The push to net zero - Can project finance fuel investment in the Hydrogen market?

19 minute read
18 November 2021


Discussion of hydrogen fuel has become increasingly prevalent over the past few years. Hydrogen as a source of energy is not a new technology; it has been used as a fuel source for decades. However, the increased push to reach net zero targets, as highlighted in the Government's newly published 'Net Zero Strategy: Build Back Greener', has brought hydrogen back into popular discussion. New technological innovations look to be making hydrogen energy cleaner, cheaper and more accessible for industry. This may be opening new doors for the element.

Yet, continued and significant investment is required to bring hydrogen to the point of competing on a level playing field with other energy sources, such as natural gas or solar power. Hydrogen production is estimated to require between £3.5 billion and £11.4 billion in new investment by 2035 in the UK alone.[1]

How will this unprecedented scale of energy innovation investment be funded? Historically, groundbreaking energy technologies have relied upon significant government subsidies, supported by bankable project financing. Can hydrogen replicate the project finance model? If not, where will the money come from?

In this article we discuss the current funding model for hydrogen projects, the potential benefits of a project finance model and what other factors will be integral to the successful development of the hydrogen energy market.

Current funding of hydrogen projects - Equity, equity, equity!

The current funding for investments into hydrogen technologies is found largely in government or university research and development grants and corporate venture equity. This applies both to the creation of hydrogen energy (balance sheet funding by large industrials) and the technologies needed to use that hydrogen energy (i.e. hydrogen ready boilers, hydrogen ready cars).

There is very little hydrogen being funded through debt finance. Why is this an issue? It's a matter of scope and growth potential. Equity funding can only go so far, and has never previously been sufficient on its own to develop a scalable market in a renewable energy technology.

The role of project finance in energy

Obtaining project finance - the long-term non-recourse debt financing of a specific and capital-intensive project - is reliant upon a project being able to demonstrate that it will generate sufficient (future) cash flows to cover both operating and capital expenditures and its debt repayments.

This differs from corporate financing, where an established corporate stands behind the investment, serving as guarantor and security provider to whom recourse can be sought if project revenues are not sufficient to meet debt service obligations.

Project finance is attractive to investors. Leveraging a project with project finance can enhance equity returns, reduce the initial equity commitment of the sponsor (significantly below the project cost), provide an attractive risk allocation and attract tax benefits through interest-cost deduction.

Project finance of electricity projects is often backed by Power Purchase Agreements (PPAs): long-term agreements between independent power producers and public, or strong-covenant private buyers (off-takers), with fixed unit prices or floor prices. PPAs provide a project with an element of long-term price certainty.

PPAs have been the dominant solution to the need to create the long-term and secure stream of revenue necessary to make a project 'bankable' from a project finance perspective.

Can Hydrogen benefit from the Project Finance Model?

For a sponsor to secure project financing, they generally need a proven technology and an established customer base or creditworthy off-taker that can demonstrate a certain revenue stream.

Proven technology

Other renewable energy sources, such as solar and wind, benefit from their ease of use. Solar and wind generated electricity feeds into existing electricity infrastructure, without any need for changes or investments in new technologies.

Alongside the increasing attractiveness of solar generated revenue, costs of solar products have decreased substantially. Costs of PV systems fell by more than 70% between 2008 and 2017.[2]

Hydrogen, however, is an energy source that still requires significant investment; both in production (for example, developing effective and cost-viable carbon capture and storage facilities to accompany blue hydrogen production) and in delivery and use (for example, in getting gas infrastructure and networks, consumer products and energy storage ready to facilitate a hydrogen market).

An established customer base

Renewable energies, such as electricity from solar and wind, produce electricity that is easily sold into the grid, or into large corporates with substantial individual electricity needs. Further, the production of solar and wind has been subsidised and incentivised significantly through government regulation, creating a customer base willing to engage in long-term PPAs for its production.

Hydrogen does not have an established customer base. There is one growing - particularly among automotive and boiler manufacturers, ammonia agricultural players and gas companies looking to diversify - but each of these remains at early-stage viability testing.

