Hydrogen has been touted as a clean energy solution for decades, but the costs of production have always presented a barrier to uptake compared with other energy carriers. Now, as more countries sign up to net-zero carbon emission targets, there is a renewed focus on the potential for low-carbon production of hydrogen to facilitate these ambitions, particularly in sectors traditionally seen as challenging to decarbonise.

Arguably the biggest barrier to the uptake of low-carbon hydrogen is still its cost not only relative to traditional sources of hydrogen (e.g. from steam methane reformation) but also as an alternative to counterfactual fuels (e.g. coal, diesel, heavy fuel oil and aviation fuel). As such, the business models for low-carbon hydrogen projects need to be developed to bring forward investment.

Part of the challenge of developing business models is the potential wide range of applications for hydrogen—from transport, electricity and heating to steel production and other industrial processes. This presents the challenge of designing demand-side support regimes. More likely, early models will focus on generator subsidy/price support, with a view that supply will lead to development of a hydrogen economy.

The debate over green or blue hydrogen extends beyond price considerations. For example, the UK, with good access to potential long-term storage sites, is keen to develop blue as well as green hydrogen. The thinking is that the UK can utilise these geological and geographical advantages to bring forward lower-cost hydrogen initially, while allowing the costs of green hydrogen production to fall. This also improves the business case for the carbon capture, utilisation and storage clusters around the UK, while having more users reduces the reliance on large ‘anchor’ capture projects. Finally, with access to both low-carbon hydrogen and long-term carbon storage, industrial emitters have the ability to reduce their carbon footprints.

In other countries, such as Germany, there is public resistance to long-term carbon storage, meaning blue hydrogen may be less viable politically. Nevertheless, with nuclear projects being retired and a high reliance on coal, Germany still has a significant challenge to decarbonise its electricity production. Diverting green electrons to produce green molecules may be counterproductive. As such, the German strategy is to support importation of low-carbon hydrogen. This would provide opportunities for producers in countries with access to lower costs of production to access markets through long-term purchase contracts.

Understanding the value for such offtakers over the medium-to-long term will provide mitigation against the long-term counterparty credit risk

We are starting to see the development of large-scale green hydrogen/ammonia projects being developed across the Gulf Cooperation Council region. These projects can take advantage of the low levelised cost of renewable energy and expertise in production and transport of energy to global markets.

These mega projects still need a strong offtake story, with likely one (or more) counterparties with sufficient financial strength to provide comfort to lenders that the project is not exposed to market pressures—particularly when initial cost of production is likely to be above counterfactual alternatives.

One area that will need to be firmly negotiated with any offtake parties centres around the requirements to be defined as ‘green’ hydrogen. Projects will be expected to follow specific regional and local legislation (e.g. Red II requirements) to ensure access to end-markets. This may mean some projects will prefer to develop ‘inside the fence’ renewable energy generation, which can accurately track production compared with grid-connected projects. This may need to follow more complicated requirements to be deemed sufficiently green (i.e. load following when renewable output is high and also not encouraging more polluting technologies to run more to meet the increased electrical demand).

Another area where there will need to be a clear risk allocation regarding any potential tightening of qualifying regulation, such as a tightening of the average carbon intensity required to qualify for a particular subsidy.

More than $11bn/yr of government support has been announced by over 24 countries for 2021-30, with the majority coming from EU states in the form of subsidies and contracts for difference. In addition, the EU is looking to provide protection for local industries by developing carbon border adjustment measures designed to reduce risk for producers investing in green technologies versus imports from jurisdictions with higher-carbon but lower-cost production.

Understanding the support available will be central to lenders’ analysis of projects, even where price risk is taken by an offtaker. Understanding the value for such offtakers over the medium-to-long term will provide mitigation against the long-term counterparty credit risk. It can also give comfort that, in a counterparty default, if the project is able to find an alternative route to market, it will not be left in an uncompetitive position.

Further deployment

Over time, support for hydrogen business models will allow for further deployment of electrolyser technology, which will facilitate a reduction in cost of producing green hydrogen. In onshore wind and solar, every doubling of capacity was associated by a 14pc and 29pc respectively in cost reduction, with the trend expected to drive the cost of wind and solar below $20/MWh by 2050. A similar range has been seen in electrolyser costs—with costs falling approximately 18pc (+/-6pc) with each doubling of capacity.

Over the longer term, hydrogen demand could reach over 500mn t by 2050, or approximately 18pc of total world energy demand, by which point we would expect to see less reliance on subsidies or single offtakers as the global market for low-carbon hydrogen develops.

As more countries sign up for net-zero carbon targets, and as support regimes and standards become more defined, we can expect a significant development of low-carbon hydrogen production capacity over the next decade. MUFG is committed to supporting the transition to a hydrogen economy and is working with clients, stakeholders and partners to achieve this.

Andrew Doyle is director, power & renewables team for Japanese bank and financial services company MUFG.

---

Author: Andrew Doyle