The potential role of government intervention in shaping hydrogen demand: Keynesian stimulus consideration?
The low emission hydrogen market has struggled to find its footing, with its investment case losing ground. However, a new financial mechanism called demand-linked financing could provide a solution to the cost gaps and financial risks that have been hindering the sector's growth.
According to Fatih Birol, the Executive Director of the International Energy Agency (IEA), demand-linked financing could make low emission hydrogen projects more bankable and attractive by better balancing financial risk and incentive. This financing approach ties repayments or returns on investment to actual hydrogen sales or usage, encouraging investment despite current demand uncertainties.
For producers, this means they can ramp up production capacity with reduced financing costs and risks, knowing that financing costs adjust to the hydrogen demand they secure. Investors, on the other hand, receive returns commensurate with the real market uptake of hydrogen, making the investment less risky.
The cost gap between grey hydrogen (produced from fossil fuels) and low emission hydrogen is significant. In Japan, the levelised cost of grey hydrogen is less than $4 per kg, while the cost for low emission hydrogen is over $8. Addressing this cost competitiveness gap and securing firm buyer commitments from project inception is crucial, according to Andrew Doyle, Executive Director of Power & Renewables, Project Finance at MUFG EMEA.
Currently, most of the demand for hydrogen is serviced through production that relies on unabated fossil fuels. The IEA's Global Hydrogen Review states that these technologies account for less than 1% of global hydrogen production. However, in the context of decarbonising hard-to-abate sectors such as long-distance transport, aviation, steel, and chemicals, hydrogen is hard to ignore.
The IEA's analysis agrees with the need for a shift towards demand-linked financing mechanisms and the importance of reducing costs and ensuring clear regulations. A new white paper from MUFG, a Japanese banking group, suggests demand-linked financing as a way forward for low emission hydrogen. The paper proposes a shift towards demand-linked financing mechanisms to provide certainty for both producers and off-takers.
By 2030, projects that have already reached a final investment decision could expand low emission hydrogen capacity fivefold. For investors looking into hydrogen as a climate solutions opportunity, demand stimulation could improve the investment outlook for low emission hydrogen or at least make it less risky.
In summary, demand-linked financing adjusts funding costs based on hydrogen demand, helping close investment cost gaps and fostering greater production scalability and commercial viability for low emission hydrogen. This financing method contrasts with traditional fixed debt or equity financing that requires repayments regardless of demand, creating a mismatch and making green hydrogen projects relatively risky.
Fatih Birol, the IEA's Executive Director, suggests that policymakers and developers should look carefully at tools for supporting demand creation while also reducing costs and ensuring clear regulations. As John Maynard Keynes wrote in a letter to President Roosevelt in 1938, if demand and confidence reappear, the problems of the capital market will not seem so difficult. With demand-linked financing, the problems of the low emission hydrogen market may soon seem less daunting.
The new financing mechanism of demand-linked financing, proposed by the IEA and MUFG, could shift the low emission hydrogen market towards greater financial security and investment attractiveness. As the cost competitiveness gap between traditional and low emission hydrogen is significant, this approach could encourage producers to ramp up production with reduced risks, while investors could potentially receive returns that align with the hydrogen market uptake. In the context of decarbonizing various industries, hydrogen, supported by innovative financial mechanisms like demand-linked financing, seems to be a crucial environmental-science solution that businesses and investors might want to consider for climate change investment.
