Decarbonising industrials and hard-to-abate sectors: Three keys to harnessing clean molecules for the energy transition

Decarbonisation of the electricity system is a critical part of the energy system. But electrification alone won’t be enough for the world to reach net zero. By 2050, the IEA estimates across its scenarios that 10–25% of energy use will require low-carbon solutions that don’t involve electrification, because of high costs or technology limitations. 

Many of our most important sectors – like aviation, ocean freight, heavier terrestrial transport, and heavy industry – are all actively seeking to abate Scope 1 emissions using ‘clean molecule’ solutions. We define these as hydrogen, carbon capture and storage (CCS), biogas, and liquid biofuels.  

As explored in the previous article in this series, accessing, decarbonising and purchasing green electricity presents a unique trilemma for organisations. Similarly, clean molecules come with their own set of challenges. At Baringa, we’ve supported some of the earliest large-scale financing of hydrogen, CCS, and biofuel infrastructure. We understand the market dynamics and risks of this space. We’ve also seen first-hand what it takes to maximise the benefits of investments in clean molecules.  

Here, we set out three principles that should be top of mind for chief financial officers (CFOs) and other executives who are evaluating investments that involve clean molecules, along with key considerations for integrating these technologies into your organisation’s decarbonisation mix. 

Principle 1: Clean molecules are simply too expensive to scale up without regulatory support. Corporates must understand how the push and pull factors generated by mandates, subsidies, and other incentives impact the timing, location, and choice of solutions they invest in. 

• Clean molecules require major policy interventions. We estimate that hydrogen, CCS, and advanced biofuels increase the cost of energy by 1.5 – 4x versus conventional fossil fuels. This leaves companies dangerously exposed to competition if they move too quickly. However, with appropriate carbon pricing, fuel mandates, or subsidies, these solutions become viable and competitive.  

• Pinpoint where you need to act first. Regulation is highly unequal across geographies and sectors. For instance, the shipping industry is moving towards a global mandate for low-carbon fuels under the IMO. Mandates for sustainable aviation fuel (SAF) are proliferating across OECD countries and long-haul airlines. Currently, the EU is the only regional bloc pushing for meaningful regulation of heavy industry via its reformed ETS and its upcoming Clean Industrial Deal, while Japan, Australia, and California each have sizeable industrial economies taking concrete regulatory steps. Understanding where and when different rules apply enables you to prioritise your response and avoid unnecessary cost, effort, and risk.  

• Know where the money is and whether it’s bankable. The lowest net-cost solution for clean molecule plants can often hinge on a complex array of incentives for fuel producers, feedstock suppliers, and consumers. These can be transformative, as in the case of the UK’s hydrogen subsidies or Japan’s hydrogen CfDs, where a single subsidy bridges the cost gap. But they can equally be fraught with risk, such as where subsidies are time-limited and dependent on other subsidies appearing in future. That’s currently the case with many of Europe’s green steel proposals or hydrogen-for-HGV projects seeking finance through complex transport certification schemes. Knowing how to navigate and leverage these funding resources is a crucial element for success and long-term viability. 

Principle 2: Markets are currently full of distortions. Analyse long-term dynamics and the economics of individual molecules carefully to get a realistic picture of the most cost-effective options. Be wary of white elephants created by strong but unsustainable incentives. 

• Some sectors will pay more than others. Willingness to pay for clean molecules will change over time as regulations hit different sectors. Trade-exposed sectors like steel and agriculture might have lower initial costs to decarbonise versus aviation and shipping. But they face higher risks from moving too soon, and are under less pressure from their customers to act. In contrast, aviation has a higher ability to pass costs through to passengers, which is leading to stronger mandates within the sector. This should generate a higher willingness to pay for biofuels in that sector versus road transport or light industry, where electrification can bear most of the burden of reducing emissions. 

• Not all solutions will get cheaper. Biofuels will get more expensive as demand grows and competition for finite bio-feedstock increases. Similarly, e-fuels derived using biogenic CO2 will plateau once competition for biogenic CO2 outweighs any benefit from the declining cost of hydrogen. By factoring these cost changes into any long-term commercial plans you’re in a much better position to make informed decisions today. 

• Avoid picking solutions with no residual value. Existing subsidies and mandates for clean molecules can heavily distort the market, leading to rushed introduction of what should be longer-term solutions or incentivising the wrong solutions entirely. For example, mandates for e-fuels are driving projects in countries that have poor long-term fundamentals for production. Meanwhile, huge subsidies for hydrogen to displace natural gas heating are pushing out electrification, even where it is a more efficient option. Focusing on long-term fundamentals and avoiding decisions driven entirely by temporary incentives will allow companies to make the right strategic investments now to guarantee security of supply in the future. 

Principle 3: Invest early in commercial feasibility and partnerships, recognising the crucial role of clusters and avoiding over-weighting on technical feasibility in the earlier stages of project screening.  

• Map out local dependencies and costs. Identifying future networks and their impact on energy sourcing is vital. Clean molecules will require new infrastructure, adding commercial risks and costs that you must account for. Start thinking about where future networks might emerge and how this impacts your energy sourcing. For instance, hydrogen-based fuels are more likely to be attractive where solar and wind are very cheap, while CCS clusters are likely to emerge where there is readily accessible sequestration and an established upstream oil and gas footprint.  

• Choose your partners wisely. Prioritise working with partners that have assembled well-rounded consortia, where dependence on, and risk of, new third-party networks is minimal. Be wary of the current glut of ‘PowerPoint projects’, which seem impressive on paper, but may have major barriers that developers understate, such as speculative infrastructure plans (pipelines), immature tech processes and unclear commercial models. 

• Dedicate strong commercial teams. Clean molecule projects are more commercially complex than current energy arrangements. The way they interface with regulation and incentives, as well as the involvement of multiple commodities, means you should prepare for more commercial oversight to get first-of-a-kind (FOAK) contracts over the line and avoid last-minute deal-breakers.      

• Focus on what makes projects financeable and don't feel pressured to accept unnecessary complexity. Push back on partners seeking to introduce risk to make projects more palatable to their commodity trading arms. Also, be clear on what risks you must take to attract debt. For example, 10- to 15-year contract commitments are often essential to making projects financeable. Industries used to hedging oil or gas may now need to hedge power or bio-feedstocks, while subsidy and incentive mechanisms create certificate markets that also require hedging. Understanding the wider context around project financing will give you clarity and confidence of your risk appetite and bargaining position. 

Capture the clean molecule opportunity 

Adopting clean molecules comes with a host of challenges and questions. Organisations that act now to understand the options available to them, and the associated costs and risks, will be poised to capture maximum value as the energy transition accelerates.  

If you’d like to shape a clearer picture of how your business can harness clean molecules to support its decarbonisation efforts, Baringa is ready to help with detailed analysis, industry benchmarking, tailor-made strategy, implementation support, and more. Get in touch with Shane Heffernan today for more details.