Hydrogen 101: the uses, the costs and the opportunity
What does the opportunity around hydrogen look like? Our experts at Schroders Greencoat explain in this Q&A.
What are the different types of hydrogen?
James Samworth, co-head of Energy Transition, Schroders Greencoat, said:
Hydrogen can be made using various methods and they're normally known by a colour scheme.
Our primary focus is what's known as green hydrogen, which is the production of hydrogen from electrolysis of water using renewable power as the input source. Electrolysis is the process of using electricity to split water into hydrogen and oxygen.
The other types of hydrogen, like pink or blue, depend on the way they are made.
Pink hydrogen is created with the electrolysis of water too, but the source of the electricity comes from nuclear power.
Anther type is brown hydrogen, which is produced from the gasification of coal.
Most hydrogen today is grey hydrogen, which is produced via a process of steam methane reforming.
Blue hydrogen uses effectively the same process: fossil gas as an input material, but capturing and storing the carbon dioxide. The UK has a slightly different policy than Europe on blue hydrogen; with an attempt to have comparable volumes of both being produced, Europe is focusing more intently on green hydrogen. We think that's mostly because the UK believes it has better storage reserves for carbon dioxide (CO2) in the North Sea and perhaps some slight competitive advantages in oil and gas.
That is also true in some parts of the US, but we believe that green hydrogen is ultimately going to be the winner.
How is hydrogen used?
James Samworth: Hydrogen is used in a variety of sectors today and its production makes it a major carbon dioxide (CO2) emitter. The hydrogen molecule is very flexible and can be used as a raw material for many processes. In some cases it will actually be used as hydrogen directly, for example in the steel industry, which accounts for 9% of global emissions, making it an important industry to decarbonise.
Hydrogen can also relatively easily be made into ammonia, which is the largest market for hydrogen today for use as a fertiliser. But ammonia could also be used as a fuel for shipping, for example, which is also a large CO2 emitter at about 6% of global CO2 emissions.
Ammonia can also be used as a transport vector because pure hydrogen is quite expensive to transport, being a small molecule and very expensive to compress and liquefy.
Hydrogen can also be combined with CO2. This combination can blended to almost any part of the petrochemical stack as required. The most simple is e-methanol, for use in shipping or plastics and the chemicals industry. Or slightly more advanced derivatives like sustainable aviation fuel, which is effectively e-kerosene, or other e-fuels for heavy road transport.
Which industries use green hydrogen?
James Samworth: A lot of the early movers have been consumer-facing industries where in addition to the economic drivers, they have a brand-driver or an ESG-driver around decarbonisation. This includes some paper companies, but also some food and drink manufacturers. The big industrial sectors are starting to move as the subsidy schemes firm up, and that will drive the rapid scale-up.
How do the economics of hydrogen work?
James Samworth: With hydrogen, you have a physical offtake. An offtake agreement is an arrangement between a producer and a buyer to purchase or sell portions of the producer's upcoming goods. So you must sell your hydrogen to a customer. This has implications for projects on multiple dimensions.
Typically, you want long-term agreements for those offtakes, ideally from credit-worthy counterparties and therefore the norms in that area are going to be an important driver of how the sector develops.
But essentially you need to produce hydrogen in a predictable way from good operations and have some stability around the pricing for many years.
We expect most of that stability to come from some government-backed subsidy or price certainty mechanisms, as was the case with the first 20 years of the development of renewables. The additional factor is that you are spending a lot on power, so optimising the cost of that power is very important.
On a relative basis, for every €100 of revenue that you generate in a project today, you'd be spending €65 on power. You need to make sure you've got no basis risk between those two. They're either both fixed or they're both linked to the same index and so they need to be contracted to deliver you a secure income.
You have construction risks in development stage assets, both in terms of what your estimated capital expenditure (capex) will be and how your outturn capex compares to that. This is relatively plug-and-play in terms of the onsite activities, where construction costs can more easily get out of hand. However, it's not a mature supply chain yet; it remains quite an early industry, resulting in some delivery risk in building these projects.
How much does green hydrogen cost?
James Samworth: Hydrogen is difficult to compress efficiently and to transport. This means there's a much better economic case in being able to supply a factory, via a pipeline directly for example, as opposed to putting it into compressed high-pressure storage for trucks to deliver it to different offtakers via road.
That's not the case though for fuels such as e-Methanol, which is easily transportable and is already being transported globally.
