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The barriers and drivers for the ramp-up of Power-to-X in non-OECD Countries
FS-UNEP Centre / 24 August 2023
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Diogo da Conceição Rego works at the Frankfurt School-UNEP Collaborating Centre as a Project Manager and has over 15 years of experience in the energy and infrastructure sectors. He is currently involved in topics related to climate finance and sustainable energy and infrastructure. He holds a master’s in Petroleum & Gas Businesses from the Federal University of Rio de Janeiro (UFRJ) and an Executive MBA from Frankfurt School of Finance & Management.

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Power-to-X (PtX) is a term used to describe a variety of technologies that convert surplus electricity from renewable energy sources into other forms of energy, such as green hydrogen, ammonia, or synthetic fuels. The ramp-up of a global PtX industry can reduce greenhouse gas emissions and combat climate change while creating new jobs and economic opportunities in the clean energy sector. In addition, it can improve energy security by reducing dependence on fossil fuels, diversifying the energy mix and making it more resilient to shocks.

The “chicken-egg” dilemma

However, some challenges still need to be addressed before PtX can be widely adopted. A major factor is the nascent stage of the industry, whose products are still more expensive than their fossil fuel-based alternatives. Combined with regulatory and market uncertainties, this situation hinders the signing of long-term offtake contracts, a critical condition for investors and financiers to make final investment decisions (FID), leading to a “chicken-egg” dilemma.

With the mission of accelerating the global energy transition, H2Global was created as an efficient funding mechanism for PtX projects outside the European Union. Supported by the German Federal Ministry for Economic Affairs and Climate Action (BMWK) with a first commitment of EUR 900 million, H2Global aims at kick-starting the global trade of PtX products, e.g., green ammonia, e-methanol and kerosene (for more details, see here)

Focusing on understanding the financing challenges

Under the request of the H2Global Stiftung, the Frankfurt School-UNEP Centre conducted thorough research focusing on understanding the financing challenges faced by PtX projects in non-OECD countries. The report is available here, but a summary with the main takeaways also follows:

  1. Despite the recognition of PtX projects as a promising sector for future financing activities, most financial institutions and Development Finance Institutions (DFIs) are yet to make substantial investments. While many have PtX projects in their pipeline, they are mostly at the feasibility study stage. The industry is new and evolving, leading to cautious engagement, often through grants. Many DFIs have established dedicated PtX working groups to navigate this emerging sector.
  2. PtX projects are capital-intensive endeavours, requiring substantial funding for successful implementation. Given the scale of investment required, there is a need for financial institutions to participate in financing projects at significant leverage levels and with extended tenors.
  3. The novelty of the PtX industry demands innovative business models that effectively mitigate risks. Two main models are identified: the “Captive Model,” involving on-site PtX production for self-consumption, and the “Merchant Model,” where PtX is produced for sale. The project’s specific business model impacts risk factors and cash inflow dynamics.
  4. PtX projects encompass multiple stages, including renewable energy, electrolysis, storage, processing, shipping and utilisation. Investments can be bundled under a single Engineering, Procurement and Construction (EPC) contract or separated into different projects, each with distinct financing mechanisms tailored to their specific requirements.
  5. Challenges facing investors and financiers in PtX projects are attributed to the early stage of the PtX market. Uncertainties regarding prices, regulations and standards affect long-term offtake agreement commitments. Equipment suppliers’ limitations in providing firm delivery deadlines and technical guarantees, as well as the risk of technological obsolescence, add to these challenges. The transportation and logistics of PtX products also pose concerns for potential investors.
  6. The specific financing instruments needed for PtX projects vary based on project characteristics. Strong governmental support and de-risking instruments, such as first-loss guarantees from DFIs, are critical for enhancing project bankability. Concessional loans and grants can make projects more attractive to equity providers. These instruments are particularly vital for early-stage projects with higher risk perception and capital expenditure.
  7. Initial PtX projects may require guarantees from sponsors capable of shouldering risks related to supply and demand. Companies driving the early projects could be those seeking to decarbonise their operations, such as ammonia manufacturers, fertiliser plants and steel mills.
  8. The required return on investment for PtX projects is influenced by perceived risks. OECD countries tend to have single-digit required returns on equity, while non-OECD countries demand higher double-digit returns due to perceived risk premiums. The expected return of a PtX project needs to exceed the hurdle rate to attract investor interest.
  9. To make PtX projects competitive, factors such as remuneration of PtX production, risk perception reduction and establishment of a global PtX-finance knowledge hub are essential. H2Global’s mechanism can play a pivotal role in setting standards for PtX fuel auctions. Collaborative efforts to reduce risk perception and information dissemination through a knowledge hub could accelerate industry growth.

In conclusion, the nascent nature of the PtX industry, uncertainties in demand and supply and the need for tailored financing instruments all play roles in shaping the landscape. By addressing these challenges and leveraging governmental support, industry collaboration and innovative financing mechanisms, the path to a greener energy future through PtX projects can be expedited.

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