Solar benefited hugely from government backing of a project finance model. The UK is not a natural home for solar energy production. You only need to spend a few weeks here one summer to see why! However, UK solar energy production has increased from 16 MW in 2006 to more than 13 GW in 2019. [3] By the end of 2020, the UK government had aimed to see solar PV panels in 2 million households and on 24,000 commercial rooftops, in addition to the establishment of 2,000 solar farms.[4] Future growth is predicted at a CAGR of 5% from 2020-2025.[5] There is now an established and mature market in solar energy production.

How did we get here? Between 2002 and 2017 the UK Renewables Obligations (RO) programme provided substantial support for large-scale renewable electricity projects in the UK.[6] The RO programme required UK electricity suppliers to source a proportion of their energy supply from renewable sources.[7] The RO programme issued certificates (ROCs) to accredited renewable generating stations for eligible renewable electricity generated. These ROCs were tradeable between operators and delivered to suppliers to demonstrate they have met their RO obligations. Failure to meet RO obligations resulted in a payment obligation.

Smaller scale generation of energy was also supported in Great Britain, through the introduction of Feed-in Tariffs (FITs) in 2012. FITs supported renewable energy production in the early stages of development by providing long-term guaranteed above-market prices for smaller levels of energy output. The scheme in Great Britain provided payments from energy suppliers to anyone generating electricity from renewable sources, including, for example, homeowners generating their own electricity through solar PV.[8]

As new projects are developed, there is now a healthy and self-sufficient market that is attractive to the most cautious of investors and project finance banks, without the need for on-going government subsidy and incentive schemes.

The UK Government has set out a roadmap for hydrogen as part of its Ten Point Plan for a Green Industrial Revolution and other related 2050 net-zero targets. This policy plan commits the UK to 5GW of low-carbon hydrogen production capacity by 2030. However, committed economic support, such as the UK Net Zero Hydrogen Funds and Net Zero Innovation Portfolios, focus on research and innovation grant funding to develop and improve low-carbon hydrogen technologies alongside significant (£4 billion) (as of yet undiscovered) private sector investment. The UK has not yet launched a subsidy or incentives programme for hydrogen production or usage that could support project financing.

Guaranteed revenue stream for Hydrogen?

As noted above, PPAs are the gold standard for project finance revenue, as they insure a guaranteed and fixed income; in contrast to selling energy on the merchant or wholesale markets, which can be extremely price volatile.

In recent months, PPAs for green hydrogen have begun appearing across the US and Europe.[9] PPAs for renewable energy production have exploded.[10] These green hydrogen PPAs allow corporates to "declare themselves as 100% renewable without the need to directly involve themselves in developing or acquiring renewable energy assets".[11] However, these models relate only to the supply of renewable energy sources for the production of green hydrogen, not to the off-takers of the green hydrogen produced.

The most likely sources of off-takers for hydrogen are the automotive and ammonia suppliers mentioned previously. If hydrogen fuelled cars were to capture consumer interest, it is possible to envisage a corporate PPA between a green hydrogen producer and a major automotive player. To date, however, sufficient market demand has not warranted a long-term hydrogen production agreement. There is also no spot-priced market for hydrogen. S&P Global Platts launched the first hydrogen price assessment in December 2019, but a truly liquid market for hydrogen prices is a long way off.

UK Government subsidies - Hydrogen Business Model

The UK Government recently launched its first consultation on low-carbon hydrogen, to develop a Hydrogen Business Model that will provide a revenue support mechanism for low-carbon hydrogen. It is proposing a bespoke contracts-for-difference (CfD) model to support hydrogen through its key barriers of high cost, technological and commercial risk, demand uncertainty, lack of regulatory structures, and lack of available infrastructure. [12] Through the CfD model, low-carbon hydrogen operators will be invited to apply for contracts at competitive auction, with the UK government providing subsidies through a reference to strike price differential payment. [13]

However, the Department for Business, Energy and Industrial Strategy (BEIS) has not yet set out how this CfD model will be funded, or the level of financial support that it would provide for hydrogen businesses. They have confirmed it will not involve a backstop 'off-taker of last resort' option where hydrogen producers are unable to find a route to market for their hydrogen outputs. In addition, the first subsidy contracts will not be awarded until Q1 2023. It is likely that the EU will also follow a contract for difference approach.

