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Green Hydrogen: Is the Sector Ready to Attract Private Equity?

By Gabriel Cerdio - AINDA, Energía & Infraestructura
Partner & Chief Investment Officer


By Gabriel Cerdio | CIO - Wed, 02/15/2023 - 16:00

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Green hydrogen is on everyone’s mind, and rightly so. Global CO2 emissions are still on the rise and experts agree there are no realistic scenarios where the +1.5°C target can be met. However, green hydrogen promises to be the fuel that potentially changes those paradigms and institutional investors across the world are eager to pour resources into managers that can help massify this new game-changing technology. 

The reasons behind green hydrogen’s appeal are several. First, declining costs in solar power is making green hydrogen more attractive. Second, hydrogen is highly abundant. Third, its production requires simple and well understood science. Fourth, it is a combustible gas, making it a source of power that can be stored and transported.

There are, however, several challenges that at least in the short term should temper expectations of a massive rollover driven by institutional monies. Despite costs of solar power having heavily declined over the last decade, green hydrogen remains substantially more expensive that natural gas; producing high-scale, affordable green hydrogen will require a great deal of engineering development because doing electrolysis using a science-lab method will imply prohibitively high costs; storing and transporting hydrogen can be done, but since its molecular properties make it highly explosive and prone to leaks, thoroughly managing risk is still considerably expensive. There are more challenges ahead, but, in short, substantial R&D investments are required to make green hydrogen a competitive market player.

Private equity managers specialized in the infrastructure and natural resource sectors, which are the ones that can drive massification, are not in the business of managing big technology risks. Their role is providing institutional investors with a steady stream of returns, which cannot be ensured if the technology is prone to performance or , safety issues, or if cost-effective maintenance services cannot be obtained (which would be the case if the technology does not achieve substantial scale), among many other hurdles to investing in nascent technologies. 

As has happened in the past with other technologies, such as renewables and  nuclear, governments around the world are filling the market gap. Countries representing some 70% of world GDP have some sort of hydrogen strategy, according to a study published by McKinsey & Company in January 2021. According to the World Economic Forum, leading the way are China, the EU, Japan, South Korea, India, and the US, with several other countries also pushing policies to promote it. To this end, governments are providing research grants and are also actively investing in projects. For example, the California Energy Commission and the Japan Bank for International Cooperation invested in First Element Fuel, a company dedicated to the production of hydrogen for transportation.

Many economists believe governments are not the best suited to fill the investment gap in technological massification, either directly or through direct subsidies, and rather believe their main role should be creating the right regulatory framework that can incentivize the flow of funds, including not only environmental aspects but also safety standards. For better or worse, governments are – and will continue – supporting the efforts.

As institutional investors arrive to the arena, there are other players helping build the market. One key category is project developers, including big corporations and innovation funds. The former includes IOCs and other energy firms with a long-term focus, risk tolerance and oversized balance sheets that allow them to pursue ambitious, high-stake endeavors while protecting their share in the future global energy matrix. An example of the latter is Amazon’s Climate Pledge Fund, which is investing in tech startups that are trying to find solutions to some of the problems mentioned above and are driven by both a high-stakes economic incentive and environmental drive. 

On the other hand, mainstream industrial technology developers, such as Siemens, GE and Mitsubishi, are also making bets on hydrogen. Because these firms are poised to be strongly disrupted by the massification of green hydrogen, as with big energy firms, their main incentive is to survive change. 

Finally, venture capital investors, such as Breakthrough Energy Ventures, are making deals across the value chain, looking for multiple times their investment for the risks taken (as with any other emerging technologies). Venture investors are increasingly funding disruptive energy transition technologies, a space previously dominated by apparently sexier sectors like the multiverse or AI. 

Those efforts are surely yielding results: In 2021, McKinsey counted 228 projects around the world with more than US$300 billion in investment through 2030. While only around 13% of the amount corresponded to projects either realized or in the planning stage, the sheer size of the pipeline is certainly telling. These projects have different orientations of hydrogen applications, which can range from industrial inputs, such as for ammonia production, to hydrogen as a fuel to power transport systems or alternatively, they may be hydrogen transportation and storage facilities, but cross-fertilization is helping manage risks and reduce costs through innovation.   

Right now, there is one common thread around the type of organizations that are investing in hydrogen: they are all either heavy-risk takers or at least have deep enough e pockets to do so. As is the case in any new tech venture, there will be many investments that will no doubt go under. Today it is not at all clear which will be the winning bets and for the next several years, many questions will remain unanswered.  In the next few years, we will begin to see patterns around which hydrogen tech trends are the most promising. Once the storm begins to clear, we can expect investments to arrive through both institutional investors and mid to large vertically integrated energy firms.

We are a long way from seeing hydrogen substituting hydrocarbons. Technology problems still need to be solved. Ecosystems need to be planned, developed, and built. And a large asset base of power-generating plants, pipelines and storage facilities will need substitution or at least substantial overhauls to adapt them to a new fuel.

But make no mistake, the advent of green hydrogen is one of the greatest developments happening today. It promises to change the energy matrix without destroying the planet. Investors will need to ponder an increasingly complex and uncertain set of variables and, thus, need to closely monitor how technology evolves, all the while making investment decisions in established technologies. As in previous technological evolutions, this promises to be a thrilling one. But technological evolutions mean that there are winners and losers. Who ends up where is anything but certain today.

(In collaboration with Andrés Castillo)

Photo by:   Gabriel Cerdio

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