With only around 9% of new green hydrogen projects under construction or having reached final investment decision stage, Nadim Chaudhry, Chief Executive Officer, World Hydrogen Leaders, takes a look at the challenges and likely pathways to drive the industry forward.
Hydrogen – particularly green hydrogen – is now recognised as a vital zero-emissions energy source instrumental in the fight against climate change.
It can be transported over long distances, stored for lengthy periods and certain existing fossil fuel infrastructure such as gas pipelines can be adapted to handle hydrogen supply. It is also a clean energy and feedstock source for those hard to abate industries which rely on high temperatures for key parts of their process.
Despite these attributes, the promise of a new hydrogen economy is facing multiple financial hurdles including capital still not flowing in at the scale needed; inflation (with costs of projects having increased considerably over the last year compared to when budgets were decided); slowness to implement policy around regulation and subsidies; and technology and infrastructure issues.
A year ago, at COP27 there were several significant announcements around new initiatives and projects to move the clean hydrogen industry forward. However, despite some progress, the economic challenges around the future of hydrogen remain, ultimately resulting in few low-carbon hydrogen project financing deals being closed. While some in the industry argue that the small number of final investment decisions (FID) is normal for such a nascent industry, others are concerned that only around 4-5% of clean hydrogen projects are under construction or have reached FID stage[1].
What’s holding us back?
The International Energy Agency (IEA) points to a combination of policy and regulatory uncertainty, high costs, lack of infrastructure and uncertain demand for the final product. To keep climate goals on track, it estimates that 70 million tonnes of clean hydrogen will need to be produced per annum by 2030, with only 1 million being produced today. But at the current rate of around 1,000 announced projects to date globally, this means we are looking at only 30 million tonnes annually by 2030[2]. And of those that actually have investment locked in, the figure falls to less than 2 million tonnes[3]. According to the Hydrogen Council, a total investment of $320 billion is needed for those anticipated 1,000 projects, but with only $29 billion committed so far[4].
From a geographic standpoint, Europe leads the way, accounting for 117 investments in green hydrogen projects in comparison to 46 in North America, 21 in the Middle East and 18 in China. However, across all new financing, less than 10% actually accounts for committed capital, with the US accounting for a significant 70%[5].
Currently, green hydrogen has less energy per unit volume than fossil fuels, contributing to its higher price. Unlike grey hydrogen, which is extracted from natural gases in a carbon-intensive process, green hydrogen relies on electrolysis powered by renewable energy, such as solar or wind power, to split water into hydrogen and oxygen. However, renewable energy facilities are not being built at the rate needed to decarbonise the new sustainable electricity demand. Added to this, the few hydrogen projects that are operational are relatively small-scale, representing less than 1% of total hydrogen production over the last three years[6] – and typically, green hydrogen infrastructure mainly becomes economically feasible when bigger facilities can meet higher demand.
Inflation matters
Following the supply chain disruptions and political tensions emerging from the Russia-Ukraine war, inflation has become a major concern for many industries. With more nations reducing their reliance on Russian gas and looking to towards energy self-sufficiency, there has been an increased demand for raw resources (particularly steel and copper) for renewable development, which has also been exacerbated by logistics issues. While these higher costs of construction have not had much impact on assets already in operation (as costs are typically hedged at the time of FID), inflation risk remains in the growth pipeline, where tariffs have been approved but the project itself hasn’t been confirmed and costs not yet locked in.
As an example, according to S&P Global Commodity Insights, the cost of electrolytic hydrogen from renewable energy rocketed to $16.80/kg in July of last year, three times the normal price in recent times[7].
Inflation predictions for the foreseeable future are likely to mean that future projects become more expensive, particularly those with multiyear construction periods, where assets are valued at the start of the construction period. While developers will no doubt factor this in, they are likely to be confronted with increased insurance premiums.
The need for policy
Many believe that without strong government policy support, green hydrogen development will not scale up in the timescale required.
As Director of Infrastructure Investments at Igneo Infrastructure Partners – and one of the impressive line-up of speakers at World Hydrogen Week, Devina Parasurama suggests that “investors require a degree of certainty, more financial support and scale, which can be done through effective policies at various levels. At the national level, strategies with timelines and targets are the first step to creating a stable planning horizon and certainty for stakeholders.
“Supply-side policies are required to advance technologies from early R&D to scale up stage. Similarly, demand-side policies such as assisting consumers with conversion costs reduces the investors’ constant worry about where the demand will come from, at what level, and crucially, when. Fiscal policies, such as carbon pricing and CFDs, will encourage the use of low- or zero-carbon hydrogen – this will help lower operational costs and provide predictable terms for both producers and end users. Finally, certification and standards provide clarity and harmonisation, which will be key in scaling hydrogen and fostering international trade.”
