China's largest green hydrogen project stores 210,000 cubic meters of hydrogen. Photo credit: VCG via Getty Images
The United States is about to build dozens of clean industrial projects, from green ammonia to sustainable aviation fuel. And to take these emerging technologies from plans and projections to the construction phase requires financing.
Take SAF, for example. There’s real enthusiasm for the nascent commodity — even if SAF is currently used for only 0.1% of U.S. jet fuel and needs to scale a hundredfold by 2030. United Airlines agreed to buy 50 million gallons per year of SAF from Cemvita over 20 years, and Microsoft announced a 10-year SAF deal with World Energy. But supply must catch up to this burgeoning demand, which means that developers are no doubt in the midst of conversations about how to get their projects funded, and fast.
Project finance allows a small team of experienced developers to raise billions of dollars — primarily via bank loans — using legally-binding contracts for everything from revenues to supplies, and construction to insurance. Though every project is uniquely challenging, many share common financing barriers.
To identify these, RMI surveyed 10 projects in development across the Southern California and Gulf Coast industrial hubs, and broke them down into standard risk buckets: technology, offtake, construction, feedstock, and regulatory risk. Technologies included hydrogen, ammonia, methanol, SAF, cement, and steel, while sponsors varied from venture-funded start-ups to consortia of industrial conglomerates with market caps of over $100 billion.
As we ranked and mapped each unique project’s risks side-by-side, some patterns emerged.
Offtake is perhaps the most important contract for an industrial project since it determines how much revenue a project will generate — and therefore how much a bank can lend up-front. The market lacks transparency on revenue contracts, especially on those where offtakers are also equity co-investors.
Banks and private equity investors will want offtake contracts to guarantee tenor, price, and volume as well as investment-grade counterparties, among other things. The problem is that commodity markets for hydrogen, ammonia, methanol, SAF, and green steel are new and rapidly evolving; projections are difficult to make, let alone verify.
Hydrogen and SAF offtake contracts are in the works –– even if details are scarce and crucial tax credit rules aren’t yet finalized. And sustainable steel and cement are poised to come next. But offtakers today have to strike these deals with imperfect information. To find comparative data points, companies will need to scour commodity purchase and sale agreements disclosed to the SEC, attend industry events, and monitor listed frontrunners’ investor presentations.
And offtake announcements also generally lack details on feedstock and carbon intensity, such as whether a SAF project’s carbon dioxide feedstock is biogenic or fossil-based. Aside from being bad for the climate, higher carbon feedstocks may also result in a finished product that is ineligible for tax credits, throwing off the entire project’s economics.
Given this lack of clarity, neither buyers nor sellers want to lock themselves into long-term contracts that will be uneconomical in a few years. But offtake opacity is no excuse for inaction.
The U.S. power sector solved for this tension using innovative “collar” features in contracts that lock in target ceiling and floor prices, for example. Similarly, where firm offtake isn’t always available, financiers can still disburse loans but include “hedge toggles,” which substantially increase the interest rate if the project does not meet certain offtake criteria.
For industrial project financing, feedstock may be as important as offtake — it determines both a project’s location and economics.
SAF is a prime example. SAF plants generally use either woody biomass or cooking oils. The former generally have to make sure the biomass is located within 100 miles, whereas the latter could import feedstock from as far away as India.
And ESG-conscious investors — European pension funds for example — often want stringent supply chain transparency and governance. SAF plants, for example, would have to certify that oils are truly waste feedstock rather than extracted from virgin palm.
It’s important for feedstock contracts to be strong and to share risk fairly between buyer and seller. Investors will not fund a project whose feedstock contract allows a supplier to cheaply exit their obligations, and instead supply higher-paying rival projects nearby or even opportunistically tap the spot market.
Investors will also scrutinize projects that want to switch feedstock in the future. An eFuels producer may plan to start operations using blue hydrogen as an input before switching to green hydrogen down the line. Lenders will want to know how that technology and feedstock switching will impact project costs and tax credits.
De-risking first-of-a-kind clean industrial projects in the U.S. will likely involve using federal funding via loan guarantees, grants, or tax credits. The Inflation Reduction Act’s tax credits are by far the largest pool of public funding for industrial projects — but accessing them won’t always be straightforward.
Large project developers with taxable income in the U.S., such as fossil fuel companies, may be able to use tax credits to offset their tax bills. But what about smaller companies whose projects’ tax credits may dwarf their own taxable income by an order of magnitude? To make their projects economic, they’ll need to sell their tax credits — but to who and on what terms?
Renewables have been mostly financed in the U.S. via complex, relatively expensive tax equity deals with roughly a dozen Wall Street banks. And the supply of tax credits has exceeded demand; the few banks who can provide tax equity can extract high returns.
But going forward, the sheer volume of industrial tax credits will require more tax investors. Fortune 100 companies like Silicon Valley technology giants can work with their banks, law firms, and tax equity advisors to buy transferable industrial tax credits on attractive terms, similar to how renewables tax credits are already being transferred. The rise of the tax credit transfer market for manufacturers is a good sign for the industrial sector: tax credit buyers are getting comfortable moving beyond wind and solar projects.
Despite many emerging tech projects being first-of-a-kind, the individual sub-components are often technologies that have been placed in operations somewhere in the world. The “technology risk” for investors rests in how different technologies are layered together in the same project.
For instance, SAF investors know that hydrogen electrolyzers will work; they just haven’t seen them set up to create syngas (a mixture of carbon monoxide and hydrogen) as a downstream output of SAF conversion before. Project developers will need strong insurance, solid operating track records, and airtight engineering, procurement, and construction (EPC) contracts.
Several enterprising start-ups are using grants and venture capital to develop billion-dollar projects, but are struggling to raise later rounds of equity. Venture capital generally prefers software to hardware; private equity funds avoid project development risk. A small start-up building a single asset in a niche market with technology stacked in a novel configuration has an especially tough time.
But these small developers have options. They can first bring in equity co-investors such as offtakers, suppliers (of power, equipment, and feedstock), EPCs, and large foreign industrial conglomerates. Resources like RMI’s Industrial Investor Database can help companies find potential partners.
And smaller developers may further entice private equity by developing multiple projects in different markets.
Ultimately, successfully bringing emerging climate tech projects to market will require learning from the strategies that have worked for others. It’s tempting to think that every industrial decarbonization project is different: on its surface, a SAF plant in Louisiana may not have much in common with a green ammonia facility in California.
However, our financing diagnostics shows that overcoming just five key hurdles — offtake, feedstock, tax credit, technology, and permitting — can unlock the private finance needed to move from first projects to scale.
Shravan Bhat, Hartej Singh, and Julia Thayne work on industrial decarbonization at RMI. RMI’s Asia Salazar also contributed to this research. The opinions represented in this contributed article are solely those of the author, and do not reflect the views of Latitude Media or any of its staff.