Financing Large-Scale Hydrogen Projects in Global South – example of Africa: Overcoming Challenges and Exploring New Opportunities in collaboration.

Authors: Jean-Michel Binefa, Kesh Mudaly, Zane Jamal and Erik Rakhou*.

How to bring Hydrogen investments to Global South? Short answer – by encouraging commercial banking community to share risk, and move first together with Multilateral Development Banks (MDBs), and Export Credit Agencies (ECAs). Collaboration between Commercial Banks, MDBs, and ECAs Holds the Key to Success in Global South including Africa. Lets unpack this.

BCG study showed first movers will be rewarded

As a BCG team, we recently conducted a global review of where banks stand on financing Hydrogen and carbon capture. Banks are holding back financing for low-carbon hydrogen and carbon capture, utilization, and storage (CCUS) projects due to the perceived risks involved. According to a survey of over 100 experts and interviews with more than 35 executives from banks, energy companies, and other institutions, commercial banks are keen to finance these projects to meet their own sustainability targets and support clients, but their inflexibility with their risk criteria is hindering progress. As technology matures and policy support increases, the risk profile will improve and more projects will become "bankable." First movers - well prepared, and collaborating thoughtfully with others - will be rewarded we found (1).

So how would that “collaborative first movement” look like in Africa - a very diverse, and complex emerging market for green energy transition? Below we have combined some of our participation experience to a recent forum, and our broader team thinking.

Scenesetting for African H2 investment

The development of large-scale electrolysis capacity, exceeding GW-scale, for hydrogen production presents a crucial opportunity. However, the success of such projects hinges on international demand and firm offtake commitments, to complement local demand and scale supply side investments. Financing these ventures through non-recourse debt requires addressing investment risks, especially in any global emerging economies, related to political and regulatory environments, currency fluctuations, and limited experience in developing extensive infrastructure. At same time, these investments must be equitable for local communities and contribute to addressing long-term challenges for energy infrastructure development such as reducing cost of capital. Mitigating these risks requires the involvement of strong sponsors, robust offtake agreements with reputable international buyers, and a reliable engineering, procurement, and construction (EPC) structure. In addition, it requires orchestration of the role of commercial banks, multilateral development banks (MDBs), and export credit agencies (ECAs) in facilitating the financing of hydrogen projects in Africa.

?How to attract financiers – illustrative checklist for Africa and Global South

To attract financing through non-recourse debt, large hydrogen projects in Africa must address key concerns and align the interests of various stakeholders. The following three elements are essential, drawing inspiration from successful projects like NEOM in Saudi Arabia, while specifically addressing Africa's investment landscape:

?·??????Robust Offtake Agreements: The presence of international, reputable, and creditworthy buyers in the offtake agreements is crucial. Such arrangements enable project revenues to be denominated in stable currencies like USD or euros (2), mitigating potential currency risks and ensuring a sustainable financial model. ECA's and MDBs may play a role in taking some of such risk as well through instruments such as "guarantees" - as we see discussed in a recent IEA report (3).

?·??????Strong Sponsors: Ensuring involvement of the local African government, possibly with support from an MDB, helps align the interests of the host government and international sponsors. This collaboration reduces political and regulatory risks while creating a favorable investment environment. In addition, balance sheet quality of corporates involved in the project execution will matter.

?·??????Reliable EPC Structure: A Lump Sum Turnkey (LSTK) contract with an experienced and creditworthy EPC specialist can mitigate technical risks arising from a potential lack of local technical expertise and infrastructure. This approach provides reassurance to investors and enhances the project's overall viability. An example of this can be e.g. seen in US recently.

Addressing more elements, outside the three described above - depending on country risk - may matter for availability of banking finance as some expert discussions pointed us to - which are very similar to issues seen in financing other natural resources deals. This can be as simple as having a local banking team being able to assess and assist on the deal execution, reasonable country indexation on global indici of doing transparent business, ability to collaborate with MDBs on assessing policy risks, and ESG-aspects of the deal. ?

