A Cold Hard Look At Hydrogen
Seeking Alpha Analyst Since 2013
Summary
- Hydrogen demand (based on use cases) is likely to remain muted for the next 5 years.
- Significant engineering and scaling challenges in order to drive hydrogen to $3/KG.
- Competing technologies such as batteries, natural gas (with CCS) and nuclear may provide more cost effective pathways to carbon reduction.
- Plug Power is relatively the strongest contender with vision. However, there is no apparent player in the hydrogen space with the capability to innovate and deliver breakthroughs.
Objective
The hype around hydrogen has certainly been palpable. A Biden presidency is slated to drive substantial new investment into renewables, of which hydrogen is a key benefactor. As a result, we have seen numerous hydrogen related stocks (PLUG, NKLA, BE, NEL, FCEL, etc.) post substantial gains, with the hope that hydrogen will be the next big thing.
Numerous articles and videos have also been articulated the benefits and issues with hydrogen. I will not attempt to recap or summarise all of them, but instead address what I think are some of the glaring omissions or “leap of faith” assumptions that have been made. My goal is for readers to have a more nuanced perspective of this investment theme, and know exactly what bets they are making (and not making) when they invest into this sector.
This article will only focus on green hydrogen, and not hydrogen derived from any other sources, because ultimately, I believe it is an imperative to decarbonise the economy. If the goal were to just reduce emissions, using natural gas just makes so much more sense. I firmly believe that hydrogen will have a role to play in our energy mix, because there will be use cases where batteries are just not suitable. However, I think the contribution of hydrogen to the energy mix is actually quite a bit smaller than what the hype makes it out to be.
Use Cases and Key Issues
Hydrogen can basically be consumed in 3 different ways. First, hydrogen to electrical energy, which involves the use of an electrolyser. Second, hydrogen to thermal, which involves burning the hydrogen to create heat. Last, hydrogen to product, where hydrogen is used as a feedstock in the manufacturing of industrial products such as ammonia.
Given these 3 ways of consuming hydrogen, their applications range all the way from mobility to stationary power solutions. Obviously, the key driver for these applications is going to be cost of hydrogen, viability of substitutes, and policy.
There are 4 factors that I feel needs to be considered more thoroughly:
- How and where will demand be generated?
- What are the engineering and technological challenges that need to be overcome to achieve the often quoted $2.50-3.00 / KG cost?
- Where will the competition be in 3-5 years? How will the substitutes compare?
- Who are the players that can execute successfully?
How and where will demand be generated?
I classify hydrogen use cases into waves, primarily driven by the cost of hydrogen. The first wave started perhaps decades ago, and focused predominantly on the forklift and stationary power market. These are the applications that can absorb a hydrogen cost >$5-6/KG. These first wave applications will mature in the next 2-3 years as the cost of hydrogen comes down. The second wave, which I believe has barely begun, applies to the long-haul mobility market and natural gas blending, with a hydrogen cost of $2.50-3.00/KG. The last wave comes with a hydrogen cost of about $1/KG, which includes use cases such as steel production and shipping.
The Hydrogen Council published an excellent report in January 20201 detailing out the path to cost competitiveness for hydrogen. They do a great job at articulating the drivers, especially the returns to scale for hydrogen. In addition, they take a deep-dive look into the different TCOs for each application. The returns to scale are extremely compelling. Moreover, Tesla’s first Gigafactory in Nevada has set a great precedent at how scale can drive down cost.
However, my challenge with these “returns to scale” and “utilisation” arguments is understanding who exactly is going to buy it. What go to market strategies would companies adopt? In Tesla’s scenario, they have a charismatic founder, an undeniably attractive product, and legions of fans. They marketed well, executed well, and managed to get scale. The go to market strategy for hydrogen is markedly less clear.
Virtually all viable use cases for hydrogen does not lend itself to Tesla’s go to market approach. End customers of forklifts and stationary power i.e. businesses have a totally different sales cycle from consumers. I am sure many readers have experience in solution sales and can attest to this. Businesses demand proof of concepts, proof of values, trials, and validation, even before the first purchase order is signed. As it is, the first wave hydrogen applications are struggling to penetrate the market, as evidenced by frankly been posting disappointing revenue growth.
The other way to bridge this gap between expectations is for policy makers to step in. Carbon taxes are an easy way to solve this.
BNEF has quoted some statistics like $50 / MT of CO 2 on coking coal for green steel to $78 / MT of CO 2 for natural gas, and $145 / MT of CO 2 to make shipping viable. All this is based on the assumption that $1 / KG cost of hydrogen is achieved. Let’s take a brief look at these implications using data from the EIA.
Use Case |
Steel |
Ammonia |
Shipping |
Feedstock |
Coking Coal (MT) |
Natural Gas (MT) |
Bunker Fuel (MT) |
Feedstock Price per Unit |
108.00 |
134.08 |
390.00 |
CO2 Emitted per Unit |
2.32 |
2.79 |
3.11 |
Carbon Tax Per Tonne |
50.00 |
78.00 |
145.00 |
Total Carbon Tax |
115.79 |
217.65 |
450.95 |
Effective Unit Price |
223.79 |
351.73 |
840.95 |
Factor Increase |
2.1x |
2.6x |
2.2x |
At the minimum, there will be a 2x increase in input prices for all these applications. To mitigate these, there will need to be a combination of price increases, and efficiency increases. More simply, a cynic would say some of these use cases are flat out unrealistic. Admittedly, some European countries already have carbon taxes ~$50 / MT (e.g. Finland, France). Sweden tops out at ~$120 / MT. The catch? Hardly any of these products are produced in these countries.