Let’s look at some examples. Green hydrogen - at around $8 a kilo currently - is substantially more expensive than grey hydrogen. Putting the carbon cost aside, the cost of green hydrogen will come down significantly through scale and through technology development. Namely as electrolysers go from tens of megawatts to hundreds of megawatts, that's before taking into account the gigawatt-scale projects that are being developed for the early 2030s .
Opinions vary on how fast those costs will come down and where they get to, but common numbers are suggesting around €3 a kilo by the end of the decade. That is still more expensive than grey hydrogen and is likely to remain so for a while.
Estimates also vary about what investment is required in renewable energy globally to get to net zero. But many suggest it could be around $10 trillion by 2050. In addition, around $5 to $7 trillion in hydrogen is needed. The hydrogen industry will need to be roughly comparable in size to renewables by 2050 to fully decarbonise the economy.
What’s the future of hydrogen?
James Samworth: The industry needs to go through a very substantial scale-up over the next ten to 15 years. Risks abound, for example to do with technology and to the extent that revenues and costs can be optimised over time. There are also regulatory risks, such as over changes in standards, though in Europe and the UK these are reducing as standards start to become binding. The biggest risk is probably regarding electrolyser efficiency.
How big is the hydrogen market in Europe?
Karin Kaiser, Head of Private Markets Europe, Schroders Greencoat, said:
In order to reach net zero by 2050, the EU's energy transition strategy focuses on a couple of areas. One is the decarbonisation of electricity, the electrification of heat, and the electrification of vehicles. A big role in the European strategy is the adoption of hydrogen for hard-to-abate sectors.
In the short term, the market opportunity is more limited, but we believe that over the next decades, annual investment in hydrogen will become comparable to the annual investment size of renewables. Until 2030, the EU has a target of an annual production capacity of about 20 million tonnes. We estimate that by 2050, about 30% of today's electricity demand will be required for the production of hydrogen for electrolysis. This means that we're looking at about a $2 trillion overall market opportunity by 2050 to build out both the electrification targets as well as the electrolysis targets by the middle of the century.
What is your hydrogen strategy in Europe?
Karin Kaiser: We're getting exposure to the full energy transition opportunity set. We're combining exposure to renewables, which is a very established asset class, and a very institutional scale opportunity set, with exposure to what we call adjacent technologies.
Hydrogen forms the largest part of that subset of adjacent technologies. What's key to it, is that electricity is a large input factor to the investment case. That means you are combining the production and the use of electricity, enabling you to manage your risks from two angles: 1) creating a certainty of cash flow and a secure income and 2) adding additional layers of diversification.
For our hydrogen strategy in Europe, three points are key: we really like working via partnerships; we are very actively involved in overseeing construction and investment management (about half of our staff are engineers); and we are focusing on what we know best, which is power-generating assets at scale.
What does that mean in terms of our actual hydrogen strategy?
From a product perspective, we are very focused on local production and local consumption of hydrogen as well as e-Methanol. These are probably the most mature products at the moment and are most likely to produce infrastructure-like cash flows.
In the short term, from a development stage, we are not looking to take large scale development risk, we're going in in late stage development and/or construction. That ensures relatively quick deployment and relatively quick beginning of secure income production.
From a deal structure, we are always looking at this as an asset-based strategy, so looking to invest in asset platforms as well as standalone assets.
What initiatives are you working on in Europe?
Kristian Høeg Madsen, Co-head of Hydrogen. Schroders Greencoat, said:
Most of our projects are targeting operations by 2030, but we are already seeing that the timelines of large projects are being pushed back. The multiple hydrogen projects can only come to life if there's actual equipment being produced.
We certainly foresee a significant bottleneck in supply of electrolysers. In Europe there is quite a broad spread of electrolyser capabilities with several strong European original equipment manufacturer (OEM) suppliers, particular German suppliers, as well as UK producers.
Our European pipeline of hydrogen projects is built around the major consumption and production areas. In particular, Spain, Portugal and the Nordics are widely considered to be the powerhouses for production in the period to come, mainly driven by low power prices, and by a large penetration of renewables.
We have also established a significant pipeline of projects in Germany, which is set to be a major consumption hub of not only hydrogen but also many of its derivatives.
Overall, products range from pure play hydrogen projects to more e-fuels such as e-Methanol.
All of the projects are focused on late stage development and onwards, which essentially ensures that there's a manageable period until actual deployment of capital would be required.
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