How to orchestrate between various financial actors – banks, MDBs and ECAs

In Africa's infrastructure project financing landscape, collaboration between commercial banks, MDBs, and ECAs is already well-established. MDBs and ECAs play instrumental roles in facilitating non-recourse debt financing provided by commercial banks.

Considering these factors, MDBs can support commercial banks' involvement in large hydrogen projects in Africa through two complementary approaches:

Aligning Interests: The alignment of interests between host governments and project sponsors significantly reduces perceived country risks for investors in Africa. One effective strategy involves the host country acquiring a direct stake in the project's legal entity. MDBs like the World Bank, EIB or EBRD can facilitate this process by providing direct loans to the host government (4). This can be enhanced through training and policy support. Capacity building with host governments is a critical enabler of energy transition; potentially such capacity building could be included as part of a requirement for "local content" of any large scale project being developed.

Cost of Feasibility Studies: Feasibility studies are crucial but can impose significant sunk costs on project developers. Given the time and complexity involved in structuring projects, MDBs can support prospective projects by offering dedicated funding facilities that cover the initial costs at equitable conditions - those can be as high as 20-30 million USD for large scale projects. This way, project sponsors bear the full share of expenses only if the project materializes.

ECAs play a significant role in supporting large-scale hydrogen projects in Africa. Subject to projects having ECA relevant content (eg offtake of Hydrogen in its country, or countries collaborating in other ways), renewable focus, and acceptable credit risk which could be associated with the government, corporate entity, or non-recourse project finance – ECAs can insure some of the risks in their role as government-backed institutions that provide various forms of financial support to facilitate international trade and investments. ECA’s primary objective is to promote and support exports from their respective countries by mitigating commercial and political risks associated with such cross-border transactions as developing global Hydrogen value chains. OECD ECA's are preparing to step up further in energy transition. From our interactions, we have seen that several ECAs have also been funding domestic (non export) projects - that is important given a risk of only focusing on exports.?

Equitable development of African energy resources

?Before moving to conclusions, key to note that African countries will need to consider how best to use their renewable resources, for both domestic and export purposes. Any push for hydrogen in Africa to be exported back to Europe, or other global markets without holistic planning, may be at risk of cannibalising Africa's renewable resources, when these should be put to use in decarbonising its own needs first, and resolving domestic energy security. The latter balanced focus may be helped by a "must have" involvement of MDBs who have long-standing experience in weighing and supporting local economic development, including provision of concessional finance as well argued by fresh IEA study. So far globally only 1% of what is needed to scale private finance for energy transition has been provided - particularly Africa is lagging behind.

Conclusion

MDBs, ECAs and commercial banks' coordinated involvement alongside host governments and project developers, in large hydrogen projects in Africa is critical. By encouraging commercial banking community to share risk with MDBs and ECAs, and move first as a coordinated orchestra, Hydrogen investment will be advanced. We cannot put all the onus on commercial banks to ‘move first’. What is required are well structured blended-finance instruments, and this requires MDBs, ECAs and commercial banks to collaborate as shown in this article - avoiding any sense of competition for best projects.?Failing such collaboration, the dynamic would lead to finance deals failing.??

Key will be to assure that local stakeholders are consulted and equitably involved, advancing local economies and creating just transition - where Global North may be needing to lean in more (5). Africa needs to decarbonize and Green Hydrogen is a critical component of ensuring a Just Transition i.e. if Africa is asked to accelerate the decarbonization of its economy and progress economically at same time - notably after having only contributed 3% to cumulative emissions since industrial ages AND being disproportionately affected by the physical risk of climate change.

In addition, as we have seen from above, project developers must do their homework by fulfilling minimal criteria of the provided checklist – offtake, sponsorship, EPC.

The financing and Hydrogen market development space will be evolving - Europe has been developing mechanisms such as Germany's H2 Global Facility and the EU Hydrogen Bank to structure the end-demand market – and as we have seen – H2 Global has now been invited to develop international imports for EU. The imports can help to finance local projects at turn. Seeking win-win will be crucial.

