Breakingviews - Hydrogen investing is a lottery worth playing

LONDON (Reuters Breakingviews) - Hydrogen is the energy buzzword of the moment. The chemical element could play a key role in the global push to produce carbon-free energy. That appeal is already evident in the toppy valuations of some of the industry’s main participants. Yet it’s still a lottery worth playing.

A 2020 Toyota Mirai hydrogen electric fuel cell car is displayed at the Canadian International Auto Show in Toronto, Ontario, Canada February 18, 2020.

Hydrogen is earth’s most abundant element, but only occurs naturally in compounds. Producing pure hydrogen means breaking those chemical bonds. The most common way to do so is to apply steam to natural gas. This approach accounts for nearly all the 70 million tons of hydrogen produced annually, which is then used to make chemicals like ammonia. This energy intensive process also emits a lot of carbon.

The excitement about hydrogen as an energy source is based on an alternative approach, which involves passing an electric current through a so-called electrolyser. This splits water into its components of hydrogen and oxygen and emits no nasty carbon.

For a world that wants to minimise carbon emissions by 2050, clean hydrogen is seriously interesting. In a best-case scenario, electricity produced by cheap wind and solar power would fuel the electrolysis that creates hydrogen. The output would then be used in a fuel cell which can provide power for vehicles and industrial processes, or electricity when renewable energy sources are not available.

A wholesale shift to clean hydrogen could remove carbon from the electricity system, which is currently responsible for around a quarter of the world’s annual 33 gigatonnes of carbon dioxide emissions. It could also help clean up transport and heavy industry, which account for much of the rest.

Analysis cited in the European Union’s new hydrogen strategy reckons the element could meet 24% of world energy demand by 2050. Barclays analysts think the market could grow from 70 million tonnes a year to as much as 800 million tonnes by the same date. That could drive annual revenues of over $1 trillion and cut up to 15% off annual carbon emissions.

It’s therefore no surprise that investors are getting high on hydrogen. The share prices of 11 key companies, including Canada’s $4.6 billion Ballard Power Systems, Britain’s $1.8 billion ITM Power and Norway’s $3.3 billion Nel, have risen by an average of more than 300% over the last year. The enterprise values of Ballard, ITM Power and Nel are more than 20 times their expected sales in 2022, based on Cowen estimates.

Investors undeterred by these valuations still face the question of which part of the industry to bet on. ITM Power, Nel, Siemens and many others make the electrolysers that supply the raw hydrogen. Ballard Power, $2.1 billion U.S. outfit Bloom Energy and Britain’s $1.2 billion Ceres Power develop different types of fuel cell which generate electricity from it. Companies including recently listed $14 billion Nikola make hydrogen-powered trucks. Meanwhile the likes of Italy’s Snam are blending hydrogen into natural gas for heating.

To add to the confusion, carbon-free “green” hydrogen produced by electrolysis isn’t the only game in town. Big players like France’s Air Liquide want to turn their dirtier, hydrocarbon-based product – dubbed “grey” hydrogen – into a more environmentally friendly equivalent using emerging “carbon capture” techniques. The end product is called “blue” hydrogen.

Investors have some signposts to guide them through the fog. Hydrogen takes up lots of space at normal temperatures. Hydrogen-powered trucks, and the fuel cells used in them, still have a cost advantage over diesel-fuelled rivals and those using conventional electric batteries. But smaller passenger cars powered by hydrogen are less competitive.

Projects like Saudi Arabia’s recent $5 billion deal with Air Products to create an electrolyser producing 650 tons per day of green hydrogen also have clear appeal. Ample solar power means Middle East projects could produce green hydrogen for $2 a kilogram after 2030, Credit Suisse research estimates. That’s in line with the cost of dirtier grey hydrogen, and less than two-thirds the cost of producing the green equivalent in areas less blessed with renewable energy sources.

Green hydrogen is therefore riskier. Barclays expects it to constitute a third of annual production by 2050, but that assumes governments and companies will by then have invested to enable 900 gigawatts of global electrolyser capacity. Right now, there’s only 3 gigawatts. In order for the numbers to stack up, analysts at the UK bank reckon green-hydrogen costs will have to fall by 75%.

Investors might be forgiven for avoiding hydrogen altogether, especially as a similar burst of sector enthusiasm two decades ago proved short-lived. But there are good reasons not to. It’s only 10 years since offshore wind was seen as impossibly expensive, but government subsidies supported the sector and costs fell. Taxes that raise the price of carbon would also boost green hydrogen’s relative appeal.

The other potential boost comes from environmental, social and governance principles for shareholders. In the first five months of 2020, sustainable investing inflows more than doubled in Europe. Part of the reason why some hydrogen companies’ valuations are so inflated is that fund managers are buying anything that appears to be on the right side of the energy transition. That could keep share prices elevated even if the returns that justify the hype remain a long way off.


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