power, oil and gas, infrastructure, transport and mining projects to analyse hydrogen project risks and structure financing.

Rachel Crouch is a senior associate at Norton Rose Fulbright