The future of a hydrogen project17 August 2022

The hydrogen industry is in its infancy, both from a financing and development perspective. In exploring how we believe the legal framework and financial bankability structure will develop over time, we therefore draw parallels with similar power production and development areas, the most appropriate and comparable being LNG and oil and gas production.

Producing green hydrogen is not a simple extraction exercise. Hydrogen production is similar to LNG production in the sense that there is an original energy source that is then transformed into hydrogen (by means of wind, natural gas, biomass or waste/waste gasification), which can then be turned into liquid hydrogen, liquid or gas ammonia, methane, or transported as a gas. One of the benefits of hydrogen is that, unlike a battery, hydrogen storage does not lose significant energy and can be converted back into electricity for utilisation (albeit at the cost of losses). Additionally, hydrogen or products from hydrogen (such as methanol or ammonia) can also be used as a feedstock in high polluting industries, such as mining, general industry, shipping, and aviation.

Financing considerations

Some of the key takeaways from the conference were that:

• Hydrogen is still in its early stages, in terms of investor and user awareness and the actual capability of the technology and energy.
• Significant capital investments will be needed for a scalable green hydrogen project to emerge as well as a market.
• One of the main concerns arising from investors was the need for a strong sponsor driving the project to be comfortable from a bankability perspective.
• Additionally, there will need to be evidence that there is a strong market to supply hydrogen to which at present there is not. This creates a catch 22 scenario in terms of next steps for hydrogen as an area whereby sponsors and investors balance a first-mover advantage perspective against the risk of oversupply and/or a low return on investment.

However, with energy markets globally currently in turmoil and economies at present beginning to be more inward-looking than globalisation-focussed, we anticipate governments will look towards incentivising energy production such as hydrogen (through renewables and nuclear power) to develop energy independence and not rely on a foreign fossil fuel import economy. Further, green hydrogen has an inherent risk mitigant built into it by having the ability to redirect the renewable energy production to the electricity grid rather than to electrolysis, and this can assist current energy majors such as BP, Shell and Exxon (to name a few) to diversify their assets and get projects up and running despite there being no real hydrogen market at present.

There are many geopolitical factors that will impact how financing will be put in place. For example, in Europe, project financing (in most cases) will take away the ability of a developer to receive public funding. However, in regions like the Middle East, this is less of a consideration due to the intrinsic links between national champions and the state. As such, we anticipate green hydrogen projects fitting into a limited recourse project financing arrangement in the Middle East.

Please click on the thumbnail for a more detailed diagram.

Project development and commercial risk considerations

In respect of the project development considerations, on large scale hydrogen developments we see there being a risk in proceeding with a single construction solution for the various production and construction needs. Therefore, a split construction package may be needed – this is explored further below. Additionally, there are also operational phase risks to consider once the project is producing hydrogen and has potential offtake.

Construction phase

Construction of a hydrogen plant will share many of the risk/mitigant features that arise on many other construction projects. These include for example risks of delay in completion and underperformance at completion mitigated by, among other things, liquidated damages, experienced contractors and insurance. For large scale hydrogen projects, it is likely that a multi-contracting strategy will be used because of the disparate nature of the component parts of the project. Using multiple contracts though brings in several challenges, for example, certainty of construction cost, certainty of timetable and meeting contractual completion dates, and certainty of revenues and performance at completion. Contractual interface risk is always difficult to manage during the construction phase. Creditors will expect to see a robust regime passing liability or relief up and down the contract chain, and across a multi-contract structure, as consistently as possible. However, on smaller scale green hydrogen developments, if the scale does not pose a risk on a single contractor approach, and because the renewable and electrolysis infrastructure is a common and well-developed technology, developers may seek to streamline developments in this manner with a single contractor and one stop method.