The solar market over the last five years tells the story of the power of economics in creating demand, and this could very soon also be the story of hydrogen.
A solar manufacturing boom in China from 2015 drove down module prices and enabled compelling solar auction results, first in South Africa, Brazil, Chile and Mexico, then by followed by a series of world record lows in the Middle East and Europe. This was the start of solar being not only competitive, but also cheaper than conventional power in many parts of the world. Once “grid parity” was reached, demand at scale was naturally unlocked, both for utility procurement and private offtakers. We see, in today’s growing corporate PPA market, clear appetite for 10-15Y offtakes, driven, inter alia, by carbon tax mitigation and increased ESG pressure on corporates.
In parallel, after several years of marginal levels of activity, clean hydrogen has now reached the top of the agenda for governments and corporates alike. As an energy vector having the potential of decarbonizing swathes of the economy out of the reach of clean electricity, it is one of the small number of options available to achieve the net zero targets: combustion of hydrogen does not involve any carbon emission, and hydrogen can be produced through electrolysis of water using renewable electricity. In addition, it can easily be transported and stored in gaseous form, and has much more in common, for example, with natural gas, with the upside of a low/zero carbon footprint. However, it is perceived as being expensive. Is there, therefore, a way to accelerate the clean hydrogen market today, so that market “parity” is reached without years of direct regulatory or government support? Reliance on government support is a steady, but generally costly, and, at times, slow path. And, as we have all witnessed in several instances, not devoid of risk.
In contrast to early stage solar, nascent hydrogen appears to have mobilised wide stakeholder support, whether it be governments, corporates or financiers, and its growth is anticipated to be explosive. While deployment over the last decade has been very limited, at less than 25MW p.a., 2021-2022 is expected to be the start of exponential growth as projects prompted by national strategies are put into implementation. Twelve countries to date have launched national hydrogen strategies and thirteen more countries are in preparation, including potential export titans like China.
Nowhere is the momentum for hydrogen more apparent than in the pipeline of projects announced to date, that totals to nearly 17GW to be commissioned between 2021 and 203, with more added every day. Most of these projects are located in Australia (6.5GW) or Europe (8GW). Europe alone has to date announced c.50 projects totaling close to 4GW targeted to be commissioned over the next 5 years, backed by diverse sponsors from diverse sectors. While ambitious, this 8GW pipeline still falls far short of the 40GW capacity targeted by 2030 under the EU Hydrogen Roadmap, which implies average installation volume of 4GW per year, or more than 28 times the installed capacity globally in 2020. This, in turn, provides momentum for a European hydrogen transport backbone, which today has the support of transmission grid operators across Europe. The European Hydrogen Backbone initiative published by eleven transmission grid operators in July 2020 anticipates a network emerging across ten European countries (Belgium, Czech Republic, Denmark, France, Germany, Italy, the Netherlands, Spain, Sweden and Switzerland) from mid-2020s onwards, leading to a 6,800km network by 2030 and 23,000km by 2040.
Figure 1 – Historical electrolyser installed capacity for hydrogen production by application
Source: IEA, last updated 26 May 2020
Figure 2 – Announced 2021-2030 hydrogen pipeline globally
Source: BNEF electrolyser projects database (April 2021). Large-scale projects soft-announced in Latin America have not been included.
Market acceleration is clearly needed to have any chance of meeting EU’s 2030 targets, and we have started observing initiatives going in that direction. It is in that context that HyDeal Ambition, a group of c. 40 industry stakeholders, came together. Drawing from the solar experience, HyDeal members share the common objective of working, in open architecture, towards a green hydrogen price of EUR1.50/kg delivered in Europe. This is, in essence, “green hydrogen parity”, or a price threshold low enough that green hydrogen becomes, combined with carbon pricing, competitive in Europe with most applications that today utilize fossil fuels. While transport and fuel cells often come to mind as a potential end use, the more compelling needs and volumes are anticipated in heavy industry that either already consumes hydrogen (e.g., refineries, having historically used carbon-intensive steam methane reformers for hydrogen production) or could, through equipment retrofitting and process change, convert to it (e.g., steel or cement manufacturers).
