Prime Capital: Hybrid strategy ‘vital’ for success

This article is sponsored by Prime Capital

With war raging in Europe and time running out to avert climate disaster, the energy transition has become more urgent than ever before. Replacing fossil fuels in hard-to-abate sectors, as well as in electricity generation, has become a key priority.

Mathias Bimberg, head of infrastructure at Prime Capital, and Jens Walzner, an executive director of infrastructure at the firm, believe investors should seek to control the entire value chain, from generation to offtake solutions, in power-to-X projects. Doing so, they say, will ensure a supply of low-cost renewable energy to enable green hydrogen and e-fuels to be produced profitably.

It has been a momentous year for the energy transition. How has your strategy evolved?

Mathias Bimberg: Our approach is based on what we call a hybrid strategy. We want to control the entire value chain.

The first step is to secure the green electricity generation, but then we try to do something intelligent with it. That means we want to help decarbonise the hard-to-abate sectors, for example by producing green hydrogen and other derivative products, which can then be used for transportation or heavy industry.

We only pursue hydrogen investments if we have secured a profitable offtake. This is an approach that seems logical, but a lot of our competitors structure pure energy transition funds that do not invest in the underlying electricity generation as well. We believe our approach is less risky and we have a higher additionality and a higher impact.

Jens Walzner: We continue to build out renewables, particularly in the Nordics. However, we would also like to expand that strategy into other European regions, where you can produce at a low levelised cost of energy – such as the Iberian Peninsula.

Our approach requires knowledge and relationships on the renewable energy production side. It is a relatively lengthy process to get projects developed and built. Renewables capacity is the most important cost impact factor, as 70-80 percent of the cost of producing green hydrogen comes from electricity.

We are progressing on several power-to-X projects, where we seek to replace fossil fuels through the use of green electricity-based conversion technologies. One of our largest projects is in Kristinestad, Finland, where we are planning to build a 200MW electrolyser facility.

We have secured roughly 600MW of renewable capacity serving that electrolyser facility in order to produce green e-fuels at that site. We have initiated the permitting process, secured the land, procured the electricity and secured a lot of other ingredients that are required for the project, most importantly offtake agreements for our end product.

To what extent has interest in power-to-X grown recently?

JW: After the outbreak of the war in Ukraine, the whole energy transition has become much more urgent in Europe. At the same time, rising energy prices have obviously made it more important to think about where to procure the energy from for power-to-X projects.

That is why we believe our hybrid strategy makes sense. While other investors may focus on the development of hydrogen or specific power-to-X projects, we are also securing the green power to serve those projects. Securing electricity at an acceptable cost level is vital to enabling power-to-X projects to move forward.

The EU has passed several delegated acts, setting the regulatory scene for power-to-X projects, which should ensure that the end product is accounted for as being ‘green’. A lot of market interest has been established and various projects have been announced throughout Europe. Now, the core question for the industry is: how many of those projects will actually be realised?

What is needed to ensure that projects can get off the drawing board?

JW: On the plus side, we have gained more clarity throughout the year, including around the regulatory framework in Europe. Clarity is always helpful. Some of the electrolyser OEMs have also made up their minds in terms of adding additional capacity. The growth of that market has also, to a certain extent, brought clarity.

However, there are clearly certain supply chain issues. There are long lead times for some components, such as transformers, which impacts the development of projects. And permitting processes still take a long time. There is a lot of support for streamlining permitting, but the need to really accelerate those processes does not seem to have got through to everyone.

Then, there is also the question of finding the right offtaker for a project. There is a lot of development ongoing on the offtaker side. Companies are becoming aware that a green end product will cost a little bit more than a non-green product.

MB: When we talk about our power-to-X or our e-fuel projects, we are often asked what our product will cost. And, of course, it is more expensive. But this is only one part of the equation. We also need to factor in the cost of emitting carbon.

There is not a lot of supply of e-fuels, and there will be a lot of demand. Of course, how much it costs is important. But through regulation, the cost of emitting carbon will significantly increase, and this will ultimately make the green product very attractive.

Several important regulatory measures have taken shape in the past year. Can Europe keep up with the US in developing hydrogen and other green industries?

JW: A lot of investors are concentrating on the US market following the Inflation Reduction Act because there is obviously a very large programme of subsidies being offered. The EU is trying to counterbalance that to a certain extent. But the EU has taken its time in responding and has stipulated requirements for projects in a quite detailed manner, which potentially makes it complex to invest.

However, the measures in the EU do create certainty that regulations will soon to be in place. That enables us, as an investor, to take those regulatory requirements into consideration when we make our final investment decisions, and to plan the projects in accordance with those regulatory stipulations.

The EU has announced a plan to produce 10 million tonnes of green hydrogen within the EU, and to import another 10 million tonnes. If you simply look at those numbers, it is clear that the EU has an ambitious strategy.

To produce 10 million tonnes of green hydrogen within Europe, we would need roughly 70-80GW of electrolyser capacity, and if those are being served by renewables, we would need more than 200GW of new renewable capacity. That shows how large the efforts will need to be in order to achieve the EU goals.

MB: There are major differences between the US and EU when it comes to sheer numbers. The US IRA offers $369 billion dollars in incentives for energy and climate spending, with a large focus on green hydrogen. By contrast, the EU has just launched a ‘Hydrogen Bank’, with a first tendering for €3 billion. That puts things into perspective. Only a few dozen projects are participating, which shows that we are still at the beginning of the wave.

Also, the EU is not able to shape national policies in the same way that the US government can. It can provide a framework, but that framework needs to be implemented into law by the European countries themselves.

On the other hand, it is not always the case that subsidies are needed. Regulation can be equally as important or even more so. In Germany, for example, we have a quota mechanism for fuels, where the blend needs to become progressively greener by certain dates. That is vital for the development of the green fuels industry.

How has appetite from investors for power-to-X projects developed recently?

Mathias Bimberg: Many of our investors, in light of increasing interest rates, are looking for value-add or core-plus strategies. They are moving up from core to core-plus.

Many can directly invest into the underlying new green electricity production. This is something that might have been new for them five or six years ago, but they have become comfortable with renewables risk, then moved more into greenfield risk and now they are explicitly looking for new opportunities to generate higher returns.

They like the combination of the hybrid product that we are offering in our approach to the energy transition, which they see as a differentiating factor.

But it is still the beginning. To a certain extent, we are a first mover in this segment. But that also gives us opportunities. The key is really to find the right offtaker and make the projects profitable.

And, of course, it needs to be accretive. No energy investor would invest into the energy transition, where there is more perceived risk and more complexity, without a higher IRR.

The technology readiness is not at the level of venture investors anymore. Elements of the technology has been around for more than 100 years. Power-to-X strategies could be considered core-plus or value-add, perhaps even with private equity-like features.

My view would be that we are not investing in companies or investing in technology – we are investing in projects. So, it is infrastructure, but with private equity-like returns.