Inflation threatens power-to-X as costs soar

• Low-carbon hydrogen development costs have risen by up to 50%
• Inflation has made electrolysers, finance and power more expensive
• Sector needs support to stimulate demand and set common standards

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Inflation is making it harder for companies in the low-carbon hydrogen sector to turn ambitions into completed projects. That is one of the International Energy Agency’s headline findings in the ‘Global Hydrogen Review 2023’ that it published last week.

Companies’ ambitions for low-carbon hydrogen are huge. The IEA said production of low-carbon hydrogen could reach 38 metric tonnes annually by 2030 if all announced projects are realised. That includes 27 metric tonnes from electrolysis, and 10 metric tonnes produced by carbon capture, utilisation and storage (CCUS). The figure is an increase of 50% year-on-year, which shows that appetite from developers is growing.

However, developers are struggling to take projects to financial close. This is due to a combination of long-standing regulatory and permitting barriers, and newer challenges including the impacts of inflation on project costs and a lack of demand from off-takers. Developers have only been able to make final investment decisions on projects with 2 metric tonnes of low-carbon hydrogen production annually.

Steep cost increases

The most urgent concern for power-to-X developers is common to other infrastructure types: the impact of inflation on the cost of electrolysers, raw materials, and electricity used to power the electrolysers; and on the cost of finance.

The IEA has warned that a rise in the cost of capital of three percentage points leads to an increase in total project costs by almost one third. It also said that the developers of several projects had raised their initial cost estimates by an eye-watering 50%. This eats into their profit margins and raises the cost of the ‘green’ fuels they produce.

Inflation also means that government support for developers of low-carbon hydrogen projects is less effective. If projects are more expensive then it means governments can support fewer projects than they previously expected, because developers need more money to close the cost gap between low-carbon hydrogen projects and those that create hydrogen from fossil fuels. This compounds difficulties in the US, Europe and UK, where the IEA says government support has been introduced too slowly.

In an inflationary world, project delays lead to extra costs that put projects at risk.

The knock-on effect of these rising costs is that there will also be fewer orders for the manufacturers of ‘green’ hydrogen electrolysers. This is a particular concern for firms in Europe and North America, which are seeing Chinese firms rapidly building market share. In 2020, Chinese companies made less than 10% of the electrolysers deployed globally, but that was up to 30% in 2022 and could hit 50% this year. This also gives Chinese manufacturers the opportunity to scale their operations and reduce prices.

In addition, the developers of low-carbon hydrogen projects face delays in securing permits needed to build their schemes; and many are also struggling to secure deals with off-takers for the hydrogen that they are looking to produce. We have focused on how to fix these challenges in our power-to-X Leadership Council meetings.

Three policy priorities

The IEA sees three policy priorities that could help developers take more low-carbon hydrogen projects to financial close.

First, more support to encourage industrial users to increase demand for low-carbon hydrogen. Global demand for hydrogen grew 3% in 2022 to 95 metric tonnes, but that is mostly in the industrial and refining sectors. Less than 0.1% of demand came from new applications in industry, transport and power generation. In addition, low-carbon hydrogen accounted for just 0.7% of total hydrogen demand; and this is still at a very small scale. Developers would benefit if governments could stimulate demand.

Second, more international agreement on low-carbon definitions and certification. We see consensus that low-carbon hydrogen is a major opportunity, and 41 countries now have hydrogen strategies in place. However, developers face difficulties because there is a lack of international agreement on what ‘green’ hydrogen means, which restricts their activities. It is positive that the G7 and G20 have identified the risk that this poses to the growth of low-carbon hydrogen, but more must be done on standardisation. The COP28 conference in Dubai in November could help to further this discussion.

And third, governments must remove barriers around the licensing and permitting of new projects. Slow permitting processes are a perennial bugbear for developers, but the fact is that improving the coordination between different permitting authorities can help reduce project lead times. This includes hydrogen production plants themselves, and also hydrogen pipelines, storage facilities, and import / export terminals.

These are all sensible policy recommendations, but whether politicians follow through on them remains to be seen. Plenty of countries want to accelerate the growth of the low-carbon hydrogen sector, but developers need help getting this industry airborne.