Hydrogen’s Chicken, Egg Quandary Has Financers Flying the Coop

In hydrogen financing, there are plenty of chicken and egg paradoxes, chiefly surrounding demand and making offtake agreements. But bringing home the bacon may be the most vexing problem.

Few dollars are being put into actual projects in the U.S., according to a panel of experts speaking on financing in the hydrogen sector.

“Everyone talks about investing in hydrogen and very few people actually do it outside of big strategics and some technology plays like electrolyzers [and] fuel cells,” Sean Shafer, managing partner for Energy & Industrial Advisory Partners, said June 28 during the Hydrogen Technology Expo North America conference in Houston.

The refrain is familiar, added Brian Hodges, a partner with Aurum Capital Connect.

“It’s too early. It’s too small. We don’t have all the pieces in place yet,” he said. “But there is a gigantic pool of capital out there, whether it’s traditional banks, financial institutions. You’ve got sovereign wealth funds. Literally, everyone and their dog is interested in this space. But it’s just that. We see a lot of MoUs [memorandum of understanding] getting signed. …We’re on the cusp or right there, [but] there aren’t massive amount of dollars flowing into the space.”

Hydrogen backers are banking on it to help decarbonize a fossil-fuel dependent society. Hydrogen’s flexibility and near-zero greenhouse-gas emissions (GHG) make it one of the must-haves to hit net-zero targets. Hydrogen can be used for energy storage, for feedstock and as fuel.

However, despite its potential and a slew of government incentives, demand uncertainty and need for more offtake agreements have slowed growth. Risks at the moment are plentiful, experts say.

The gamechanger, at least in the U.S., could come when federal guidance is released on the 45V tax credit, according to Tanya Peacock, managing director for EcoEngineers, an energy transition firm. The production tax credit (PTC) awards up to $3/kg of hydrogen produced for projects with GHG emissions intensity of less than 0.45 kg of CO₂ per kilogram of hydrogen. The rules are not set yet, and the carbon intensity of upstream inputs could impact the pace of development.

Waiting three or four years for a new wind or solar project to be connected to the grid before even starting to finance a hydrogen project pushes into the PTC timeframe, she said.

Policy is not the only holdup; there is also uncertainty brought on by politics, says Roxana Bekemohammadi, founder and executive director of the US Hydrogen Alliance.

Everyone is not on the same page, and politicians have their own agendas, she said.

That may or may not bode well for an industry that had a single-year infusion of $22.5 billion from the federal government alone—by her estimates— while not knowing what the future holds. And hydrogen is being met with opposition from some environmentalists.

Assessing risks

The biggest factor impacting hydrogen is offtake, Shafer said, adding infrastructure funds want to see five- or 10-year contracts with creditworthy offtakers.

“There’s just not really the volume of demand to justify those and/or the people who are going to buy the hydrogen are not creditworthy,” he said. “So that’s a huge kind of chicken-and-egg problem that I don’t know exactly how we crack.”

The material handling and transport segments, along with existing gray hydrogen users, could fuel demand for green hydrogen, Shafer said. That includes basic needs such as forklifts and transport, Shafer said, adding, "everyone is chasing mobility,” but hydrogen fleets won’t be adopted without consistent hydrogen supplies.

Another chicken-and-egg type of problem involves debt. Debt providers that underwrite debt hydrogen projects are considering it but not yet acting, he said.

Plus, “there seems to be a lack of middle capital to get smaller companies to get their projects more baked, where they can have the creditworthy offtakers…and write the big checks,” Shafer said. “One of the reasons is they’re worried about losing all their capital: There’s no downside protection right now in the industry.”

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By the end of January 2023, the hydrogen industry had announced plans for more than 1,000 large-scale projects—more than 1 gigawatts (GW), Hydrogen Council data show. The announced projects require direct investments of more than $320 billion through 2030. Only $29 billion has passed final investment decision (FID).

Costs are another concern, particularly for green hydrogen. Offtakers could be locking themselves into a “green premium,” paying more today when cheaper alternatives exist.

