April H2 Investing Newsletter - Hubs funding, hubs timing, and small projects moving

                “In midst of chaos lies opportunity” – paraphrasing John Archibald Wheeler 

That’s certainly where we are this month with hydrogen. It’s not all doom and gloom- real opportunities for investment and development in H2 have more chance now than they have had in a long time. 

Here’s what happened:

1. DOE announced plans to cut four of the seven hubs – all in blue districts or states
2. OCED, which runs the H2hubs, is being dismantled. There is no clear plan or successor organization to manage the hubs
3. Several projects have left the hubs – some of which are moving forward on their own without federal funding
4. A circuit judge ordered the administration to halt all freezes to IRA and IIJA funds – so freezing and canceling of the H2Hubs will be a lot harder
5. Plug Power went below $1 per share – which means little in the big scheme of things
6. The senate window for rejecting 45V guidance ends in 3 days in-session days. This edges us closer to having more final clarity on 45V – making the investment opportunities in the space much less risky
7. Smaller scale projects are moving forward now that they are out of the shadow of hubs – some eschewing 45V and government funding entirely

The major implications are:

1. The dismantling of OCED means H2 Hubs are going to fail the original goal to disseminate learnings and move more towards being corporate handouts – reducing the goal of moving the broader industry forward
2. More mega-projects in H2 are likely going to be pushed back or cancelled – including hubs
3. Smaller projects – with much more investment opportunities – are already starting to move forward, regardless of hub funding and 45V

Surprisingly, the result here could be that hydrogen is more investable for investors because equity opportunities are much more available and viable at small companies than at companies with ten digit market caps.  

The dismantling of OCED – Shared learning likely lost

Hydrogen Hubs was the flagship program of OCED - a significant amount of time was spent doing commercial analysis and interviews to come up with the DOE H2 Commercial Liftoff report (which I was a lead author on) was meant to guide the H2hubs selection process and the shared learnings to take from project execution. 

The plan was for OCED to re-build DOE’s internal engineering, commercial energy, and project delivery experience to help the hubs overcome shared obstacles – and then disseminate those learnings to the public. Without those teams in place, the hubs are not synergistic and they won’t share learnings outside their projects – which means they much closer to corporate handouts rather than a springboard for H2 development. Moreover, it means that every company that wants to get into large scale H2 projects is either going to have to recreate the wheel or poach experienced talent from other companies – not a great recipe for growth at the large project end.

Implications of OCED/hubs for H2

The largest implication is that there isn’t anyone at DOE to handle invoicing from the hubs. Even if the courts ordered unfreezing of funding, the lack of ownership over the hubs and other OCED funding means that processing and disbursement of awards is stalled. 

Will the four identified hubs get cut?

Historically this would have been hard to do – but the current administration has demonstrated a keen ability and significant support to break precedence. I anticipate that at least five of the seven hubs will make it past the proposed cuts eventually, and that significant parts of most will go forward. 

That being said, even if the administration is ordered to cease cuts by courts, the options to slow-roll the progress to push projects out of the hubs still remains. No company is willing to hold billions of dollars of investment on the sidelines while waiting for the outcomes – the result remains that projects will leave these hubs. Here are examples: 

• SoCalGas and parts of the ports have both left the CA hub
• Sempra left the TX hub
• Much of the Heartland hub has left or downsized
• The original main offtake from the Philly area hub has left
• One of the largest blue H2 projects in the West Virginia hub has left
• FFI left PNW
• The Midwest hub has had its share of ups and downs as well – and would not have made it to award when it did if the administration wasn’t changing

Every hub had major projects drop even before the new administration decided to slow the hubs. Expect continued hurdles to increase departure.

The key positive takeaway is that many of these projects that left the hubs are still moving forward – notably SoCalGas and the switch of ports to H2 vehicle operations in California.

The remaining opportunities in hubs

Many hubs still have some shared infrastructure. If these shared infrastructure move forward then regional hydrogen communities could expand – bringing in new offtake and production. This will be 5+ years before serious investment and growth opportunities arrive.

Small projects see big opportunities

The market for small scale hydrogen seems to be thawing. Smaller projects outside of hubs or adjacent to hubs are starting to move again. While there are many drivers for this, two stand out:

1. Hubs and other large scale projects are having trouble getting access to federal funding
2. All projects are having trouble making 45V work - and smaller projects are often more able to work around this

45V is difficult for a lot of large scale projects to make commercially viable, particularly reformation projects. Many large projects are paused or cancelled. Smaller scale hydrogen projects are seeing an opportunity to do an end-run around the major projects with their delays and high overhead. Projects I’ve seen moving forward (and contracted with) are now 1-10 tons per day – much smaller than the 50+ tons per day that many projects in the hubs are looking to do. 

The largest advantage most smaller projects have is much lower overhead costs. A very lean developer may as low as 10% of their CapEx as overhead costs, whereas an international energy company can have as much as 70% overhead – all those layers above project execution all the way to CEO have a way of adding a lot of cost to these projects. When a developer is a small team, the overhead to execute is significantly lower. In an environment with hard-to-access credits and tight margins, small developers may be able to deliver more reliably and at lower cost.

Why this is good for investing directly in H2

Investing in Shell or Air Products to get exposure to H2 doesn’t work – they have significant other businesses. The same goes for the equipment they use – they are buying hardware from massive suppliers like Baker Hughes that make tons of other equipment – investing in this part of the supply chain tends to be an investment on the broader oil and gas space rather than just H2.

Smaller and growing parts of the supply chain are more focused on H2 - with commensurately more direct exposure. Investing in ITM power – a publicly traded electrolyzer manufacturer with sales to companies like Shell – is much more focused than investing in Air Products to get exposure to H2. Investing further up the supply chain in a company like Versogen that develops membranes used in electrolyzers is also very targeted – and is not available on the open market since it's not a publicly traded stock. Depending on risk tolerance and understanding of the markets, the expansion of smaller scale projects will provide investment opportunities in H2 that won’t be available from the development of large projects. Many of these new opportunities aren’t publicly traded and thus will be more in the real of private equity, venture capital, or corporate M&A.

A remaining gap – project financing and long-term offtake

Project financing is equity or debt to build projects. It generally costs much less than taking money from VC or PE investors. Typically project financing in energy projects like solar and wind have guaranteed long-term offtake – whether 5, 10, or more years. This allows solar and wind companies to develop projects where the project financiers invest in the individual projects.

Project finance investors won’t put money in the projects that don't have long-term offtake. Instead, they want to invest in the parent corporation at a much higher rate of return - which requires commensurately wider profit margins to work for either party. 

Given that most commercially viable new H2 end uses aren’t compatible with long-term offtake guarantees, there isn’t a clear path forward here yet. 

Until hydrogen markets develop more – likely at least with common carrier pipelines – expect project financing to be the exception rather than the rule. This leaves equity and secondary market investments as the main investment opportunities in H2 over the next several years. Once the markets for long-term H2 contracts work out - likely once shared H2 pipelines exist - the investment opportunities will expand significantly.

That’s it, thanks for reading