Role of export credit agencies for hydrogen?

Government guarantees through export credit agencies have stepped in to prop up burgeoning renewable energy technologies. Biomass has been largely set-up as a bankable industry, as a result of Danish Export Credit EKF backing of the biomass EPC operators. UK Offshore wind has also seen almost 60% of investments involving ECA input. Export credit could play a similar role in guaranteeing investment in hydrogen.

The ESG capital markets

One advantage hydrogen may have over other renewable technologies is the state of play of current capital markets. Whereas in the late 2000s when solar and wind were rising up, the capital markets remained deeply engrained in fossil fuels, now the rise of ESG, sustainability and climate change-awareness has created a new source of financing for 'green ventures'.

In 2020, green bond issuances alone stood at $269.5bn in issuances.[14] The ESG market as a whole is predicted to top $53 trillion by 2025.[15] If hydrogen can access these markets for financing it could see an influx of funds that were not accessible to other renewable energy technologies. Green bonds are a good early step for hydrogen, as they are not linked to off-taker revenue as a hydrogen project financing would be; they are supported by the strength of the corporate underlying the hydrogen production.

Plug Power Inc., a US hydrogen fuel cell provider, launched a convertible green bond offering to fund its hydrogen strategy in the US in May 2020, highlighting a potential addressable hydrogen economy market valued at $2.5 trillion in their bond launch presentation. In March 2021, Northern Gas Networks also tapped into the green bond market to fund their hydrogen transition, launching a £1 million, 1.6%, 10-year green-transition bond alongside Abundance, a UK crowdfunding platform.[16] In France, Air Liquide raised €500 million with a significantly oversubscribed 0.461%, 10-year Green Euro Medium Term Note.

How will you be affected by the developing hydrogen market?

The potential for innovation and success in the development of the hydrogen energy market will require a combination of corporate motivation, creative government policy and innovative financing. A funding model that is scalable and captures the ESG agenda, supported by government market building activities, is a pre-requisite for hydrogen to meet its potential as a player in net zero target ambitions.

Ultimately, Hydrogen projects will need access to bankable offtake schemes, but in the interim, there are opportunities for investors willing to explore more innovative financing models and ESG markets for up and running hydrogen deals.

If this article has raised a question you'd like to discuss with our banking & finance experts on the subject of project finance models, green finance and related-ESG issues, please contact Naomi Sander, Gareth Baker, Gus Wood or Nath Curtis. Our team of legal experts in ESG comprises lawyers from a range of disciplines who are fully engaged in developments around ESG. The team provides a wide spectrum of advice, helping clients to understand their responsibilities and identify where risks and opportunities may lie.


[1] Deloitte UK Energy: Investing In Hydrogen p5
[2] Solar Bankability Report 2017 p. 4
[3] United Kingdom Solar Power Market - Growth, Trends, COVID-19 Impact, and Forecasts (2021 - 2026)
[4] United Kingdom Solar Power Market - Growth, Trends, COVID-19 Impact, and Forecasts (2021 - 2026)
[5] United Kingdom Solar Power Market - Growth, Trends, COVID-19 Impact, and Forecasts (2021 - 2026)
[6] OFGEM: Renewables Obligation
[7] OFGEM: Renewables Obligation
[8] OFGEM: Feed-in tariffs
[9] Plug Power Setting the Precedence for Green Hydrogen
[10] Plug Power Setting the Precedence for Green Hydrogen
[11] Plug Power Setting the Precedence for Green Hydrogen
[12] Design of a business model for low carbon hydrogen
13] Design of a business model for low carbon hydrogen
14] Record $269.5bn green issuance for 2020: Late surge sees pandemic year pip 2019 total by $3bn
[15] ESG assets may hit $53 trillion by 2025, a third of global AUM
[16] Northern Gas Networks offers opportunity to invest in a greener future

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