Episode 24: Developing hydrogen ecosystems featuring HYCAP and MorGen Energy

The transcript highlights below have been edited for clarity.

Mark Lee

The topic we're going to be tackling is hydrogen and how ecosystem approaches to hydrogen development are incredibly important, what are sometimes referred to as hydrogen valleys. Ben, I want to turn to you first, what is HYCAP and what is your role there?

Ben Madden

I'm the Chief Technology Officer at HYCAP. HYCAP is an investment fund, effectively a private equity fund, looking to invest in hydrogen and its derivatives in order to try to get this difficult bit of the energy transition going. My role here is primarily about strategy for the company in terms of trying to build an overall investment case for getting hydrogen investments to work and then also screening investment opportunities as they come in.

Mark Lee

Patrick, please tell us about MorGen, what the organization is trying to do and why are you working on hydrogen?

Patrick Huber

Let's start with why I work on hydrogen and the reason for this is very simple. Climate change has always been a concern and climate change goes hand in hand with the energy transition. A few years back, together with my brother, we assessed what the energy transition could look like and nothing seemed to make sense, we just couldn't put the parts together. When we threw hydrogen into the equation, we realized that would be a missing link. I still believe and I'm confident that the energy transition will not be possible without hydrogen. But I'm also aware that it's not only hydrogen that's needed for the energy transition.

We need more renewables if we want to execute the energy transition, but renewables have the characteristics that they never appear in the space or time where they are needed. So, you need to have the ability to transport and to store the energy. And so, you need to have large storage capacity and hydrogen is simply the only technology at this point in time that could actually fill that gap.

Mark Lee

Ben, can you describe a bit more fully the ecosystem approach and how that shapes some of your investing?

Ben Madden

I think it's important to understand from an investor perspective that any investment you make in the hydrogen space automatically fits into an ecosystem, come what may. There's a dimension from renewable energies, through hydrogen production, through packaging to end use, which is a long chain. And then there's also another dimension of all of the technology which has to be produced, manufactured and then supplied into the system. The important thing to understand about hydrogen is that pretty much every single actor in that chain is doing something as we move to commercialization on a scale that they haven't done before and also often using new technologies and challenging existing regulations, making the whole thing very complex and very hard for each of the individual actors. What we're then seeing is when you consider the investment in any individual piece of the system, it becomes very complex. You look left or right in the chain and you see all of those risks which your counterparty is bearing in the system, and you get very spooked as an investor and you start to demand quite significant contractual ways of recognizing and mitigating against those risks. And that's proving really hard in practice, and I'd say that's one of the things which is slowing down the speed at which hydrogen projects are getting to final investment decision, just the degree of risk management which people are expecting within the ecosystem.

At HYCAP, what we're trying to do is take a slightly different approach, what we call an ecosystem approach to investing. It's probably a slightly different use of the word than Patrick might use, but essentially we're looking to invest in companies from production through the distribution and packaging all the way through to the end use, who are basically deploying companies and also companies who are manufacturing the goods into those systems. And the idea is that by investing like that we can put our arms around the whole thing as a single coordinated approach. We actually build that into our investment approach for every individual investment that we make, we do an appraisal of the company as an individual company, effectively as a standalone entity. Does it work as a standalone entity? Does it make sense as an investment? But we also check does it work with all of our portfolio companies, what's the synergies that we can expect from our portfolio companies? Also, our investors and the various partners that we have attracted along the way. We won't make an investment into a company until we see both of those things getting a big firm tick and that's the way we look to try to cement the ecosystem approach into our way of doing things.

We're seeing three main benefits from that approach. The first is confidence because we can see and control all aspects of the chain, it gives us confidence to make investments significantly earlier than some of the other actors in the chain who are requiring this heavily contractualist approach. The second is around diversification. We've got multiple end users in our ecosystem and multiple sources, just like a biological ecosystem, we feel that gives greater stability. What we're finding when we take our projects to larger scale investors, big equity and bank investors is valuing that multi off taker or multi sourcing strategy far more than the single sourcing approaches, which we've seen in some of the projects, which again have been struggling to FID. The final point is around price because we can see the economics of each of the individual steps in the ecosystem, we can persuade our portfolio companies to work together to give an all-in offer to the customer, which starts to give a plausible ownership proposition, either as a service model or just simply making sure that all of the components of the system work economically for the end customer. And because we can see the economics, it gives us the confidence to make the investments up the chain and the thing becomes a bit of a virtuous circle and that's how we think about the ecosystem approach to investing.

Mark Lee

Can you give us one example of an investment where the synergies were particularly high?

