US hydrogen financing faces project bottlenecks

Financing for new clean hydrogen projects in the United States is flowing less rapidly than hoped for as bottlenecks are addressed and policies put into action.

The U.S. Internal Revenue Service is reviewing the details of the clean hydrogen tax credits (Source: Reuters/Andrew Kelly)

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Final investment decisions (FID), compared to the number of projects announced, are low. However, the Department of Energy’s (DOE’s) Loans Programs Office (LPO) – tasked with providing debt financing for large-scale energy projects – says it is seeing continued and robust interest from those in the hydrogen space.

Considering how long it takes to develop a project in a new industry and that subsidy programs, such as the Inflation Reduction Act’s (IRA’s) 45V tax credits, are still very new, the perception of slow development of the industry is unreasonable, according to the Director of the LPO Jigar Shah.

“For many, the 45V and some of these other components were very critical and they just passed in 2022. Average development cycles generally take longer than two years,” Shah says.

“When you think about how much progress these projects have made in less than two years, it truly is breathtaking to see how fast this is happening.”

The “irrational exuberance” when projects are first announced, is often followed by a more sober assessment when companies move into details such as feed studies and other complex development steps, he says.

“When we look at how many projects have been announced recently, we continue to see the marketplace being quite bullish, even if they are a little bit more mindful of just how hard it will be to get across this bridge to bankability,” Shah says.

Early- and growth-stage equity investment in energy start-ups in hydrogen related areas by region, 2018-2022

(Click to enlarge)

Sources: International Energy Agency (IEA) analysis based on Cleantech Group (2023) and Crunchbase (2023).

Bottlenecks to bankability

Technological development, geographic restraints, demand formation, and long-term uncertainty all play into financiers’ reticence.

In the United States, the IRA, which will offer Production Tax Credits (PTC) on a sliding scale depending on CO2 emissions of each project, is considered essential to finance the initial push to develop low-emission hydrogen projects.

However, the definition of low-emission hydrogen is still to be decided and until that piece of the puzzle is put in place – expected later this year – many projects are in limbo.

“We're waiting for the rules to be set, and some companies with announced projects appear to be waiting to make final investment decisions (FID) until the regulatory framework is clear,” says Brett Perlman, CEO of the Center for Houston’s Future, which is working to build the clean hydrogen ecosystem in the Gulf Coast.

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Gas and chemical company Air Products CEO Seifi Ghasemi echoed Perlman’s concerns during the company’s second quarter earnings call.

“We have done a significant amount of engineering on the North Texas project, but we are not going to make a commitment on FID on that project until the rules for the implementation of IRA are finalized,” he said.  

The release of the IRA money is just one of the many bottlenecks in financing an establishing industry in the United States. Infrastructure investment tends to come from relatively conservative lenders who are unwilling to pour large amounts of money into untested business models.

While the technology for hydrogen production and carbon capture is not new, the business models behind the engineering, procurement, and construction (EPC) of low-emission hydrogen projects are novel, leading to higher borrowing costs.

“We're seeing a premium of cost to capital several hundred basis points above what is likely needed to make these projects economical,” says Tom Baker, Managing Director & Partner at Boston Consulting Group (BCG).  

“In a perfect world, we'd love to see the cost of capital of clean hydrogen that was closer to solar and wind and battery storage, technologies that are now being deployed at large scale.”

Focus on developers

Investing in projects led by credible industrial sponsors and developers is a key to keeping risks and lending costs down, according to an analysis by the World Economic Forum.

The ‘developer model’ is becoming the front-running approach to hydrogen financing, the World Economic Forum said in its study ‘3 ways to accelerate financing for clean hydrogen projects.’

“Don’t pick a winning technology, but instead, pick a credible industrial sponsor or developer for investments,” it said.

Investments into parent companies help balance first-mover risk and reward, while government investment in tools such as contracts for difference (CfD) boosts investor confidence and spurs project financing, the study said.

At the consultancy KPMG, the solution is finding a balance between funding and financing.

On the funding side, the question is where the revenue stream is, while on the financing side, the question is whether the project is bankable, says the consultant’s Managing Director, Infrastructure, Capital Projects, and Climate Advisory Fred Morris.

Given today’s high costs, the current state of the tax code, and low demand for a premium product, banks are asking whether projects make economic sense from a returns perspective, Morris says.

Geography and project readiness matters, he says, with places like the U.S. Gulf Coast making more investment sense since the region has an installed customer base and low carbon storage costs.

“Are off takers willing to pay a premium if necessary? How strong are your offtake agreements? Who are the customers? How credit worthy are they? How secure are those contracts? That is what drives the financing,” says Morris.

By Paul Day