Green hydrogen is mooted to play a key role in supporting net zero ambitions by helping to decarbonise those “hard to abate” sectors where direct electrification is challenging, such as industry, shipping, aviation and heating. Yet the emergence of a global green hydrogen industry remains in its infancy. Faced with myriad risks and uncertainties, companies looking to develop first-of-their-kind green hydrogen projects are joining forces with others across the value chain through joint ventures (JVs) to share resources, know-how and risk. This blog explores some key considerations when forming a JV that aims to withstand some of the unique risks and challenges of green hydrogen projects.
Green hydrogen projects are confronted by a plethora of uncertainties – technical feasibility, emerging regulatory and subsidy regimes, evolving technology, unpredictable development costs, project-on-project interface risks, nascent marketability prospects and limited bankability precedent, to name just a few.
The JV’s governance framework will need to account for these inherent uncertainties and strike an appropriate balance between sufficient operational flexibility to allow the JV’s business to evolve with the industry and realities of the project, while ensuring each partner remains adequately protected against key risks that arise from these shifting dynamics, such as material cost overruns.
This can be a difficult balance to strike. An overly rigid governance structure that fails to anticipate the developing reality of the industry and project could result in regular deadlock and renegotiation between JV partners, frustrating the smooth operation and effective development of the project. On the other hand, an excessively flexible regime could fail to provide adequate strategic direction or certainty on key aspects (such as committed funding) that are necessary to allow the project to progress with sufficient efficiency and confidence, for example, in dealings with key contractors.
A key early structuring consideration is whether to establish a governance regime that aims to withstand the project’s entire lifecycle, or whether the framework established for the early development stages will be replaced with a new regime as the project matures. For example, it is not uncommon in large greenfield energy projects to see initial JV governance established to apply up until a final investment decision (FID) is taken, anticipating that a new governance regime will be adopted as part of the arrangements for FID which reflects the nature of FID and how it will impact the project’s future capital structure, such as the introduction of new equity investors or different forms of debt finance.
The governance that surrounds taking material gating decisions, like FID or similar milestone decisions to progress the project from development to construction to operational phases, will also require consideration. What conditions precedent must be satisfied before FID can be considered? Which regulatory permits must be obtained, which key contracts must be in place, what funding must be secured – and how will those prescribed pre-requisites be established while the industry and regulatory framework remains in flux? What are the consequences if a partner votes against FID? Can a minority partner be “voted in” to a positive FID decision? What if the minority is unwilling or unable to fund its share? Can the supportive partners force a non-supportive partner’s exit from the project, for example, through a buyout right – and if so, at what value?
Related parties and conflicts
With all stakeholders urgently seeking ways to advance their net zero ambitions, green hydrogen JVs often bring together investors from across the value chain – such as integrated energy companies or renewable power generators, hydrogen technology companies, shipping or fertiliser companies and other offtakers such as energy marketing and trading firms.
Unlocking the advantageous project synergies these cross-value chain collaborations promise will typically require various related party transactions to be entered into between the JV and one or more of its investors, such as EPC and O&M arrangements, power purchase agreements and hydrogen sales contracts. This creates an acute risk of conflicts of interests. Conflicts could also arise where one investor has its own local or broader interests that may compete with the interests of the project – for example, if an investor provides the project’s green energy source which also powers other local projects.
As well as stipulating broad ‘arm’s length’ principles for such related party transactions, joint venture agreements commonly treat related party transactions as ‘reserved matters’ which require a higher threshold of investor approval to police their terms. However, this approach might not always provide the non-conflicted investors and the JV with adequate protection, for example, where the conflicted investor has a material stake in the project and is accordingly in a position to determine or significantly influence the outcome of the ‘reserved matter’ vote.
To ensure the interests of the JV are preserved and the conflicted investor does not unfairly benefit from commercial arrangements in such situations, appropriate conflicts provisions may be required to adjust voting and quorum thresholds to suitably disenfranchise the conflicted investor, or to more generally ensure that the conflicted investor is not in a position to frustrate orderly decision-making, access sensitive information concerning the related party matter or block the JV from exercising its contractual rights (for example, should the JV determine it wishes to exercise a right to terminate a related party contract with a material investor).
While the logic of excluding conflicted parties from decision-making is philosophically sound, material investors can often feel uncomfortable to allow key JV decisions to be determined without their input – particularly where the relevant related party contract underpins a significant element of the project on which the investor may have based important investment assumptions, or where the future direction of the project is not particularly clear. As a result, the topic of related party transactions and conflicts can often become a hotbed for extensive negotiation.
