Closing the financial gap for hydrogen in Australia

The clean and green hydrogen industry is pre-commercial: there is no merchant market for hydrogen, and bankable offtake is required to obtain project finance. Offtake is hard to secure because hydrogen is competing with existing fossil fuels in an environment of limited to no carbon pricing, and there is no established ecosystem to support hydrogen production, storage, distribution and use.

This means that government plays a key role to enable industry developments and to level the playing field, via direct funding and other economic and non-economic policy measures.

The good news is there is a suite of government funding announcements and policy developments. However, the seed funding provided to date by the Australian Government and jurisdictions has not proven sufficient to spur the required additional private sector investment. As we know, despite public funding rounds from ARENA and several state governments, very few projects have reached financial close. Deloitte notes: “Many projects are trapped in a bankability gap between offtake negotiations, persistently high electricity prices, and constrained supply chains” (Deloitte Access Economics, 2023: 7).

This delay in projects reaching final investment decision has been recognised by the Australian Government (2023: i): the recent State of Hydrogen 2022 report showed a comparison of Australian projects with other jurisdictions, and the Minister for Energy explicitly called out in his introduction that most of Australia’s project announcements are yet to reach final investment decisions.

So why is this? In discussions with our members and others, we have regularly heard that the main issues that have impeded the ability for the private sector to invest in hydrogen are:

• Hydrogen does not currently have an offtake at the scale required. The cost of hydrogen is much higher than current customers’ willingness to pay, even against rising gas prices. (This is of course directly related to not having a hydrogen industry at scale to begin with: cost competitiveness with fossil fuels will not happen without extensive government policy and subsidies.) Further, major industries that will use hydrogen to replace fossil fuels – such as heavy transport and steel – do not have existing infrastructure or expertise. The investment decisions of the ‘hard to abate’ sectors are long-lived, with a real risk of stranded assets.
• Hydrogen represents an entirely new energy carrier and supply chain, requiring a comprehensively reskilled/retooled ecosystem that needs to cover – and connect – different sectors of the economy. It is very difficult for investors to put together all the pieces required, including the various risks associated with the array of legislative and regulatory instruments and the deficit of a workforce where it might be needed. While similarities to the development of LNG, solar and wind power do provide salutary lessons in how we might proceed, they were nonetheless industries producing a known energy source, with existing uses (See also Craen, 2023). As noted above, there is no end use market for hydrogen as a clean or green energy carrier – the current market relates to fossil fuel hydrogen in its chemical capacity (such as to bind with nitrogen to make ammonia).
• The lack of coordination across the jurisdictions and across sources of funding is making investors’ decisions unnecessarily difficult. And it is not just hydrogen-dedicated funding but the broader funding envelope. The State of Hydrogen 2022 report (Australian Government, 2023: 14) identifies A$28.9 billion available for hydrogen from broader funds on top of what is said to be available for hydrogen specifically (A$6.3 billion). It is almost impossible for investors – particularly those from overseas – to make sense of the patchwork of approaches, authorities and conditions rolled into this figure. Given the task ahead and our relatively lower level of government support (compared with jurisdictions like the US) Australia should be seeking to be especially easy to do business with rather than constructing barriers to investment.
• Related to the previous points, the lack of experience of our own financial system to understand and accommodate the risks is chilling developments in hydrogen. This is not merely the usual uncertainty argument but goes to a more basic inability for financiers to even price the uncertainty and take more risk. The lack of projects itself leads to a higher cautiousness in lenders because they have not yet undertaken due diligence on a sufficient number of hydrogen business cases to engage further.

Current problems also include vastly increasing construction costs, equipment from international vendors that needs to meet different standards in Australia, and issues finding the workforce to complete projects. These are issues that affect each part of the supply chain.

Most of the issues experienced are not specific to Australia (McKinsey & Company, 2022; US Department of Energy, 2023: 68), and a lack of hydrogen offtake is always raised in international fora.

As an illustration of the various parties and risks with hydrogen projects, it is useful to unpick the financial structures that project developers and financiers are engaging with.

Major hydrogen projects are commonly expected to use debt-funded project finance. Project finance is traditionally used for complex energy and infrastructure projects, where the project is off-balance sheet for a parent company and the costs need to be recovered from an end user via an offtake agreement. The best case is a long-term, fixed price offtake contract with a credible counterparty. It is on this basis that bankers will finance projects.