Ben Madden

I think the UK is a particularly good example. In the UK, one of our portfolio companies called HYGEN has secured the largest subsidized hydrogen products, a 35 MW project in in Bradford and that gives us very low-cost hydrogen, thanks to the generous subsidies which are available in the UK. They will then partner with another one of our portfolio companies who's called Rise, who is basically distributing hydrogen and learning the process of distributing hydrogen today, through to customers in the industrial sector and also early transport customers. Then we've also got JCB as one of our investors and we have an investment in a company called Wrightbus who makes hydrogen buses, basically two very big end users, both of whom are commercializing hydrogen vehicles as we speak. The confidence that we get from understanding the economics of those vehicle manufacturers as well as the industrial customers that Rise, the distribution company has, gives us the confidence to take the final investment decision in the Bradford project and thereby get this whole ecosystem going. And what we're then doing is we're managing to get a complete hydrogen system up and running in an area which everyone sees as having lots of potential, the construction sector, the large heavy goods sector, but where there has been a real struggle to get one side or the other of the equation to work. Either on supply or on the vehicle side.

Mark Lee

Patrick, a project development perspective, can you talk about hydrogen ecosystems and how you approach them to identify potential projects? What makes them look attractive to you from the developer side?

Patrick Huber

It's an extremely important question because obviously there's a lot of opportunities out there. There are investment opportunities, project opportunities and you need to have a consistent way to objectively measure their attractiveness. What we do is measure them in three clusters, which is basically infrastructure regulation, and market demand on this. On the infrastructure side, we're concerned about where we get cheap power at large numbers of hours per year to produce hydrogen to keep the cost low, but also where do we have access for transportation of hydrogen i.e. pipelines or where pipelines will be developed. So that's an extremely important point.

The second one is the regulatory environment. I don't see any renewable projects getting their feet off the ground if the regulations don't change because markets are somehow efficient to some extent and mostly if regulations don't change, markets don't change and we need markets to be efficient, transparent and have cheap hydrogen available. So, the regulatory environment is critical. How stable is the regulatory framework and are there any carbon free incentives? Is there a general appetite or need from governments or authorities for green hydrogen projects?

Thirdly, it's the market demand and where we assess whether we're going to be able to find bankable offtake contracts and where the willingness to pay is from these different off takers. If there's a project which is already existing or in the buildup or after the final investment decision has been taken, we also need to look at the technology and there we unromantically strongly favor proven technology. We want to build large scale ecosystems and if you want to do large scale ecosystems, it doesn't work unless you have proven technology. If new technology doesn't provide the solution which it initially promises, it makes the ecosystem break so those are the points that can be assessed here.

Mark Lee

Jo, you're looking across policies that support decarbonization, focused on hydrogen and clean fuels. What does the current environment look like and what is the pace of change? Give us a deeper sense on what's happening in the policy regime right now and what might be next.

Jo Howes

There's been a huge amount of development and debate on these policies, but they're not fully developed yet. An important one in Europe is the Renewable Energy Directive, that sets a target that each European member state needs to meet for renewable energy use. Within that there are specific targets for using renewable hydrogen and fuels made from that hydrogen in the transport sector and in industry. The important thing about that is it's a directive. It's up to each member state to work out how they're going to implement it in practice, and they're all at different stages of doing that and all thinking about doing it in different ways. In transport there was a bit of a boost because some policies were in place for biofuels that have been adapted for hydrogen, which could already get some revenue into hydrogen use in transport, but for use of hydrogen in industry that debate is at a much earlier stage with very little clarity about how each member state will make that happen. So, I expect that to be one of the really big topics of debate this month at European Hydrogen Week.

I think those policies are really good at thinking about how we set an overall market framework and how demand should be created in the long term, but they're not fully defined today, they don't create a bankable market even for an individual one of those value chains in many cases, never mind a more branched ecosystem. They also don't cover the whole of the value chain. I talked about transport and industry. There's also support for hydrogen production through things like the hydrogen bank, which is an auction for a fixed subsidy for 10 years. But that doesn't mean there's a full policy framework for everything that anybody might want to do with hydrogen. Not every production pathway, not all of the potential end users in power, industrial heat, steel making, chemicals or anything else you might want to do in that more branched ecosystem to get it all to work. Typically, more specific support has been key and until you know what support there's going to be, it's very difficult to plan one of those more branched ecosystems to work out how you do that most efficiently, either in terms of money, efficiency or greenhouse gas emissions.

Mark Lee

Lisa you also do the ground project work, often trying to join up the various actors in the ecosystem or the value chain. Can you talk a little bit about how the ecosystems and the relationships within it are evolving, especially within the context of a still fractured policy environment and otherwise?