As with most greenfield energy projects, developing a green hydrogen project will require significant development and capital expenditure. While project developers may be accustomed to unilaterally funding the early-stage development expenditure for feasibility studies, FEED, regulatory processes and other pre-FID early works, the relative nascence of the offtake market for green hydrogen (and derivative products like green ammonia and methanol) challenges the bankability of green hydrogen projects and may require the founding JV partners to go it alone for longer.
Joint venture agreements will usually tie the JV partners’ equity funding commitments to a project development (or construction / operating) plan and budget, which aims to serve as a dynamic guiding framework for the relevant phase of the project and is updated regularly to reflect the project’s evolution. For legal certainty, it is crucial that the link between the relevant plan and budget (and any updates to it) and the creation and nature of legally binding equity funding commitments remains crystal clear. As project plans and budgets are “commercial” documents that may evolve in style and granularity over time, there is a risk that the project plan and budget may eventually diverge from what is contemplated by the joint venture agreement funding provisions, potentially causing ambiguity in the nature and amount of the JV partners’ funding commitments and providing fertile ground for disputes.
The governance procedures for updating project plans and budgets will require particular attention where they are linked to funding commitments – especially where amendments are required to respond to cost overruns, as is so commonly the case in greenfield projects (and further exacerbated for green hydrogen projects, where inherent uncertainties make planning even less predictable). What threshold vote is required to approve a budget? Can JV partners be ‘voted-in’ to the budget and involuntarily attributed funding obligations? If not, what happens if a JV partner does not agree to provide additional funding? Do they need to veto the entire budget, potentially causing deadlock? Or can they just opt out of incremental funding (and if so, will their interest be diluted upon other JV partners providing that incremental funding, on what basis and how might this impact their governance rights)? What remedies are available where a JV partner fails to provide funding in default of its commitments?
Giving sufficient early thought to the practical procedures by which the JV will call cash from its investors can also avoid complications later. Challenges can arise where the stipulated cash call procedure requires the provision of extensive information that the JV may not realistically be able to forecast or prepare (particularly in the uncertain environment of factors that could materially affect the green hydrogen project in the future), or the completion of clunky time-consuming processes that cannot always be completed, in time for payment to suppliers. Elaborate procedures that work well on paper do not always work so well in practice, so it is worth thinking through the practicalities of the project’s cash flow requirements and, where there is uncertainty as to the nature of frequency of the project’s cash flows over the medium term, considering whether some flexibility should be embedded into in the process.
Sell-downs, exits and recycling development capital
When initially contracting the JV ‘marriage’, a partner’s eventual divorce from the project might not be front of mind for all participants. In fact, it would be customary for the founding partners to be ‘locked in’, and prohibited from selling interests in the project, until a significant milestone some way down the track (such as the start of commercial operations).
However, in similar vein to the offshore wind market, seasoned project developers might not intend to hold their entire interest for the full useful life of the project. They may instead pursue a strategy of divesting all or part of their interest in the project once it is (or is closer to being) operational and generating stable revenues (when there will be a larger market for the interest) and ‘recycling’ the sale proceeds for investment in the development of other assets.
Such developers may therefore be keenly focused on the transfer regime in the joint venture agreement and any provisions that could affect a process for the sale of its stake, such as pre-emption rights (including rights of first offer or refusal), access to management assistance and the ability to disclose diligence information to prospective purchasers. The other JV partners should consider the practical impact that the exit of a key developer or other founding investor may have on the project and whether appropriate protections are required. For example, where the exiting partner has historically been relied on for its expertise, manpower or other services, the project might benefit from ‘in-sourcing’ some of those services on a transitional or longer term basis.
The initial structuring of a green hydrogen JV will play a key role in the project’s commercial success. A green hydrogen project will inevitably be dynamic and need to withstand numerous risks and uncertainties. Establishing the JV arrangements in a way that accommodates and can adapt to the project’s changing requirements throughout its lifecycle will stand the project in good stead and help the JV partners’ relationship get off on the right foot.
We have explored above just a handful of things to consider when forming a green hydrogen JV. There are many more. We have considerable experience supporting our clients in structuring complex, first-of-a-kind and first-in-country projects – please do get in touch if we can help support the development of your green hydrogen JV.