The problems that arise for hydrogen projects are then:

• The significant uncertainty at different parts of the chain makes end-to-end financing challenging. Problems range from the inevitable (but still significant) matters for any major construction project in the current environment, to newer issues with integrating technologies for the first time and access to equipment within the required timeframe.
• The uncertainty and lack of experience are self-amplifying – ‘new’ technologies and risks (or integrated technologies) result in uncertain and cautious market observers and financiers. As observers stay cautious – to the point where they won’t engage with a project or consider new means of engagement – the experience stays ‘new’ and uncertain.
• The money only flows from the customer once the hydrogen flows, and yet the infrastructure required to produce, move and store the hydrogen may need to be built or repurposed. At scale, costs for new transmission pipelines, underground storage and purpose-built desalination plants can go to billions of dollars.
• As already noted, there is minimal demand for hydrogen – there is little to no hydrogen trading, and current users make their own (fossil fuel-based) hydrogen onsite. Once all risks are costed, the resulting price for hydrogen is much higher than anyone’s willingness to pay compared with the fossil alternative.

We build on demand side market mechanisms later; for now the issue is how governments can help package up investment cases and support risk management to get the market going.

We suggest that the Australian Government:

• Aims for clarity: Improve the long-term clarity in the pathways for hydrogen and its derivatives, as part of a resilient and net zero economy. An appropriately detailed refreshed NHS and implementation plan should meet this need.
• De-risks through public finance: Work closely with CEFC and ARENA to deploy appropriately scaled public levers that will crowd in and de-risk investment in hydrogen. This means more investment than the current A$300m for the CEFC, and follow-up packages to the Hydrogen Headstart. We have previously asked the Australian Government to underwrite demand through a revenue support mechanism (such as contract for difference) intended to incentivise domestic production of critical chemicals and metals that are of strategic and economic importance to Australia, such as iron, alumina, ammonia, urea, methanol and key derivatives (AHC 2023b). There also needs to be consideration of government underwriting and insurance of projects, including where projects may not see out their planned operating life or where their technology has been radically superseded.
• Builds attraction capability: Ensure all parts of the project development and investment chain, including local government and businesses, have the capacity to develop investor ready projects and raise capital. As discussed in Chapter 1, the sentiment we hear from many hydrogen players is that the complexity and uncertainty of the investment environment and the overall ecosystem (multiple states, regulatory differences, permitting within states) is making their decisions unnecessary difficult. There is a need for investors and other decision makers to recognise meaningful investments in new infrastructure and technology, and the current environment is not conducive to this. Government thus has a role to direct investors’ attention to the opportunities; to help create value propositions that investors recognise.
• Builds technical capacity: Improve the technical capacity of the emerging hydrogen markets to attract green investment and use public finance levers to de-risk investment and building new export markets. ?As noted by IRENA (2023: 71):

Regarding public finance, AHC (2023a) provided a response to the Australian Government’s recent Headstart consultation paper, where we said that the current and future iterations of Headstart should:

• Incentivise demand or assist project developers to manage demand side risk. This includes accepting a higher level of technology risk (to encourage orders from new providers), developing demand side policies, by supporting and funding common use infrastructure (particularly port side), by pushing for expanded program funding and clarifying how the existing suite of Australian government funding can support end to end project developers.
• Prioritise timeliness, to build momentum, to align prospective projects with the timelines for regional offtake (e.g., the Singapore tender, Korean auctions, the Japanese CfD scheme) and as a response to the investment challenge posed by the IRA.
• Avoid additional sources of risk for the bankability and financeability of projects, such as via claw back provisions.

The current and future funding should also propose industry-specific criteria to make the best use both the funding and potential applicants’ scarce resources to make a case. Further, consideration should be given to ARENA and CEFC simultaneously conducting due diligence on the shortlisted projects and promoting a ‘fast fail’ approach; that is, communicating that a project is deemed ineligible for the funding as soon as this is known rather than waiting for diligence on all shortlisted projects to be completed.

Overall, our recommendations on finance and investment are as follows.

Recommendation 4: Task the Net Zero Economy Agency to oversee an assessment of cost and clarify investment needs from the public and private sectors.

Connecting with the analysis recommended above, the Net Zero Economy Agency should oversee an assessment of the cost of the energy transition as a whole, and the capital reallocation required, and then a matching of public funding to de-risk qualified projects.