Grey hydrogen, which uses highly-polluting steam methane reformation (SMR) has long been the cheapest production method, trading around $1.50-2/kg in the United States[8]. In comparison, green electrolysed hydrogen costs about $4-8/kg[9]. While some have debated whether the real goal of the 2022 US Inflation Reduction Act’s (IRA) was solely environmentally-focused or aimed more at keeping manufacturing stateside, the $3/kg subsidy incentive for green hydrogen is likely to stimulate increased demand and an electrolyser boom. The subsidy – which acts as a tax credit – will mean that although green hydrogen is still a bit more expensive than natural gas, it will be much closer in price to grey hydrogen.
The main shortcoming of the IRA is that the production credits only last for 10 years, meaning that developers and investors might still find market confidence challenging in the longer-term. This could particularly be the case for certain industries phasing out fossil fuels – such as steel production – which will need to construct new plants to support hydrogen.
The EU, on the other hand, is taking a different, more regulatory approach. Rather than financial incentives, it is making mandatory that 42% of hydrogen used in industry should be renewable by 2030. The issue here is that such an obligation will result in additional costs on industry by compelling them to switch from cheaper natural gas to more expensive hydrogen. Additionally, the EU has applied a tight definition of what constitutes renewable hydrogen, which could increase costs further. To ensure the hydrogen is genuinely “green”, it needs to be produced off-grid during the limited periods when there is an excess of renewable electricity. By only allowing production within limited operating hours raises the cost of hydrogen, at least at the beginning of its development.
However, the EU is seeking to cover at least part of the cost gap through its own subsidies and has recently launched a new European Hydrogen Bank which will run auctions to finance the most competitive hydrogen production.
While many investors will no doubt appreciate government intervention, there are others that take a bolder approach. As a prominent figure in hydrogen financing and a leading speaker at World Hydrogen Week, Peter Van Ees, Sector Banker, New Energies and Hydrogen at ABN Amro says: “From my viewpoint, it’s too easy to simply ask governments and tax payers to fix this issue. We make sure all our customers understand that uncertainty is part of the opportunity. If all this was low risk and predictable, everybody would be doing it. We can discuss what is needed from others, but the main kickstarter is entrepreneurship and just get going with what we have. And actually, we already have quite a lot!”
Trading versus fading
As there is currently a very limited merchant market for trading hydrogen or hydrogen derivatives, producers are facing a significant challenge when seeking to take out futures contracts to guarantee a price for their hydrogen. Banks remain skittish around the potential size of future revenue and in order to resolve this, projects requiring financing need to have “bankable” offtake schemes in place, often with offtake agreements in other market sectors where hydrogen – such as petroleum refining or ammonia production – has proved itself at scale. Continued success in these industries would also go a considerable way to proving that clean hydrogen is genuinely viable and encouraging the scale-up and adoption of electrolyser technology.
In addition to offtake security, financiers have to account for technology risks, major infrastructure challenges – such as storage facilities, delivery pipelines and liquefaction plants – as well as sufficient sources of water and renewable energy as feedstock. And these risks need to be allocated in a way that project financiers understand. Financial institutions need to be confident of loan repayments which can take the form of predicted revenue streams, along with other vehicles such as collateral asset packages serving as security, insurance backing, and “on-time” delivery contract agreements.
Conclusion
While from an economic viewpoint, the immediate future of clean hydrogen might have an uncertain pathway and not insignificant financial challenges to overcome, progress is still being made. Having been largely dismissed in the early stages, it is now widely accepted that it will have a major role in the energy transition. For the latest critical insights on the hydrogen state of play, the global opportunities and challenges and to better understand the real potential for clean hydrogen, there is no better venue than the annual World Hydrogen Week due to be held in Copenhagen in Autumn 2024, where over 3,000 world-leading developers and investors will meet to accelerate the hydrogen future.
[1] IEA: https://www.iea.org/energy-system/low-emission-fuels/hydrogen and Global Hydrogen Review 2022; IEA
[2] Hydrogen Insights May 2023; Hydrogen Council, McKinsey & Company [3] As above [4] As above [5] As above
[6] Hydrogen Insights May 2023; Hydrogen Council, McKinsey & Company
[7] Utility Dive; Green hydrogen prices have nearly tripled as energy costs climb: S&P
[8] Utility Dive; The Inflation Reduction Act upends hydrogen economics with opportunities, pitfalls
[9] Utility Dive; The Inflation Reduction Act upends hydrogen economics with opportunities, pitfalls
