What Is the Right Contracting Strategy for Green Hydrogen Projects?
New energy projects, such as those that involve green hydrogen production, face many challenges associated with commercializing emerging technology. One contracting strategy that has worked well for other nascent technologies involves a design competition for the front-end work (or FEED). Can this strategy work for green hydrogen projects?
The Promise of Green Hydrogen
Hydrogen has long been touted as the low emission energy source of the future. Hydrogen‑powered cars have been on the market for almost a decade, and over the last few years, several governments have pursued research into a combined domestic gas supply. The challenge to commercialization is generation of hydrogen from a green supply. Most hydrogen today is made from natural gas, becoming so-called gray hydrogen, but there is a new wave of investment into green hydrogen and more is on the horizon.
Green hydrogen is made from electrolysis of water. Unlike the other colors of the hydrogen palette, it can be produced with almost zero emissions if the electricity supply is a renewable source. It could be the answer to the growing industry question of how to store surplus energy generated from renewable sources, particularly when battery technology requires maturation.
The role of hydrogen in the global effort to meet government climate targets has not gone unnoticed by oil majors in Europe. Companies previously known for their success in oil and gas—many of whom are long-standing IPA clients—are ramping up their investment in hydrogen. As these and other companies venture into unfamiliar territory, several of them have engaged with IPA to help navigate governmental policy and incentive schemes. Our work for these clients follows our business model of risk analysis and benchmarking to help with making strategic decisions.
The Challenges of Green Hydrogen Projects
Like all ventures, hydrogen projects benefit from the primary drivers of success: a strong business case, fully aligned stakeholders, bought-in sponsors, an integrated owner team, and Best Practical Front-End Loading. However, these projects have additional considerations. Hydrogen—and new energy projects in general—do not always prioritize cost or schedule, instead favoring the need to demonstrate interest and willingness to invest in the new industry. The most challenging aspects of these projects arise from two (often interacting) factors: the scaling of the nascent process technology and the complex stakeholder alignment challenges that arise from external stakeholders coming from different sectors with different priorities (some tied to governmental targets) and different risk tolerances.
The Role of Design Competitions
The combination of a diverse set of stakeholders and an emerging technology often leads to solving the challenges through a contracting strategy that relies on the contractor’s technical and project development capabilities. In particular, the strategy selected by a number of companies undertaking green hydrogen projects is a FEED design competition with rollover of the FEED contractor into a more traditional lump-sum engineering, procurement, and construction (EPC‑LS) contract for execution. This strategy consists of hiring two or more EPC contractors (or consortia) to undertake FEED on a scope the owner developed. The competitors often bring with them licensed technology, and the winning contractor’s technology is adopted for the project.
This contracting approach can be insightful to owners who do not have previous experience in the field. When the technology is unfamiliar, a design competition forces the FEED contractor—often in a consortia with the owners of the technology—to develop the optimal design to meet business needs in a competitive way. Design competitions typically produce better defined FEED packages at the start of execution than other contracting forms. As a result, cost growth from authorization to mechanical completion is often minimal for project teams selecting this contract type. The predictability associated with FEED competition also renders it attractive to investors because it minimizes uncertainty.
Although this strategy can be insightful from the technical perspective and works well for a broad range of industrial projects, its success still depends on following project Best Practices. In particular, a key component to success is clearly articulating and aligning on the sponsors’ business objectives early on, and sharing them with the competing contractors. The business objectives must be coherent and include detailed trade-offs among the project’s priorities. Because a break-even business case for green hydrogen projects is rarely viable without public support, these projects tend to have a various stakeholders and gaining alignment between them on cost, schedule, and technology commercialization (i.e., commercial-scale operation) is a challenge. This alignment is necessary to create a stable project environment in which to execute the project.
Once the business objectives are well defined, owners still need to ensure the scope requirements are well developed and shared with the competing contractors in a consistent way while ensuring no information flows between the competitors. Owner organizations will need to support all competing contractors and ensure that best project planning practices are consistently followed. Gaining early sponsor alignment, adequately supporting the competing contractors, and following best project planning practices requires significant owner attention and resources. If these practices are followed, a FEED design competition with rollover into a more traditional EPC-LS contract for execution can be a winning strategy.
IPA’s New Energy Transition Initiative
As part of our New Energy Transition Initiative, IPA is helping clients who are implementing cutting-edge innovation—and those just beginning to consider green energy initiatives. IPA is positioned to provide support on the understanding, development, and selection of execution strategies for hydrogen projects. Our focus is to support project teams in setting up their projects for success by guiding them through early shaping of the project, alignment among partners, and best commercialization and project management practices.