Deploying various private capital is a must to scale up low-carbon hydrogen
by Shahnaz Namira Fairuza, Marcel Nicky Arianto, and Indira Pradnyaswari
24 December 2024
Hydrogen gained top-level support last year through its inclusion in the ASEAN Carbon Neutrality Strategy, highlighting Member States’ collective goal to standardise cross-border low-carbon vehicle infrastructure. Recently, Indonesia, Malaysia, and Singapore have also endorsed The Hydrogen Declaration at COP29, which emphasises the role of hydrogen in meeting global climate goals. It also underlines in scaling hydrogen production, setting up global standards, and fostering international collaboration, with progress to be reviewed at COP30. However, due to high upfront cost, to hit the ground running, ASEAN Member States (AMS) must first conduct derisking measures to improve the bleak risk-return profile of low-carbon hydrogen investments, breaking free from the chicken-and-egg problem. Discourse on policy derisking has been a ubiquitous focus of institutions that champion the energy transition, but not so much on financial derisking, despite both having equal importance. With a global investment gap of USD 100 billion per year between now and 2030, low-carbon hydrogen calls for fast and scalable solutions, and most importantly, those that come from private finance. Its abundance is the sole reason why a minimum of 60% of clean energy investments in emerging markets need to be financed by the private sector.
The core of financial derisking is transferring risk. As different parts of the low-carbon hydrogen supply chain have different risk factors and prevalence, it is imperative to understand what financing instrument and scheme would be required to effectively manage those risks and eventually generate favorable risk-adjusted returns. Different financial instruments have different risk-return profiles, as shown in Figure 6. According to their risk appetite, investors will pick a mix of these securities to achieve the level of risk-adjusted returns that they desire.
Figure 1. Risk-return profiles of selected financial instruments (Source: IFC)
For technologically mature but commercially unproven value-adding activity, prevalent risks would centre around high hydrogen prices and offtake uncertainty. This would be the best area for industrial incumbents. They are utilising corporate finance that has both equity and debts (bonds, loans) that can absorb the extra cost of fuel production to a certain extent, while their market expertise and connections will help them in arranging off-take agreements.
Industrial incumbents can also form special purpose vehicles (SPV) to fund projects using project finance. It would match value-adding activities with higher capital and operating costs who is better funded through debt, as the debts that SPV typically take are limited or nonrecourse debts that, in the case of default, would not be included in the company’s balance sheet. The project must centre around mature technology and business models to provide a reasonable cash flow projection for debt service, such as large-scale hydrogen production.
Sometimes using debt would be too risky when dealing with proven but not yet mature technologies and unproven business models. Using ordinary equity hence would be the best bet for companies to fund the development of those products, as well as efforts to comply with standards. Meanwhile, for highly immature and unproven technologies that show great promise to scale up, venture capital is the best match as they have a relatively longer time horizon on expecting returns.
Sometimes risks can just be assumed as emerging markets like ASEAN are mostly underserved. Singapore’s sovereign wealth fund GIC formed a standalone investment group Sustainability Solutions Group that utilises patient capital. It has a longer time horizon in expecting returns due to long-term orientation, hence may accept lower return rates. However, this is not based on blind trust, as the Singaporean government has intensified its low-carbon hydrogen research and development activities. It illustrates a mutually reinforcing system to bring down costs, which sets an example for other AMS. Understanding that low-carbon hydrogen is an increasingly promising solution, Singapore has also launched the Singapore’s National Hydrogen Strategy, supporting country’s effort on decarbonization. In addition, the country highlights the importance of participating in the global hydrogen trading market by constructing a trading and financing ecosystem for low carbon hydrogen. With this being said, preparing a stable hydrogen market serves as a crucial preliminary step for ASEAN’s further consideration for hydrogen development.
Besides risk, another aspect that plagues the lack of private financing is the problem of an early mover, as many private sector actors have sustainability inclinations but do not want to be completely exposed to the risk of an early mover. Driving a positive change in this aspect will require thinking outside the box by mainstreaming alternative financial instruments and exploiting uncommon revenue streams, which will tether together these sustainable-inclined investors to low-carbon hydrogen projects that, if otherwise done individually, would not be financed.
Issuance of green, social, sustainable and sustainability-linked bonds (GSSS) are alternative sources of debt, which can attract ESG-oriented investors that seek more sustainable portfolios. However, the information asymmetry on issuers’ sustainability commitments and the bonds’ impacts would need to be addressed, which calls for numerous standardisation and regulatory actions. As of late, many AMS such as Cambodia, Vietnam and Thailand have received financial and knowledge support in the development of their green bonds issuance, while the Singaporean, Indonesian, Malaysian and The Philippines’ markets continue to grow, signaling a positive trajectory in the use of the instrument.
Carbon credits can also be an alternative source of capital, in light of the prominence of compliance markets due to top-down decarbonisation pressures from governments worldwide. Revenues from selling carbon credits are quite huge, as precedented by Tesla’s USD 518 million carbon credit revenues in only the first quarter of 2021. The revenues can cover the operating costs of carbon crediting activities, debt services, or even recycling the money through reinvesting in the low-carbon hydrogen project in question. Voluntary carbon markets also give rise to carbon credit futures that are highly applicable for long-term low-carbon hydrogen projects. As some of the AMS have established their carbon market, low-carbon hydrogen projects can slide in to participate at any time.
Another innovative instrument is pooled investment vehicles, with the prime example being the Securities and Exchange Board of India (SEBI)-regulated infrastructure investment trusts (InvITs). This project aggregation platform helps to direct investments from individual or institutional investors in infrastructure projects. InvITs also help to perpetuate a virtuous cycle of capital, by allowing project developers to sell a portion of their revenue-generating assets to sovereign wealth funds, pension funds, and insurers who also happen to have longer time horizons in expecting returns. AMS can establish something similar to this to help repurpose existing infrastructures for hydrogen transport, as a pathway to gradually transition to cleaner hydrogens.
Other than InvITs, portfolio syndication platforms can also be a source of capital. International Finance Corporation (IFC)’s Managed Co-lending Portfolio Program (MCPP) raised more than USD 11 billion by allowing sovereign wealth funds, private institutional investors, and global insurance companies to co-lend alongside the IFC or provide credit insurance coverage for the IFC, which creates a positive ecosystem for low-carbon energy projects’ growth.
At the end of this brief but broad-ranging theoretical excursion, we can concur that there are various sources of private capital available to fund low-carbon hydrogen projects. Utilising them will help to reduce many risks that plague low-carbon hydrogen investments and actualise the amazing potential of hydrogen in achieving carbon neutrality goals. Reducing risks through policy reforms and increasing public-private partnerships exemplified by Japan will be key to ensuring all of this can be turned into a reality so that ASEAN can truly secure a low-carbon sustainable future for all.
