Getting H2 right

Forming project consortia reduces risk

Traditional private sector energy and infrastructure projects source only 20%–40% of total financing from equity, which can make optimising debt finance key to a project’s capital structure. 

There are three primary risks that can be mitigated by forming hydrogen project consortia:

• Construction risk (deliverability) – Infrastructure projects face the most significant risk during the construction phase. If the project runs over time or budget, it will defer initial revenues and the ability to repay debt. Demonstrating deliverability is crucial to achieving not only debt funding but also equity and government support. Hydrogen projects represent a new form of construction risk for many financiers in the sector. Lenders will need to get comfortable with EPC guarantees and equipment warranties relating to first-of-a-kind projects. Some comfort may be taken by EPC or OEM parties having a direct equity stake in projects.
• Technology risk – Electrolysers (alkaline and increasingly PEM) are proven technologies but primarily at a small scale. Financiers will focus on the performance of these technologies as projects grow in scale and the number of operational case studies increases globally. If the technology does not perform to at least the standard projected in the base case financial model, the project will not be viable, so financiers will rely heavily on the opinion of technical advisers and the ability to stress-test key technical assumptions such as efficiency, losses and degradation.
• Market and offtake risk – Long-term, stable cash flows from creditworthy counterparties will remain paramount to financiers. The hydrogen market is yet to emerge as a tradeable commodity market such as LNG or electricity, meaning the commercial structure surrounding offtake is critical to ensuring guaranteed revenue at a time when newer projects can benefit from the declining cost of key equipment. This places a strong focus in the short term on the role of an offtaker in underwriting some or all of the hydrogen produced at a fixed or pegged price for a significant period of an asset’s economic life. It is likely that debt financing will be sized on these parameters if gearing of >50% is to be achievable.  Because of the modular nature of electrolysers, the forecast increase in hydrogen demand and the reducing capital costs (per MW capacity), hydrogen projects are likely to be developed in stages.  Depending on the project consortia, each stage may have a different offtake arrangement and contract structure (e.g. long term, short term, take or pay, fixed volume, domestic supply, or export supply).

For investors, the complex supply chain considerations for hydrogen projects present more challenges than common infrastructure assets. Many hydrogen export projects under development in 2021 have formed consortia bringing together the requisite industry knowledge, skill sets and delivery capability. We have observed companies like Stanwell, Origin, Fortescue Future Industries, Province Resources and Total Eren forming strategic partnerships with offtakers and value chain participants, such as IHI, KHI, ENEOS, Marubeni, Iwatani and others.

Partnering with a credible export party improves investor confidence

Ideal export partners have strong creditworthiness with existing knowledge and skills in related industries. This makes them well placed to guarantee their component of project delivery and operational efficiency, bolstering investors’ confidence. 

These partners have tended to emerge from jurisdictions with strong policy commitments to a green hydrogen economy and have a vested interest in the progression of the wider industry.  In some cases, the export partner may be the offtake party or may develop a ‘back-to-back’ offtake arrangement with a trading partner or industrial user in the export country.

Offtake parties provide financiers with assurance over revenue

At present, hydrogen has multiple uses and no liquid traded market. With no merchant market, projects will require a bankable offtake arrangement to be financeable. To give confidence of the returns the project is likely to achieve, a project will need clear end-use markets and customers, and certainty of volume and price.

Domestically, displacement of grey hydrogen or use of clean hydrogen in gas blending may be among the first opportunities to be financeable given the existing downstream infrastructure and market. For export projects, the end user may be separated from the party providing guarantee of offtake. An example of this could be a consortium member that may provide volume and price guarantees to the project but may sell the hydrogen to a variety of changing domestic customers. In this case, it is the role of this party to absorb price risk, potentially integrating earlier higher-cost hydrogen offtake agreements into a portfolio of new hydrogen projects to create a blended price average to maintain price competitiveness.

Strategic partners add value across the construction phase

A variety of additional strategic partners should be considered by project developers, depending on size, location and government stakeholders. These may include:

• EPC partners and renewable energy providers – These parties must provide guarantees of generation volume and key equipment availability, including pass-through warranties and credit support from technology suppliers. In the case of EPCs, construction delay risks can be mitigated with liquidated damages that compensate for the period of the delay. Hydrogen poses a risk as the extent of delay factors are still being understood by the market. For this reason, a credible EPC party (or multiple parties) is required for a project, with its credit support able to provide assurances to investors that delays or faults can be rectified without the project becoming insolvent. 
  
• Port authorities – A number of existing ports are being upgraded and new port infrastructure is being developed. Partnering or early engagement with port providers and operators is required to achieve appropriate access to port-side processing facilities as well as berths or buoy systems that are being proposed by a number of new liquid ammonia projects. This may include shared infrastructure to reduce the cost to the project.  
• Water authorities – Water is a key requirement for hydrogen projects. For owners aiming to draw from local fresh water sources or develop their own desalination infrastructure, engagement with water authorities will be needed to give financiers confidence of access to water.
• Other stakeholders – Local, state and federal government bodies are key for a variety of reasons; in particular, for access to grant funding, obtaining ideal land tenure, securing development approvals, and ensuring that projects meet regulatory requirements. Continued engagement with the traditional land owners and the applicable land councils for a project should also be prioritised.

Throughout our Getting H2 right series, we have looked at Australia’s path to building a competitive hydrogen industry, from getting the price right, and establishing a hydrogen-ready supply chain, through to navigating policy and regulation and engaging partners and offtakers. These success factors will need to be considered by project developers and investors as projects progress towards construction and operation. The factors remain essential for both individual projects looking to secure financing, and for the development of the wider hydrogen economy.