Bankability considerations in green hydrogen projects

Key themes of the conference included supply chain security, hydrogen infrastructure, storage solutions, generating demand and project bankability. Given the importance of external funding in construction projects, especially in net zero technologies such as hydrogen, it was refreshing to see some focus on the topic of project finance.

Following the closing date for participation in the second Hydrogen Allocation Round (HAR2), and as stakeholders look towards future allocation rounds, independent UK law, firm Burges Salmon, thought this would be an opportune time to highlight some of the key bankability considerations that will be of key importance for funders and developers alike when procuring and negotiating hydrogen projects.

OEM financial standing

At the heart of any hydrogen project is the electrolyser technology that enables the conversion of water to hydrogen. There are numerous electrolyser OEMs in the market employing various business models. Some are start-ups whilst others are subsidiaries of much larger, more established, players in the market. Financiers will consider the balance sheet health of such OEM (and their corporate groups) as projects will require ongoing OEM support for the duration of a project. A weaker balance sheet position may require additional financial protections for the financier to get comfortable.

Instruments securing performance

It is common for financiers to seek various protections when backing projects in respect of the OEM’s performance. The suite of protections will be important considerations when analysing whether and on what terms finance can be offered to the project. These include:

• Parent company guarantee: a parent company guaranteeing the obligations of the contracting OEM entity so that the employer/financier has recourse against a more financially established entity should the OEM fail in its contractual obligations.
• Performance and warranty bonds: typically we see bonds provided by OEMs so that the employer has recourse against a bank or insurer issued bond should the OEM fail in its contractual obligations. Generally, we would see a performance bond in place up to take-over of the project i.e. the point at which the plant becomes operational, and a warranty bond from take-over until the defect notification period expiry. The value of these is subject to negotiations and may step-down during various stages of the project as the risks of non-performance decline, but employers should remember that ultimately the cost of these bonds will likely be passed on to them via the contract price.
• Advance payment bonds: a bond which seeks to protect the period between an advance payment to an OEM and the title to the equipment passing to the employer (usually upon the earlier of delivery to site).
• Collateral warranties: financiers will often seek the benefit of collateral warranties or direct agreements from OEMs and their subcontractors. Collateral warranties create a contractual relationship between the financier and the OEM and subcontractors where there otherwise would not be one (in which case the financier would have to rely on the employer to enforce the rights under the OEM contract instead). Typically, these allow step-in rights, allowing the financier (or its nominee) the opportunity to step-in to the shoes of the employer and continue the contract which may otherwise have been terminated. Usually, step-in rights become relevant where an OEM’s right to terminate the contract arises e.g. where the Employer has failed in its payment obligations. In such scenario, the financier’s step-in rights would activate such that before the OEM can terminate the underlying contract the financier has the option to step into the contract as an Employer and, upon remedying the underlying Eemployer breach, continue the OEM contract.

Performance guarantees

Financiers will have technical advisors scrutinising technical specifications and performance requirements of the electrolysers. This can relate to a variety of technical elements of the equipment including the conversion efficiency of the electrolysers, the heat output of the effluent water, general heat and noise of the running equipment and any degradation expected in the equipment. Technical advisors will be seeking to confirm that the warranties set out acceptable minimum performance thresholds and the warranty is for a suitable period of time following practical completion. These advisors will also have views on and will want to receive justification on the levels and rates of liquidated damages payable in the event of warranty obligation failures so that financiers can understand any financial exposure that the project may have.

Long-term electricity supply

Hydrogen projects rely on a sustainable and cost-effective means of electricity input. Financiers will be seeking to satisfy themselves that each project has secured this and the costs are not disproportionate in the overall financial case of the project. This will involve developers negotiating parallel PPAs (or seeking to co-locate their hydrogen projects on their own existing renewable energy projects such as wind or solar) to secure such pipeline.

Water supply

For green hydrogen projects, a steady supply of water will also be needed. Depending on electrolyser specification and intended use of the resulting hydrogen, certain purity of water may be required. Likewise, a suitable effluent strategy needs to be in place to ensure the project complies with environmental legislation.

Minimise interface

Financiers will be looking for projects which minimise complexity and interface between multiple parties or have clear, well thought through strategies to mitigate the risk to the project of interfaces. Whilst a single contracting entity providing a full EPC wrap would reduce interface, it can be difficult to find a contractor willing to provide a full EPC wrap for technologies which are relatively new at a price that makes sense. We saw this pattern in tidal, biomass and wind projects historically. Hydrogen projects are no different, and we are most commonly seeing multi-contracting approaches in these projects (i.e. OEM supply, BoP, EPCM etc. being used in each project). Care should be had to ensure all elements of risk are allocated to the various contractors, with minimal risk being left with the employer.

Transport

The financial viability will depend on the output demand and how the developer will transport the resulting hydrogen. As with the construction stage, financiers are seeking to minimise interface and transport risk. The considerations here will differ if the project is co-located with the end-user, minimising transport risk. Otherwise, developers should seek a reliable and long-term transport and storage strategy to ensure the hydrogen demand is catered for.

Long-term returns

Financiers will give little stock to unsecured and unsubstantiated potential demands on the hydrogen output. Understandably, it is more desirable to demonstrate a fixed and guaranteed pipeline of hydrogen demand with little room for the parties to terminate the contracts or renegotiate pricing.

Bankability is a key consideration that Burges Salmon consistently bear in mind when it advises clients. In order to future proof clients’ projects Burges Salmon ensure that bankability is considered from the outset of involvement, from initial procurement strategy (e.g. divestability of contractual packages) all the way through to secondary market financing and re-financing as well as variations and dispute avoidance/resolution.

Read the article online at: https://www.globalhydrogenreview.com/hydrogen/10062024/bankability-considerations-in-green-hydrogen-projects/