‘Financing Clean Hydrogen in Asia and beyond: Catalyzing the development of this emerging industry’ is a report prepared by Castalia for the Asian Infrastructure Investment Bank (AIIB). This extract discusses the key risks for green hydrogen financing and how international financial institutions (IFIs) can utilize various financial instruments to best support the commercialization of clean hydrogen.
Assessment of risks and barriers
Hydrogen is an emerging clean energy technology and energy vector with many proposed use cases. There will be uncertainties as regard to whether hydrogen will be the most economical clean energy solution for each of the proposed sectors and use cases considered in the analysis. Commercial risks also need to be taken into consideration. Accordingly, a risk assessment was carried out with two elements:
▪ First, the competitiveness and economic viability of the hydrogen use case, production technology, or logistics engagement point was assessed in the short to long-term.
▪ Second, the commercial risk of the engagement point was assessed in the short to long-term.
Competitiveness and economic viability risks
The competitiveness and economic viability of each engagement point was assessed (hydrogen use case, the production modalities, and each hydrogen logistics method). The analysis focused on how each engagement point is likely to develop in the short- to long-term. The whole clean hydrogen value chain faces some degree of barriers and risks to full, mainstream commercialization. There will continue to be uncertainties as to whether hydrogen will emerge as the most economical clean energy solution all along the value chain. There are competing technologies and energy vectors that are also being steadily improved upon. For instance, competing battery electric technology, and battery size/weight is improving. In hydrogen storage, developments in long-distance electricity transmission from low-cost renewable energy regions to high-cost regions could change the economics of storing and transporting hydrogen. These are related to physical limits to clean hydrogen technologies, including:
▪ End-use—on-board storage constraints and the requirement for carbon feedstock.
▪ Logistics—low purity, low hydrogen content, and the involvement of fossil fuels.
Commercial risks
Even if hydrogen technology becomes economically competitive in the respective sectors and use cases, commercial risks will continue to be an important consideration. For some segments, the commercial risk will decline over time, as the particular use case, production modality, and logistic modality matures. The commercial risks, the mitigating factors, and the risk management approaches were identified.
Finally, financial instruments were matched to the engagement points according to their risk profiles. IFIs’ available financial instruments were determined.
IFIs could help catalyse the development and scale-up of clean hydrogen technologies. This can be done by providing early-stage capital and expertise, crowd in private capital, and de-risk investment. This in turn will support sustainable businesses (especially ones with high economic, social, and environmental benefits but limited financial returns), build credibility, and guide industry development in a sustainable direction.
IFIs offer a variety of financial instruments. In addition to concessional finance, technical assistance, and policy dialogue that are traditionally provided by IFIs to support the early stage development of clean technologies.
Framework for matching financial instruments to clean hydrogen engagement points
Venture capital: Venture capital is used for long-range opportunities where there is high risk of failure, but where large payoffs are possible if the business opportunity succeeds. Investors require a high-risk tolerance, and typically invest in a portfolio of opportunities. Venture capital can provide capital for relatively immature businesses engaging in high-risk business activities. Any one business is likely to fail, but successful businesses should provide returns high enough to make the overall venture capital portfolio profitable.
Venture capital in clean hydrogen will be most appropriate for overcoming risks and barriers associated with highly immature and unproven technologies. For clean hydrogen, these are all technological barriers where venture capital can fund research and development to potentially overcome these barriers:
▪ Immature technology (end-use and logistics).
▪ Alternative clean competitors (end-use and logistics).
▪ Large conversion, storage, or transport losses (logistics).
Ordinary equity: Ordinary equity exposes investors to higher risk. It can be used to support emerging opportunities in most locations. Ordinary equity can provide capital for relatively mature businesses that do not have a strong balance sheet. However, the underlying business activity should be well understood and sound in principle. Ordinary equity is most suitable for overcoming risks and barriers associated with technologically proven but commercially unproven business models. For clean hydrogen, these include:
▪ Limited commercial models or projects (end-use and logistics)—funding development and manufacturing of new commercial models (that may or may not be successful on the market)
▪ High regulatory barriers or standards (end-use and logistics)—funding efforts to comply with the standard by going through certification process, and providing operational runway while certification is underway.
Corporate finance: Corporate finance exposes investors to lower risk. It can be used to support emerging opportunities in most locations, backed by a firm’s balance sheet. Corporate finance can provide capital to mature companies that wish to invest in risky technologies. The strength of the corporate balance sheet will enable repayment, should the project cash flows prove insufficient. Corporate finance is most suitable for overcoming risks and barriers associated with technologically mature but commercially unproven business models. For clean hydrogen, these include:
▪ Off-take uncertainty (production) – betting on sufficient off-take demand, assuming that it is at least somewhat likely that future cash flows will be sufficient to cover repayment
▪ High cost of hydrogen fuel (end-use and production) – absorbing the extra costs of hydrogen fuel, assuming the cost is unlikely to shortly decrease to a viable level.
Project finance: Project finance exposes investors to lower risks, provided the appropriate structuring is adopted with sufficient certainty about cash flows. It can be used to support mature opportunities in certain locations where there are significant non-technological barriers to adoption. Project finance can provide capital for mature projects that can provide certain future cash flows, which will help repay the loan.
Project finance is most suitable for overcoming risks and barriers associated with commercially mature technologies and business models. For clean hydrogen, these include:
▪ Limited supporting infrastructure (end-use)—financing the supporting infrastructure to strengthen the ecosystem as a whole
▪ Long asset replacement cycles (end-use)—enabling replacement prior to typical replacement cycles, assuming there are economic, social, or environmental benefits associated
▪ High capital cost (end-use and logistics)—providing initial funding for capital expenditure for businesses with limited liquidity
▪ High cost of hydrogen fuel (end-use and production)—absorbing the extra costs of hydrogen fuel, assuming the cost is likely to shortly decrease to a viable level
▪ Slow scale up of renewable electricity (production)—providing project finance to renewable electricity projects.
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