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How Project Finance Could Fuel the Clean Hydrogen Wave

In 1874, in his book “The Mysterious Island,” science fiction writer Jules Verne envisioned a world powered by hydrogen. Nearly a century and a half later, the idea that hydrogen can play a crucial part in the clean energy transition is anything but a fantasy.

As the cost of producing clean hydrogen has declined and demand for clean energy has surged, hydrogen is now seen as a viable future replacement for fossil fuels across the energy chain.

While the vast majority of hydrogen today is “grey,” meaning it’s sourced from fossil fuels, hydrogen can be produced cleanly with little to no carbon emissions. Clean hydrogen, in turn, can be applied in multiple ways, from fueling cars, to heating buildings, to serving as a feedstock for chemical production. In fact, hydrogen could meet nearly 25% of the world’s energy needs by 2050 if governments support policies that advance hydrogen technologies, BloombergNEF predicts.

“Over the last ten years there’s been huge growth in renewable electrical power, but that only solves part of the energy problem,” said Alistair Wishart, a V&E Energy Transactions & Projects counsel in the firm’s London office. “Hydrogen is seen as a way of addressing many more challenges and for filling any gaps left by renewable energy in the drive to achieve net zero targets.”

But producing clean hydrogen on a large scale will require innovative financing. While the clean hydrogen market is still at an early stage in its development, project finance lenders are already positioning themselves to fund the hydrogen wave. In some cases, they’re taking advisory roles to get in on the ground floor of clean hydrogen projects.

Wishart and Lauren Davies, who is also a counsel in V&E’s London Energy Transactions & Projects practice, recently sat down to discuss the rising momentum for clean hydrogen and the role of project finance in funding hydrogen projects. Here’s what they had to say.

How is clean hydrogen produced? 

Clean hydrogen falls into two main categories, blue hydrogen and green hydrogen. Blue hydrogen is created by capturing and storing the carbon emissions generated in the production of grey hydrogen.

Green hydrogen is produced by using renewable energy to electrolyze water, separating the hydrogen from the oxygen.

Are you seeing investments being made in clean hydrogen production?

A growing number of energy companies and utilities are becoming more bullish on the prospects and commercial viability of both blue and green hydrogen. This has led to a surge of project announcements in recent months.

What about project finance? Has there been notable project finance activity in the sector? 

Not yet. The projects in development to date are not of the scale that would require significant amounts of debt financing. At the same time, the costs of producing clean hydrogen are still relatively high.

However, as the sector matures, as costs continue to fall, and as the technology and market risks associated with green and blue hydrogen projects decline, project finance is expected to serve as an important funding source for hydrogen projects.

Banks are increasingly focused on sustainable lending as they respond to pressure from regulators and investors. As they gear up to lend to the hydrogen market, project finance lenders are already meeting with sponsors to discuss how projects should be structured and funded in the future.

“By getting involved at an early stage, lenders will have a better understanding of the industry, the key players, and the technology,” Davies said. “They’ll be better able to provide financial support as the market grows.”

What are the advantages of project finance for hydrogen project sponsors? 

Project financing is a well-established method of raising long-term debt for major energy and infrastructure projects. Projects are organized as special purpose vehicles, and loans are repaid from the cash flow generated by the project on a stand-alone basis. Debt incurred by the project company is customarily off-balance sheet for sponsors and there is limited recourse to the assets of the equity investors.

The wide range of project finance lenders means that a project might be able to attract a higher level of debt, with longer tenors and more favorable financial terms than would be the case with a typical corporate financing. 

What will project finance lenders look for when assessing a hydrogen project’s creditworthiness?

Project finance lenders tend to gravitate toward projects where risks can be identified, mitigated, and allocated in a way that’s acceptable to both the lenders and other key project participants.

They seek assurances that projected revenues will support debt service as well as the project’s ongoing operating expenses. In order to satisfy those requirements, sponsors of large-scale energy projects often secure long-term offtake arrangements or demonstrate that there’s a strong market that will support sales for (at least) the tenor of the debt.

Certain types of hydrogen projects will have advantages in obtaining project financing. For instance, projects set to produce green or blue hydrogen in markets where there is existing demand for grey hydrogen could find it easier to satisfy lenders’ requirements.

“Projects with strong, experienced sponsors and effectively guaranteed offtake have a stronger potential for project financing,” Wishart said.

What advice would you give a hydrogen project sponsor considering project financing?

Project financings are subject to extensive due diligence. Lenders review such matters as commercial contracts, regulatory risks, and environmental and social risks, before extending credit to a project. As a result, it’s important to engage experienced lawyers early on in the development process.

“Having advisors at an early stage is really important because otherwise you could inadvertently enter into contracts that really aren’t bankable and disadvantage the project’s financing potential,” Davies said.

What does V&E bring to the table in advising on hydrogen projects and project finance?

V&E brings extensive experience in project finance and a deep bench of talent across practice areas. As the world’s leading energy law firm*, V&E represents sponsors, developers, investors and lenders in the development and financing of complex, large-scale energy and infrastructure projects around the world.

V&E has leveraged that experience to build a leading renewable energy practice which advises on financing, development, tax, regulatory, dispute, environmental, national security, and intellectual property matters related to a wide range of clean and renewable energy assets.

“All of the elements that go into a hydrogen project, we’re very familiar with at V&E, whether that be project financing, construction, looking at the regulatory environment, or the production, transportation, storage and sale of industrial gases,” Wishart said. “Hydrogen touches on all of the pieces of the puzzle of what we do, and what we’ve been doing well for years. This is our turf.”

*Based on the number of lawyers named in The Energy and Environment Expert Guide – Euromoney, 1995 – Present

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.