“Unless they’ve got an ESG mandate that their shareholders are dictating, ‘No, we don’t care about the profits as much as we do about the mandate,’ ...You’ve got some companies that are going ahead with that leap of faith, making the assumption that costs will come down, which they will,” Hodges said.

Like other panelists, he agreed offtake agreement and offtakers’ creditworthiness are among the challenges for hydrogen’s bankability.

“If you’re not an Exxon Mobil, a large integrated, publicly-traded company with a multi-hundred, billion-dollar balance sheet, it’s a ‘no, thank you,’” Hodges said. “But that’s where you see these policy initiatives stepping up. The DOE [Department of Energy] has been very active in financing some of these projects to the tune of multiple hundreds of millions of dollars per project.”

Looking up, facing resistance

It’s not all doom and gloom. Peacock turned to opportunities. Utilities could be the stable, long-term offtaker the industry needs, she said.

Utilities entered long-term, high-price contracts in California, she said, referring to the state’s renewable portfolio standards. Contracts for renewables advance those energy sources with procurement requirements for California’s load-serving entities. A similar arrangement could help hydrogen.

“These were even 20- and 30-year [renewables] contracts. We’re only talking about 10-year contracts” for hydrogen offtake, Peacock said.

The rule helped commercialize the wind and solar industries and brought prices down, she said. Hydrogen could follow a similar path.

“California has a renewable gas standard, which is similar to the renewable portfolio standard in a way, because it requires the gas utilities to buy increasing amounts of, right now, it’s biomethane,” Peacock said. “But the intention is that it includes hydrogen down the line,” providing an opportunity for utilities to become that “stable offtaker with a strong balance sheet to de-risk some of the projects.”

Politics, however, often get in the way of policy—even within the same political party.

“Essentially, we could show the science, we could show the economic impact, the job creation numbers, and we could probably get some policies through,” Bekemohammadi said. “This year, it’s been quite difficult, especially during midyear, for us in the legislative sessions because the environmental community is attacking hydrogen very strongly. Right now, definitely, there is no room for logic.”

She added that some Democrats can’t be convinced to support hydrogen, including at the state level. That could impact efforts to develop hydrogen hubs. “They actually can have a hydrogen hub that’s being developed and encouraged by DOE, but then they’re running state policies that are not supportive [and], if anything, detrimental to any hydrogen activity…I don’t know how the industry moves forward until these policies are harmonized.”

Who’s investing?

Though FIDs are slow going for hydrogen as the industry awaits clarity on incentives, early investors are moving forward.

Large corporates, especially those with large venture arms, are the most active, Hodges said. He recalled how Airbus Ventures invested in Universal Hydrogen. American Airlines and JetBlue Ventures followed. That follow-the-leader mentality isn’t necessarily a bad thing.

“But having the big corporates putting their money where their mouth is—not just because of the ESG mandates, but because it makes sense for their business, I think that’s a good thing,” Hodges said.

Early stage, pure-play startups that haven’t passed proof of concept are getting funded by friends and family, he said, before institutional investors come in at Series A and Series B. Firms like Temesek and BlackRock pull together decarbonization partners, he added.

“There’s a number of these funds out there. There are coalitions of like-minded investors that have a shared vision….That said, have they deployed a lot of capital? No,” Hodges said, “but there are absolutely instances where that’s happened,” often where there is a creditworthy offtaker and a clear path toward cash flow and revenue.

Deals are getting done, especially on the technology side with electrolyzers and fuel cells for example, Shafer added.

The investors include Big Oil, or rather long-time energy players.

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What’s missing, Shafer said, is capital for the developer who needs, say, $5 million or $10 million to make the project more attractive enough for an infrastructure fund to invest hundreds of millions more.

“The problem is, and I tell this to infrastructure funds every day, if you keep waiting for that project to get so big, it’s not going to exist because either the guy is going to go bankrupt or Exxon Mobil is going to swoop in and take it off of you,” he said. “If you go ask Exxon Mobil, ‘hey, you want to invest with us?’ Outside of very rare circumstances, they’re going to say ‘why? we don’t need you. Yeah, we’ll go invest with Chevron, not you,’ because they have a much lower cost of capital than an institutional investor.”