Lisa Ruf

The first project we were involved with originally was a first of a kind project, typically looking at low technology readiness level (TRL). The focus for this project was to look at specific sites, innovative sort of trials, looking at very specific sets of activities – for example, hydrogen refueling stations and small fleets of hydrogen buses. Then the second wave of projects that has happened, typically looks at higher TRL levels and larger scale deployment. The objective of this project was to look at diversifying the type of technologies that were being tested, facilitating the entry of new entrants into the market and also preparing for a more commercial rollout at this stage. Now we are in a consolidation phase and the objective is to have projects that work as an ecosystem as described by the other speakers today. The objective shared by both the regulator and private operators is to make projects have more impact, projects that are feasible, and also projects that are scalable. The focus today and where we see that collaborative, innovative projects happening is in that space, in the building of these ecosystems. That's why you see funding available from Europe, for example through the ecosystem support in place and that's something they describe as a hydrogen valley themselves.

Mark Lee

Ben, what are you looking for from an investor perspective in the policy space?

Ben Madden

It's very important that any investment we make, the policies which are made available, will last for the duration of the investment. If there's any risk of the policies being removed or tweaked or changed after we've made the investment, then that's a killer for our ability to make the investment. I think the second point speaks to what Jo was saying, which is that the policies are often either applied on the supply side or on the demand side, but rarely in both. We see that really starkly in the difference between the UK and Europe. In the UK, we effectively have a supply-based push, so we can get hydrogen subsidized down to the cost of natural gas, but there's relatively little imperative for people to take it up. In Europe it’s the other way around. A lot of markets have been mandated to take up hydrogen, but actually the hydrogen being produced is at a relatively high cost and that's scaring people because they worry about what happens when those mandates get removed. I would say a balanced approach between demand and supply policies and the most important thing being certainty.

The final point would be realism. Some of these policies have been set in a way that they're probably expecting price levels, which can't be hit in the early years of the deployment of hydrogen, there's lots to learn. If we look for the successful policies which have subsidized the aspects of the energy transition, they've generally been willing to be generous initially rather than really penny pinching initially, because you need to leave some margin for investors, covering that risk premium when projects inevitably go slightly over. If we look at the money that was available in solar, for example, they were very generous incentives and helped drive a rapid decrease in the price for solar. We haven't really seen that generosity in hydrogen because of the fear of effectively subsidizing and I would probably encourage regulators to be just a little bit looser, particularly in the early years.

Mark Lee

Patrick, how is the current regulatory framework guiding your project site selection, where is it looking most appealing at present?

Patrick Huber

At present we have got two projects that we have progressed far. One of them is in Milford Haven, Wales where we produce hydrogen and we've been a part of support for production. Fully support what Ben said about support for production in the UK is extremely generous these days. The other side is in Denmark or on the continent, you benefit less from that kind of support so you really have to look after the cost side. We started a project in Esbjerg, Denmark on the 1 GW Power-to-X (PtX) production plant about four years ago. I can honestly state that there has not been a day when I didn't think it wasn't the best location in Europe to start this because it provides access to renewables. The government is tendering wind farms at this moment which produce power to an extent that it can't be absorbed from the electric grid. So they need PtX to actually get a good price on that tender for the windfarms. It's also in close proximity to Germany, which is going to be one of the world's largest hydrogen offtakers in the coming years with the pipeline. There are some questions on the pipeline from Denmark to Germany, but there has been a very strong statement from Germany on their 9,000 kilometer pipeline that they plan to be operating by 2033 and smaller parts, not much earlier. I think Denmark definitely has the best position to be a leading hydrogen producer. Nevertheless, it's not all perfect. I think the government would need to step up to make the right decisions in terms of permitting process to actually execute on these projects. I think that's where we’re lagging a bit of proactive approach from the government who are willing to do the changes, but so far have not gone all the way with these changes.

Mark Lee

Jo, are you seeing areas of policy innovation that you hope kind of catch on and scale in other places?

Jo Howes

This is being used in hydrogen but also has been pretty successful in other sectors in Europe is the idea of contracts for difference. So the idea of negotiated contracts between government and project developers, where there is a discussion around the costs and the revenues of the project and then depending on the revenue and how that varies, the government subsidizing the difference. This is a very different approach from for example, the tax credit approach taken in the US where you've got a fixed subsidy. Now some industries love fixed subsidies because it's got some certainty at least around the level of the subsidy, not necessarily about whether it will be there in the future which given the election results in the US, we don't know. But some in industry like that because it's very simple, you do your project economics, you put in the fixed tax credit, you decide whether it makes sense or not.

The difference with the contracts for difference approach that's been quite widely used in different sectors and in different countries in the EU, is it allows that negotiation for more complexity. If you have a project that's producing different products or benefiting from potentially more than one different type of subsidy, you can adjust the amount that the government needs to pay to try to avoid the over subsidy that Ben was talking about governments being scared of. it's worked quite well in some renewable electricity sectors. So I think that's an interesting policy approach to consider using in other parts of the world.