Within this, the Net Zero Economy Agency should oversee a review and schedule for the effective lives of key assets (as per application priorities) that may require fuel switching to hydrogen, and set policy to support replacement options and investment cycles.

Recommendation 9: Set hydrogen targets for 2030 and 2040, with a range for 2050.

Based on modelling undertaken by/for the Net Zero Economy Agency and the revised NHIA, the Australian Government should decide and announce domestic and export targets for hydrogen production for 2030 and 2040. Consideration should be given to industry specific targets, for example dedicated hydrogen production to support green steel production. Given the uncertainty about 2050 capability, any target for 2050 could be a range or guide. These targets should be set out in the refreshed NHS and also drive further financial packages and investment attraction activities, to match goals and delivery mechanisms in direction, volume and timing.

Recommendation 11: Support the refreshed NHS through a clear investment proposition.

The Net Zero Economy Agency should use the modelling and cost analysis from Recommendation 4 and the targets from Recommendation 9 to engage with DFAT, Austrade and the jurisdictional trade and investment offices to create an investment proposition to take to international markets. This work will need to be sufficiently funded and will also require clear coordination across posts, with reporting lines through to the Net Zero Economy Agency.?

Recommendation 31: Boost Australian Government ability to attract and deploy private capital.

Building on Recommendations 4 and 11, build capacity within the Australian Government to work more closely with the financial sector to better anticipate and manage roadblocks to deploying and re-allocating private capital, and to develop investment and value propositions that work to secure private capital interests and meet the Australian governments’ aims for the hydrogen industry.

Recommendation 38: Create a ‘one stop shop’ and case management to assist with funding and permissions.

The Australian Government should establish a ‘one stop shop’ approach to permitting support and packaging financial options for hydrogen and related low emissions infrastructure.

This should include a case manager within government to assist project developers and funders to tie all potential sources of support together, as well as assist in the coordination of planning and approvals.

Read the full report on our website: https://h2council.com.au/ahc-publications/

?

References

Australian Government (2023) State of Hydrogen 2022, Australian Government Department of Climate Change, Energy, the Environment and Water, April, https://www.dcceew.gov.au/energy/publications/state-of-hydrogen-2022 .

Australian Hydrogen Council (2023a) Consultation on the design of Hydrogen Headstart program, 3 August, https://h2council.com.au/wp-content/uploads/2023/08/AHC-submission_Hydrogen-Headstart_03082023.pdf .

Australian Hydrogen Council (2023b) Securing Australia’s hydrogen future, 1 March, https://h2council.com.au/wp-content/uploads/2023/02/230301-AHC-Policy-Paper-Securing-Australias-hydrogen-future.pdf .?

Craen, S. (2023) Financing a world scale hydrogen export project, Oxford Institute for Energy Studies, January, https://www.oxfordenergy.org/wpcms/wp-content/uploads/2023/01/Financing-a-world-scale-hydrogen-export-project-ET-21.pdf .

Deloitte Access Economics (2023) Australia’s Hydrogen Tipping Point – The urgent case to support renewable hydrogen production, February, https://www2.deloitte.com/au/en/pages/about-deloitte/articles/australia-hydrogen-tipping-point.html .

Green Hydrogen Organisation (2022) Green Hydrogen Contracting Guidance: Financing green hydrogen projects, Contracting brief, December, https://gh2.org/sites/default/files/2022-12/GH2_Contracting%20Guidance_Financing%20Green%20Hydrogen%20Projects_2022.pdf .

International Renewable Energy Agency (2023), Low-cost finance for the energy transition, International Renewable Energy Agency, Abu Dhabi, https://www.irena.org/Publications/2023/May/Low-cost-finance-for-the-energy-transition .

McKinsey & Company (2022) Sustainable infrastructure: The best ideas from the 2022 GII Summit, Global Infrastructure Initiative;? https://www.mckinsey.com/capabilities/operations/our-insights/global-infrastructure-initiative/roundtables/tokyo-2022-delivering-hydrogen-gigaprojects .

UK Government (2023) Mobilising Green Investment: 2023 Green Finance Strategy, HM Government, March 2023, see https://www.gov.uk/government/publications/green-finance-strategy/mobilising-green-investment-2023-green-finance-strategy .

US Department of Energy (2023) Pathways to Commercial Liftoff: Clean Hydrogen, March, https://liftoff.energy.gov/wp-content/uploads/2023/05/20230523-Pathways-to-Commercial-Liftoff-Clean-Hydrogen.pdf .

?