HyDeal Ambition and the EUR1.5/kg H2 target
The HyDeal Ambition initiative, conceptualised and developed by Thierry Lepercq (co-founder of Solairedirect, which was sold to Engie in 2015) in Western Europe offers an interesting case study for what a mature green hydrogen ecosystem could look like. HyDeal brings together companies covering the entire value chain, including renewable energy developers, electrolyser OEMs, EPC contractors, gas TSOs, industrial offtakers, investors, and lenders, supported by an advisory team. Cranmore Partners is the financial adviser advising the HyDeal initiative, with a focus on bankability and the likely evolution of financing solutions for large scale green hydrogen production projects.
The HyDeal Initiative is focused on a complete end-to-end solution for a green hydrogen ecosystem in Europe: Integrated solar PV and electrolysis systems, long term Hydrogen Purchase Agreements (“HPA”s), support to gas TSOs for the planning and implementation of dedicated hydrogen pipelines and, in the interim, blending solutions. A clear differentiator for HyDeal is the relentless focus on achieving a EUR 1.5/kg levelised cost of hydrogen (LCOH), which HyDeal participants view to be a threshold that, combined with the green credentials of the projects, can unlock large volumes of end user appetite. This intuition is validated by the bottom-up aggregation of likely volumes that HyDeal participants have demand for – in the several hundred kilo tons per year order of magnitude by 2026. Another strong cornerstone of this dynamic is the supportive CO2 pricing under the EU-ETS, and the significant increase anticipated in the coming years.
The components of LCOH for a green hydrogen project consist of (i) the levelized cost of clean electricity – the levels of which can be observed as outcomes to utility-scale PV tenders; (ii) electrolyser capex and efficiency; (iii) operating costs including transport; and (iv) cost of capital. Scale is key to unlocking competitive economics across all cost parameters. In terms of electrolyser capex and opex, a transformation is underway, as we will describe later in this article. Securing long-dated affordable financing is also key, requiring de-risked project structures. A combination of the above suggests the target EUR1.5/kg may not be far for large projects located in strong renewable resource locations with strong land availability and proximity to consumers – Southern Europe and North Africa being the most obvious starting points.
Electrolyser prices on significant downward trajectory
The recent auctions in Southern Europe that yielded a record low bid of EUR11.14/MWh in Portugal and EUR14.98/MWh in Spain, as well as most recently in Saudi Arabia of USD10.4/MWh, have already brought LCOE to the required levels, but would need to be replicated for the green hydrogen projects .
The key uncertainty, in the eyes of the market, is therefore the trajectory of electrolyser capex, and to a lesser extent, opex. Like in solar, anticipated cost declines would be driven by any number of factors common to manufacturing, including improvement in technology efficiency, material use efficiency, production time, fixed cost degression and unit procurement cost reduction through economies of scale.
It is crucial to highlight that electrolysers, particularly alkaline, are a mature and well-understood technology that have been in commercial use for decades, even if not at the “hydrogen economy” scale. One of the measures used to describe such cost decline is the technology “learning rate”—alkaline electrolysers for example exhibited a learning rate of 18% (+/- 13%) based on data 1956 through 2014.
Figure 3 – Electrolyser cumulative installed capacity and price development
Source: BNEF, Hydrogen Economy Outlook (March 2020)
An aggregation of hydrogen volumes forecast across publications from Shell, IRENA, IA, and the Hydrogen Council puts anticipated incremental hydrogen demand at c.15 million tons per year by 2030 (Figure 4), which would require additional 300GW of total electrolyser capacity. For comparison, the EU targets 40GW by 2030, and Chile 15GW. While 300GW may seem like a staggering volume in comparison to where the sector is today, note that solar today is firmly a 100GW+ per year industry.
Figure 4 – Aggregated Forecast Global Hydrogen Demand 2030 and 2050
Source: Cranmore research, IEA, Shell, IRENA and H2 Council projections. 1) Assuming 75% green hydrogen with electrolyser at 30% load factor and 65% efficiency, and 25% blue hydrogen at 60% load factor and 55% efficiency.
With c. 20GW est. installed electrolyser capacity as of 2020, an incremental 260GW (fig. 5) is a 23-fold increase (ie 3.5 doubling) – and even assuming the same 18% learning rate for each doubling of capacity, would see electrolyser capex fall by c.50% from 2020 levels. That said, there is also reason to believe that such learning rate has likely accelerated further with the electrolyser gigafactories in the pipeline today: ITM, in early 2021 completed the world’s first 1GW electrolyser factory; NEL will increase its production capacity from 40MW p.a. to 500MW p.a. by year end; and thyssenkrupp has announced plans for 1GW incremental production capacity.