Mark Lee

Lisa, the place I wanted to go that we have not touched is the community and society side of this. All of the energy transition is happening or is supposed to be happening in the context of just transition. When we start talking about 9,000 kilometer pipelines, we know that there are going to be a whole host of different feelings about the pipeline and where it is and why it is. Can you just talk about how community and societal engagement is working in the context of hydrogen and what maybe needs to evolve?

Lisa Ruf

I think historically there's been some work done to try to explain what these benefits are for these communities. At this stage, it's another challenge our project developers have to face, they have to be the communication specialist in this topic. You increasingly have a number of institutions and association agencies that can support, but those project developers have to try and test the methods and approaches to communicate with local communities. Not only that, but also persuade local authorities, local politicians of the value and the benefit of their project. And that can make or break a project potentially and I think we are going to see more of this in the future. The more you see projects getting to scale, the more this will be an issue that will need to be addressed comprehensively. To some extent in the projects we work on, they have been first of a kind prototype projects to date. That does come with the benefits of not necessarily requiring quite as much engagement as classic energy projects with local communities. But again, in the future this is likely to change.

Mark Lee

We've been talking in the context of ecosystems, the regulatory funding, project development, community aspects. My final question – just as you look ahead, what is a shift in the nature of the ecosystem that you hope to see that will enable faster scaling?

Jo Howes

I think the thing for me that's really important is getting clarity on how hydrogen might be used in industry in Europe and what policy will drive that. From when we started working on this, many of us, quite a few years ago, were looking for the best use cases. Now we're also seeing this from the other side. We're seeing lots of industries with pressures to decarbonize and they're looking at everything that's in the toolbox to decarbonize and many of them are coming to hydrogen as potentially an area that could really help them. But they need to know whether they need to do it, when they need to do it, how they're going to do it, who's going to pay for it. And that's a really key question for me.

Mark Lee

Ben, how about for you?

Ben Madden

At a sector level, we need to see more of the projects, particularly the projects which are independently developed, reaching final investment decisions. So at the moment we do see a ramp up in the number of projects which are getting given the green light, but most of them are being developed in very tightly controlled ecosystems in refineries where for example, the refiner also owns a wind farm and is then prepared to build an electrolyzer, so very much within closed ecosystems.

What I would like to see is the companies that are developing slightly more open ecosystem facing projects getting to the final investment decision. Those are generally the projects that are being developed by independent developers or by smaller companies. It's a harder investment proposition and often targeting some of the end uses, which are slightly less mature or easy, the refinery is relatively easy because it already uses hydrogen. So, at a macro level, that's what I'd like to see happen. That would give us as investors in those types of companies a lot more confidence. I think it would give our investors more confidence. How does that happen? We've talked about the importance of regulation and regulatory stability. I would say that's probably the key request. I personally would like to see more attention given to getting hydrogen in some of the higher value segments going, in particular heavy duty, mobility, maritime, some of the derivatives in maritime and also the construction sector which looks quite promising as an early use case.

Mark Lee

Lisa, what's your look ahead wish?

Lisa Ruf

I think there are a lot of very positive elements today to get projects to final investment decision and probably a couple of the additional elements that are missing that would really help the projects progress to that stage is having frameworks that allow them to build confidence and trust across their partnership. So finding approaches that are able to work together and progress step by step into taking those critical investment decisions, to a stage where they are confident that they are sharing the risk fairly. That would require some sort of confidence coming from government and from the regulation. But also some of this can be done through slightly creative, private partners working together.

And then the other area that we continue to work on collectively is looking at developing the skills for project developers, project managers and looking at recognizing the need for a tailored approach for each of these projects. I think sometimes the frameworks that exist are bit intransigent. You have to follow a recognized approach, but each project is going to be very different and even if there are similar projects that have happened in the past, this project may need something a little bit different. So, it's helpful to bring this flexibility to recognize the complexity of this sector to make it possible for this earlier investor to be able to go all the way to making those ambitious projects happen.

Mark Lee

Patrick, you get the last shot at this to build on the rich set of ideas we've just heard.

Patrick Huber

I probably have the largest list. First of all, it's very straightforward, if you want more projects to reach the final investment decision, you need two things. One of them is more renewables and you need a pipeline. I think that would be a huge catalyst and that's the most important thing to understand. 

But now the third point that I want to raise, and we touched on capital expenditure support, having operational expense support, the third point is I don't believe in this supporting system to a large extent. If we want to decarbonize, various studies show that you need 100 to 150 trillion by 2050. This is an amount which by far exceeds the capacity of every government. So, what you need is you need the market. And if you want to engage the market, then you need CO2 pricing. And I think the CO2 pricing is by far the most effective tool because it doesn't make the government make decisions on which technology needs to be used in which area, the market can do this very effectively itself. But you need to find a way to charge industries that emit CO2 so they have an incentive to mitigate their CO2 emissions. So that's on my Christmas list definitely, the top is the CO2 price.

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