How to secure funding for carbon capture and hydrogen projects

For developers seeking to finance carbon capture or hydrogen projects, understanding how lender risk relating to commercial deployment of these technologies can be effectively mitigated is essential.

State of play in the UK market

The UK government’s current goal is to capture and store 8.5 million tonnes of carbon dioxide per year – the equivalent of taking around four million cars off the road. To this end, the government has committed up to £21.7 billion of funding over 25 years to support the implementation of the two ‘Track-1’ carbon capture use and storage (CCUS) clusters in the UK. Funding will be allocated between HyNet in North West England and the East Coast Cluster in Teesside. Funding for these initial carbon capture sites is anticipated to directly create 50,000 jobs over the long-term and attract £8bn of private investment. The first two Track-1 CCUS projects, being the East Coast Cluster and Net Zero Teesside, have both reached the final investment decision stage, with Net Zero Teeside also having achieved financial close.

The government has additionally allocated both the Acorn Project in Scotland and the Viking Project in Humberside as Track-2 CCUS clusters. However, further funding will need to be allocated for those Track-2 clusters if those clusters are to be deployed, to help the UK meet its commitment to achieving its net zero goals.

For low-carbon hydrogen, the government is supporting both ‘green’ and ‘blue’ hydrogen, targeting 10GW of low-carbon hydrogen by 2030, with the aim for at least half of that to be green hydrogen. The first wave of green hydrogen projects have recently signed their financial support contracts, under the first hydrogen allocation round.

What lenders will look for

As with any project financing arrangement in the energy and low-carbon markets, lenders will look for guidance from technical advisers – essentially to confirm that the chosen technical solution is manageable within the relevant supply chain and business model.

With carbon capture, the business models operate by tying the level of payment to the amounts of CO2 captured. Lenders therefore want to be comfortable that a project will be able to meet the required rates of CO2 capture. For the purposes of financial modelling, lenders will assume a certain performance level of the capture facility given that this has a direct bearing on the amount paid out by government to an emitter under the business model.

The hydrogen business models operate in a similar way, although there are other factors that influence the level of payment, such as the capability of the plant to produce the relevant volumes of hydrogen, and whether that hydrogen adheres to the government’s low-carbon hydrogen standard.

Although there is a strong appetite in the market for lenders to support carbon capture and low-carbon hydrogen projects, rigorous processes will be in place for onboarding projects, from carrying out extensive due diligence on all major project parties and contracts, as well as on potential revenue streams supporting the project, to covenants that lenders will seek to impose under loan documentation to mitigate the risk of default.

Corporate structure

Lenders will need comfort that relevant assets and contracts sit within an appropriate entity over which effective security can be taken. A clear understanding of how various project and contractor entities interact is also important for the same reason.

Generally speaking, lenders will require developers to set up a ringfenced project company, or special purpose vehicle, and have in place a holding company structure over which security will be taken. Recent developments around the government’s ‘minded to’ position to permit a twin-SPV structure under the Industrial Carbon Capture business model, which allows a separation between the project company operating the emitter plant and that which operates the capture plant, are beneficial from a financing perspective. The twin-SPV model may prove particularly important for waste emitters developing carbon capture plants to sit alongside energy from waste facilities, which themselves may well have been project financed, and their creditors.

Certainty of revenue

It is well understood that certainty of revenue is of vital importance for lenders. Whilst the government business models do play an important role in providing certainty, the financial support offered is dependent on supported projects actually performing as expected. This is where the role of technical due diligence is so important in defining what normal operation is, and in setting out performance tolerances such that financial support continues other than in exceptional circumstances.

In the context of low-carbon hydrogen projects, the inclusion of key provisions within hydrogen offtake agreements can support revenue certainty, unlocking lower cost funding. Increasingly, lenders are also focused on the credibility of offtake arrangements including counterparty covenant, volume commitments and transportation risk.

Insurance

Insurance is important for mitigating risks within carbon capture and low-carbon hydrogen projects, and products being developed by the commercial insurance market can play a key role on projects of this kind, including in providing business interruption insurance and coverage of leakage risks. In the context of low-carbon hydrogen projects, the ability to obtain robust insurance coverage will have an impact on the strike price and hydrogen offtake price.

Alternative debt sources

The National Wealth Fund (NWF) has communicated its openness to forming part of the capital mix supporting low-carbon hydrogen and carbon capture projects, to aid in the development of these nascent markets. The NWF has stated that it is able to lend in a variety of capacities, including at senior or sub-senior level as well as providing mezzanine debt, and even that it is open to taking equity stakes in certain projects.

Carbon credits

The continuing development of the voluntary carbon market can provide an additional revenue stream for combining bioenergy, including waste, with carbon capture. This may help the market to further realise the commercial worth of captured carbon, as well as increase value-for-money from a government investment perspective. A healthy carbon credits market is an essential tool in unlocking international carbon markets and further decreasing funding pressure on lenders and government. The anticipated government consultation on voluntary carbon markets will set the tone for the direction of this market into 2025 and beyond.

The outlook

It is clear that investment in carbon capture and low-carbon hydrogen projects will be a key focus in coming years for developers, lenders and governments alike. Cutting-edge projects of this nature are vital pieces of the puzzle in achieving global decarbonisation and hitting net zero targets.

Clients are increasingly seeking our support in understanding the voluntary carbon markets, including how access to these can provide a conduit for local and international capital investment, and how further development and harmonisation can widen the scope for revenue stacking by operators of carbon capture plants.