Funding and financing hydrogen projects for mines

MELODIE MICHEL Reporter, Energy and Mines

For most people working in the renewable energy space, green hydrogen is seen as the cornerstone of a carbon-free civilization: perhaps the only technology that can store clean energy in the long term, serve as a clean fuel in vehicles that cannot be electrified, and displace CO2 emissions even from processes where carbon has so far been considered impossible to abate.

In the mining sector specifically, this is a game changer — and miners have taken notice. In the past couple of years, tier 1 mining houses have gone from watching the space, to testing potential use cases for their needs, to forming partnerships and relatively large pilot projects. Among the latest projects announced, Anglo American set out to test fuel cell heavy haul trucks in South Africa and Queensland, Australia; BHP started exploring hydrogen use to displace diesel in mining processes in Western Australia (WA), and Fortescue Metals Group (FMG) added hydrogen-powered buses to its to its Christmas Creek fleet in the Pilbara (also WA).

These projects are ambitious, namely because hydrogen technology is currently far from being commercially viable. “The Australian federal government has set the ambitious target for hydrogen of ‘H2 under 2’ - that is A$2/kg. We believe this target is focused on export, but that is the target everyone is working towards. This target is equivalent to 16.7$/GJ. Dependent on fuel source and cost of energy inputs, current production cost is a multiple of 2-3 times the target” says Bernardene Smith, Associate Director at KMPG’s Infrastructure and Projects Group.

Government funding criteria: equity and offtake

Because hydrogen is currently three times more expensive than it needs to be to compete against diesel and gas, commercial lenders have little appetite for these pilot projects. To get them off the ground, miners need to apply for government grants and/or concessional finance which, in Australia, comes from the Australian Renewable Energy Agency (ARENA) and the Clean Energy Finance Corporation (CEFC), as well as state governments.

Australia is a strong believer in green hydrogen’s potential to dis- place fossil fuels at home and abroad, and is investing big money into the development of the domestic industry. In 2019, ARENA an- nounced its Renewable Hydrogen Development Funding Round of up to A$70mn, which has now shortlisted seven projects, including two by miners. Applications are still open until January 2021, and the agency is expected to award the funding to two or more projects once the selection process is complete.

While ARENA’s funding round consists of grant money, CEFC is fo- cusing on debt and equity with its A$300mn Advancing Hydrogen Fund. The corporation’s Head of Hydrogen, Rupert Maloney, tells Energy and Mines: ”Being concessional finance, we can take a lower return and a higher risk position than might be open to a bank or a private sector financier. We’re happy to finance these projects with very long-term tenor, either in the form of project finance or corpo- rate finance. The percentage of the project cost that we finance will depend on the type of financing chosen.”

As in the case of ARENA, demonstrating offtake is key. Maloney adds that while there is no standardized application, projects need to be at a stage where the operators understand its economics and have a procurement and offtake plan before they approach CEFC.

For smaller players, state government funding may be a better avenue: WA alone is investing A$22mn in the development of its hydrogen industry. “There are a few private R&D groups that will work with you to do the government grant application, forward you the funding upfront minus their margin and then when it comes in from the government, they’ll collect the government funds direct to their account. That’s pretty handy for smaller companies with little capital capacity. There are also asset finance facilities becoming more accessible to the junior end of the market,” explains Richard Beazley, director of Hydrogen Energy.

But before they even think about approaching government agencies for funding, project sponsors need to show commitment — by investing their own money.

“First-mover projects will have to put in significant owner equity to get going. Conversion to hydrogen comes at a cost penalty at this stage, so needs to be considered as part of longer term transition to cleaner energy. ARENA and CEFC are both supportive in providing grant and debt funding, but until the industry becomes competitive that will be the way it goes,” adds Smith.

Banks and investors waiting to cash in

While there has been no financing from commercial banks on hydrogen projects for miners to this day, bankers realize the incredible opportunity that the technology presents, and hope to capitalize on it in the future.

“Given the technology risk inherent in the project until it is proven and operations are scaled up, you do see these projects being funded largely by equity and government support,” says David Roberts, Head of Project Advisory at ANZ. “But as the offtake markets are proved up and the economics become clear, there will be huge appetite from the bank market. It’s likely that when it really becomes viable, the scale of projects will be very large in the longer-term, particularly if we develop export markets, and that is very attractive to the banks. That’s why a lot of banks are following hydrogen developments very closely.”

Banks are not the only ones hoping to cash in on the hydrogen industry: fuel cell vehicles have received billions of dollars of corporate investment, and the pace of investment is increasing: according to The Guardian, shares in UK-based electrolyzer manufacturer ITM Power have more than tripled in price since the start of the year.