The latter is bound to trigger more interest in African and more generally Global South projects financing at scale (6). Please share your views on what we can learn and should consider for scaling Hydrogen in Global South??

Notes to article.

(1) A note for readers on what it means to be a first mover for a bank

For avoidance of doubt, we do not believe any bank will seek to finance any kind of large scale hydrogen opportunity alone, given the risk appetites available nor the required bandwidth of the required capability building, and client footprint. For many banks, to be the first movers, the banks need to be clear about which opportunities they should pursue for which clients, and with which risk appetite specifically for those opportunities focusing on broader energy transition, not just hydrogen. No one can solve this alone - for multi-billion opportunities, we need consortia sharing risks, and multiple MDBs and ECAs sharing risks.

(2) Note to readers on currency to be used in offtakes

Arrangements to have offtakes in USD or Euros would be mostly assumed for export part of the revenues; not for the domestic market, otherwise if something happens to the country's currency, the local hydrogen may be priced out of being accessible to domestic economy end-users.

(3) Note to readers on what concessional finance instruments exist

As described on page 131 of IEA report on "Scaling up private finance for clean energy in emerging and developing economies", one could e.g. use guarantees. An example is eg "First loss cover, up to an agreed maximum amount. Can be protected as a (funded or unfunded) guarantee on a single loan, or as a pooled first-loss guarantee on a portfolio of loans", or "liquidity support guarantee can be provided on a revolving standby letter of credit (LC), that can be drawn by the project company if the offtaker fails to honour its payment obligation".?Please see complete list of blended finance instruments in the table below, quoting the aforementioned recent IEA overview:

(4) Note to readers of host country taking a share in the project

Having the host country taking a share in the project may find limits because the government just may not be able to afford taking a share in all or many projects; strategic prioritization, or e.g. a "golden share" approach by host governments may be required to safeguard budgetary effects of such shares in the project; a lead practices overview can be consulted in a recent OECD study.

(5) Note on "leaning in more".

For concessional debt - that is the majority of international financing provided (80-90% typically) - financiers typically still require government guarantees. For emerging markets where governments already have constrained balance sheets this is not always palatable. More risk-taking may be needed by Global North to solve for this.

(6) Note on Scale of opportunity for public and private finance

According to IEA (2023), "To meet rising energy needs in ways that align with the Paris Agreement, annual investment, public and private, in clean energy in EMDEs will need to more than triple from?USD 770 billion in 2022 to USD 2.2-2.8 trillion per year by the early 2030s, remaining around these levels to 2050. If China is excluded, the increase is even steeper, amounting to as much as a seven-fold rise in annual investment from USD 260 billion to between USD 1.4-1.9 trillion. This surge in investment provides a powerful opportunity to underpin sustainable economic growth, create jobs and provide full energy access [.]. Investments in clean electrification, grid infrastructure and efficiency are the main components of the increase in spending.?[.] ?Around 8% goes to low-emission fuels, such as biofuels, low-emission hydrogen, and carbon capture, utilisation and storage (CCUS). These investments build up a new clean energy system while aiding the adjustment of existing high-emitting sectors." For purposes of the report, IEA defined EMDE as "Emerging market and developing economies (EMDE): Africa, Developing Europe, Eurasia, Latin America, the Middle East and South and Southeast Asia.". This materially overlaps with UNCTAD definition "Global South" (Africa; Latin America and the Caribbean; Asia without Israel, Japan, and South Korea; and Oceania without Australia and New Zealand), and hence provides an indication of scale of needed financing for energy transition in Global South.

*Disclaimer: this article and thoughts have benefitted from personal summary by Erik Rakhou of the panel discussion in Paris at Green Hydrogen Africa investment forum in May 2023, including Stephan Naber, Ivan Pavlovic, Anne Sophie Corbeau and Bert van der Toorn. Many great thoughts were expressed, and the panel members deserve credit for this! Any mistakes are for authors account.

The authors collaborated on this article at personal title.