This piece of external commentary is based on RMI’s hydrogen finance roadshow, which took place earlier this year as a part of the Mission Possible Partnership coalition’s U.S. Hubs program, in partnership with the Bezos Earth Fund.
Hydrogen investment is stuck.
Most of the billion-dollar-scale clean hydrogen projects announced in the United States since the Inflation Reduction Act was passed remain too nascent — and too risky — for private financial institutions to meaningfully perform due diligence on them, never mind fund them.
This message came through repeatedly during a “hydrogen finance roadshow” conducted earlier this year with a dozen large investors, with assets under management totaling over $25 trillion. In one meeting, one private equity group preparing a more than $5 billion-dollar clean energy and infrastructure fund said they would allocate around just $100 million to hydrogen. That’s just 2% of that fund’s pie.
There are several reasons why financial institutions are viewing clean hydrogen and its derivatives (ammonia for fertilizers, e-methanol for shipping, and synthetic jet fuel, for instance) as too risky. Many bankers can rattle off hydrogen’s largely unmitigated risks in a single breath: lack of electrolyzer performance data; equipment and feedstock (water, nitrogen, clean power) availability concerns; policy uncertainty; inexperienced and/or undercapitalized sponsors; a dearth of full-wrap engineering; procurement, and construction (EPC) contracts; and more.
But the biggest risk by far is the lack of high-quality offtake arrangements. Bankers are inundated with speculative, early-stage projects that have incomplete marketing plans.
“It’s unclear who is even going to buy this stuff, never mind at what volumes or prices,” said a bulge-bracket investment banker during the roadshow.
While the lack of credible offtake is not new, bankers crystallized two deeper offtake issues: undervalued molecules and the necessity of international trade to support long-term project viability.
Undervalued clean hydrogen
In general, neither offtakers nor financiers seem to be fully crediting the ancillary benefits of clean molecules beyond just their energy use.
It feels reminiscent of early battery storage deals: aside from power and capacity, grid-scale lithium-ion batteries also provided a stack of ancillary services such as voltage control, frequency regulation, peak shaving, and black-start. But because there weren’t markets for those services, projects and investors couldn’t initially monetize them. In the years since, ancillary service markets for batteries have emerged, facilitating the sector’s growth.
Similarly, today’s e-methanol or e-ammonia from a plant that satisfies prevailing wage requirements, revitalizes an under-resourced community, or sources 24/7 clean electricity should command a “greenium” because it is a premium product. A long-term clean molecule contract — for green hydrogen or for anything else — offers the offtaker new risk mitigation strategies by diversifying exposure to commodity market volatility, insulating against future regulations tightening, and protecting the buyer from carbon market uncertainty.
Clean molecules also create new sources of value that can be leveraged into market opportunities. For example, buyers may pass the value of the clean product further downstream, allowing their customers to decarbonize their supply chains without the risk of greenwashing.
But to make this happen on a wider scale, the market must align around the full value of clean molecules so that those higher revenues can mitigate today’s project risks.
In the absence of trade
Meanwhile, for the market to truly mature, clean hydrogen and its derivatives will (and should) be globally traded commodities — which adds both opportunity and complexity.
While smaller-scale, more domestic projects with concentrated risk exposure are stalling, banks are seeing a more credible pathway to bankability for projects that are planning to export from the U.S. Gulf Coast to offtakers in Europe or East Asia. For instance, several bankers flagged potentially bankable offtake for clean ammonia from Japanese coal co-firing. The role of those coal projects in achieving banks’ long-term net-zero commitments, however, remains uncertain.
And international trade also generates an additional set of open questions for project developers. For instance, should an export project configure itself to capture European subsidies or Japanese incentives? Would doing both jeopardize its 45V eligibility, exposing it to too much regulatory uncertainty? Should a project diversify offtake across multiple regions, clients, and end-use sectors by co-locating in a clean industrial hub to share common midstream and export infrastructure?
Banks can and should help future projects answer some of these fundamental questions to ensure projects get much closer to bankability than the ones coming across their desks today.
Expanding the hydrogen market’s tent
Lowering perceived project risk increases credible demand for capital and is one key part of bringing down the cost of capital and accelerating investment. The other part is increasing the supply of capital by bringing more investors into the hydrogen market.
Most banks today are insufficiently incentivized to allocate resources to understanding the market, in part because the deals that’ll generate their fees are years away from coming to fruition. But first-mover banks can pioneer novel financial products, convert advisory mandates into lead arranger roles sooner to diversify risk across deal syndicates, and corner new end-use sectors, clients and geographies. And the clean hydrogen market represents an opportunity to move first.
Bringing new banks into the market requires multiple teams within banks (including sustainability and energy transition groups) working in unison to quantify projects’ risks and rewards — and ultimately to make the investment case to their credit committees.
Increasing the supply of (and demand for) hydrogen dollars more broadly requires coordinated engagement between financial institutions, project developers, and policymakers. Connecting credible first-mover investors with credible first-mover projects before and during project contract negotiations will make the market more efficient. That engagement is coming.
RMI and the Mission Possible Partnership, for instance, are mobilizing buyers’ clubs and market mechanisms to aggregate demand and tee up bankable offtake contracts. We are sizing greeniums — and more importantly, identifying who is willing to pay them. We aim to “roadshow” development-stage projects within regional hubs to established, hydrogen-focused investors to create a recurring bankability feedback loop that “pre-banks” key contracts before they’re signed. We are also connecting the Hydrogen Demand Initiative with the financial sector to support design of the U.S. Department of Energy’s up-to-$1 billion demand-side incentive.
The 45V caveat
RMI has also been supporting policymakers and industry to find pathways to enable grid-connected electrolysis to qualify for 45V, and working with companies to build the ecosystem required to enable compliance.
Cracking the code of renewables intermittency will not only support the hydrogen industry, but unlock the wider clean-firm electrification necessary for banks to achieve their net-zero goals. The key to that lock involves strategic buffering, forecasting, and flexibility.
In the meantime, uncertainty around the 45V tax credit’s hourly-matching requirements remains a key barrier to hydrogen investment: the up-to $3 per kilogram 45V subsidy could go a long way towards making green hydrogen (currently priced around $5 to $12 per kg) as cheap as gray hydrogen (currently closer to $1 to $3 per kg). Even though project finance bankers in the U.S. are seeing many clean hydrogen deals using a variety of production pathways, many don’t expect to see those projects close financing at scale in 2024 or even 2025.
Business as usual won’t solve clean hydrogen project finance challenges. To make projects bankable, therefore, investors cannot simply wait on the sidelines. Just the seven federally subsidized hydrogen hubs alone will require $40 billion in private investment, which corporate balance sheets alone cannot shoulder.
Never mind the climate finance prize, the project finance prize is too big to ignore.
Shravan Bhat, Nabil Bennouna, and Valeriya Azarova work on financing industrial decarbonization at RMI. 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.