Development and interest are accelerating, spurred by robust government incentives the world over, and by the realization that hydrogen seems to be following a similar cost curve to that of solar power technology.

“The reason that people are investing in the sector is that, for parts of our economy (including mining), green hydrogen is one of the only viable solutions to reduce emissions. Additionally, post the European stimulus packages, there is now a clear path for scale and cost out which means green hydrogen should compete with fossil fuels in some applications in the not too distant future,” notes Mike McKensey, Division Director at Macquarie Group.

For the opportunity to be realized, recently announced pilot projects need to demonstrate their ability to bring down costs over time, and help guide electrolyzer manufacturers toward more efficiency. They must also be willing to share learnings with the rest of the industry. “In order to be able to access government funding, you have to be prepared to share knowledge and the outcomes of your project with the industry as a whole,” says James Arnott, a Partner in KPMG’s Energy & Natural Resources Management Consulting team.

How to structure a fungible project

Arnott believes that this knowledge-sharing element must be built into the contract binding the various partners on the project. “If we take, as an example, the publicly known hydrogen relationship across the mining industry, we have to believe that all parties are drawn together around the concept of collaboration and knowledge sharing. That the learnings and IP, whether that is process or technology IP, are for the mutual benefits of all parties,” he says.

Additionally, since these early stage projects need to demonstrate their future commercial viability, the nature of the agreement has to exist in a commercially viable framework, ensuring that in the longer term, the entity of the contract will no longer depend on grants to avoid losses. “You may take a lower internal rate of return for an investment project, as opposed to a pure commercial project, but in reality these decisions have to be made considering a commercially viable principle,” adds Arnott.

In terms of offtake, CEFC’s Maloney explains that initial hydrogen projects for mines are bound to be more fungible if they follow a captive offtake model, whereby the operator of the mine will be both the operator of the hydrogen project and its offtaker. “We’re talking about a major mining company using its own staff and capability and operating the electrolyzer on site to create and consume hydrogen there. Then, at a later stage we’ll expect to start getting some third-party suppliers offering to supply hydrogen to the mine. The key challenge is distribution cost: hydrogen is very expensive to move around, that’s why most usages will be captive at first,” he says.

At KPMG, Smith believes the strategies throughout the supply chain, must ensure benefits flow all the way to the end-user. For example, the supply chain requires careful optimization of the location of energy source, hydrogen production facility and supply point (either refuelling station or export terminal).

Australia is a strong believer in green hydrogen’s potential to displace fossil fuels at home and abroad, and is investing big money into the development of the domestic industry.

And when it comes to attracting commercial financing in coming years, project developers will need to bring in guarantees, and a lot of them. “The way to get banks to the table on the initial projects would be to include government funding, sponsor equity, a technology guarantee from the technology provider, and an offtake guarantee from the miner,” points out Roberts at ANZ. “If you have substantial creditworthy parties standing behind those elements, then you could see banks coming in, and then over time, the requirement for the full guarantee of the technology will start to fall away and you will get to more non-recourse project financing.”

He adds that while banks are not currently prepared to provide debt funding to hydrogen projects, it may make sense for miners to encourage them to get involved even in the form of corporate guarantees, because at least banks will get familiar with the technology, and may be more comfortable financing future projects.

Long-term risks and cost profile

As the industry matures, banks will also be looking for some form of international certification system for the electrolyzers involved in the project, as well as safety guarantees. The good news is, the production process for green hydrogen doesn’t produce any unacceptable output, so it will have no problem meeting the Equator Principles requirements for banks. “The real attraction of this technology is its green credentials, so blue hydrogen, especially without CO2 sequestration, will be less appealing to banks,” notes Roberts.

Miners and their hydrogen partners also need to consider the longterm risks that are likely to impact the technology’s cost profile, and water is a significant one. “One also has to consider water and the quality of water: this may be a longer-term risk as water becomes more scarce. You may need to add a process and cost to clean the water down the line, as you cannot use ‘dirty’ water in an electrolyzer. So make sure you have a good supply of clean water and understand the long-term cost of that supply,” says Beazley.

There may be many hoops to jump through for miners currently looking to finance pilot hydrogen projects at their sites. But given the level of enthusiasm from financiers, and the pace at which the technology improves and lowers in cost, capital is likely to become much easier to come by in just a few years. In the meantime, large miners’ investment and collaboration with public and private partners on hydrogen projects are a clear signal that once the technology reaches commercial viability, the mining sector will jump in with both feet.