Even without such capacity expansions, European electrolyser manufacturers have been widely reported to be shipping units at below USD1,000/kW today, decreasing significantly over the next 2 years, and Chinese manufacturers already at materially lower price points. This acceleration in learning rate had previously been observed in the solar industry, for instance, from 23.5% to 40% beginning from the 10GW cumulative production mark.
Figure 5 – Solar PV learning rate acceleration
1 Assuming constant since 2014, which is likely an over-estimation, as some of this capacity is likely to have been de-commissioned
2 As low as USD200/kW – source: BNEF
Source: ITRPV 11th Edition (2020).
Commercial and financing structures are emerging
As highlighted above, the HyDeal initiative focuses on a green hydrogen production technical concept consisting of solar PV plant and electrolyser (+ compression as needed). The inclusion of both renewable and electrolyser plants within a single entity mitigates project-on-project risks, and can be implemented under a single turnkey EPC contract. EPC contractors themselves take strong comfort from the fact that electrolysers, alkaline in particular, have been deployed for over 30 years in the chemical industry. In addition, electrolysers are compact and modular, with asset life and efficiency parameters that are, already today, well understood. While significant scale up of electrolysers, both in terms of production facilities and stack sizes, are underway, this is seen as evolutionary and can be due diligenced. In addition, O&M arrangements would be similar to that for a conventional power or renewable projects.
Key for lenders will be to gain familiarity with the market for green hydrogen in Europe, as it is starting to take shape, in parallel to robust HPAs. At initial stages, hydrogen volumes may be blended into existing natural gas infrastructure, with delivery of natural gas, and guarantees of origin to trace the sustainable production source of the molecules. However soon enough, gas TSOs will provide transportation services on dedicated hydrogen infrastructure. The HyDeal process has developed the key parameters of each of these contracts to support and accelerate the development of its participants’ projects. Long-term HPAs, which take inspiration from renewables and natural gas, will be key for bankability. Similarly, fixed-price, date certain, turnkey EPC contracts with appropriate performance obligations and LD regimes are taking shape.
In essence, therefore, the contractual structure of green hydrogen projects are already very similar to that of well-banked contracted long-term infrastructure or IPPs.
Figure 6 – PV+H2 Project SPV Contractual Structure
In addition to the above, a deeper understanding of the green hydrogen pricing in the medium term, insight into offtaker readiness, as well as specifics for large scale transport and storage are necessary, and have been anticipated and supported by the HyDeal process. What is clear, however, is that a compelling starting price point, plus the benefit of CO2 price savings, has already gone a long way in catalysing demand and shaping up bankability. In terms of hydrogen pricing under HPAs, natural gas and EU ETS carbon pricing become two natural drivers – and caps and floors will likely feature, to support bankability with floors, while mitigating offtakers’ exposure to carbon price hikes through caps.
The financing products for the projects with the above profile are being shaped, and it would not be surprising to see financings similar in style to those for projects similar in nature, adapted for the specifics of green hydrogen and its maturity, to emerge very shortly.
In parallel, the ability to deliver competitively priced hydrogen will allow for a deep hydrogen commodity market to emerge faster. A key objective will therefore be to pre-empt and shape the financing structures that may emerge as the initial hydrogen production projects mature, and the hydrogen market as a commodity deepens. This, we hope and trust, should happen more quickly in this case than in other industries given the urgency of climate change action. One can anticipate, as a next step, offtake aggregation schemes, with a portfolio of projects selling to a portfolio of offtakers, in parallel to the emergence of a hydrogen spot and medium/long term derivative market. Going concern corporate-type refinancings may also ensue.
While the tasks ahead, including in terms of shaping transport options, readying end users, and capacity building in every way, are significant, the speed with which the stakeholders and the market are mobilizing, point to a very fast-moving industry, catalysed by the urgency for climate change action. One thing is for sure: the shape of the energy market, and the hydrogen ecosystem, will be radically different from where things are now. And financing will undoubtedly be a key consideration in that transformation.
Written by Yusuf Macun – Managing Partner