Moreover, even if these countries did produce such products, production of these products will just move to other jurisdictions that do not have such a tax. What then is needed, is a global carbon tax agreement. Well, good luck waiting for that.
To be clear, I believe that the third wave of hydrogen use cases at $1/KG is extremely far-fetched. Factor in a 30 year horizon for this report, and the case looks even worst. In 30 years, the opportunities for substitution are also significant. We might find miniature thorium fission reactors, or ultra-dense batteries, or natural gas ships with CCS becomes extremely cheap. Carbon taxes are also ineffective at actually forcing adoption of hydrogen for these third wave use cases. Ultimately, I caution against including these use cases in any market sizing study.
So where will the demand come from? I think wave 1 and wave 2 applications, which need a hydrogen cost of $2.50-3.00/KG.
What are the engineering and technological challenges required to achieve $2.50-3.00/KG hydrogen and unlock the second wave of hydrogen applications?
Coming back to the Hydrogen Council report, they forecast cost reductions in 4 main levers that will drive down cost, with varying levels of impact. Capex (45%), energy costs (37%), efficiency (11%) and operations (6%). I think it is a sensible approach, but I think there are significant challenges I would like to point out.
Capex
Economies of scale is a critical lever in driving costs down across the value chain. ARK invest has a great article on Wright’s Law and how they use it to forecast what the future cost of batteries would be. The exact same concept can be applied to hydrogen, and I think it is a sensible approach.
Underpinning this capex reduction is a move from largely manual batch-driven production method (please see PLUG’s factory tour as an example) to fully automated in-line manufacturing method. This transition is absolutely non-trivial. Battery manufacturers and car manufacturers have had decades of experience with in-line manufacturing. Even the newer electric car start-ups have been able to leverage existing know-how. For example, Tesla had the opportunity to learn, innovate and iterate from Panasonic. Granted, they now do it themselves, but how much longer would it have taken if Panasonic did not exist?
Now lets look at the hydrogen space and PEM/alkaline electrolyser manufacturing. Who are the players have scale electrolyser manufacturing capabilities today? Absolutely none. I have no doubt that existing players have incredibly talented teams, and can solve these difficult engineering problems. But they won’t have the same learning rate as the battery manufacturers.
Efficiency
Efficiency is a broad category and its definition differs across the value chain. I look at efficiency in 3 main segments of the value chain. For production and generation, efficiency generally refers to how well the electrolyser converts hydrogen to electricity, and vice versa. For liquefaction / gasification, it refers to the loss as hydrogen transitions from one state to another. For storage and transportation, it generally refers to the loss over time due to evaporation.
Electrolyser efficiency currently sits in the 64-68% range today for PEM and alkaline technology. The target is to bring it to ~70% by 2030. This I think is fairly achieveable.
Storage is fiendishly challenging for hydrogen. The Chemical Engineer has a great article on the issues with hydrogen transport.
that all investors should read and consider. Being a much lighter than natural gas (which is predominantly composed of methane), it introduces several headaches.
Hydrogen gas being lighter than natural gas means a lot of existing infrastructure that is used for natural gas is unsuitable. Not only will hydrogen leak through the various valves and fittings, but the boil-off rate would be ~10x higher than natural gas, assuming the same containment or transportation vessel is used. In addition, hydrogen is corrosive to certain metals, so specific alloys need to be avoided.
Everything else equal, I see hydrogen being more expensive to transport and manage than natural gas, even at scale. It is just simply a more difficult molecule. More energy is needed to liquefy it, more energy required to keep it liquid (by using boil off), etc. Ultimately, I believe efficiency is an issue that can and will be solved with dedicated and focused engineering effort.
Breakthroughs in high density clean energy generation
Associated with the cost breakthrough is a huge jump in scale, and therefore energy requirements to produce hydrogen. BNEF estimates 31,320TWh of energy.
needs to be produced to power all the electrolysers to produce ~700 MMT of hydrogen by 2050 to stick to the 1.5 degree climate change scenario. For context, this is 16% more than the ~26,900TWh produced globally. Factoring in future growth, total renewable energy requirements would be >60,000TWh, compared to ~3,000TWh today. That is a >20x increase in 30 years. A significant portion of the world would have insufficient space to accommodate solar PV and wind installations.
Given these requirements, we would need to see breakthroughs in high density clean energy generation. This includes thorium nuclear reactors, nuclear fusion, and industrial scale ultra-high efficiency (>50%) solar PV. The R&D investment needed to support hydrogen at this volume is completely non-trivial, and are major nation-state engineering efforts unto itself. In addition, the LCOE of these advanced technologies would probably be higher than today’s solar PV costs.
Where will the competition be in 3-5 years? How will the substitutes compare?
Answering this question is where I feel the case for hydrogen begins to breakdown. ARK Invest has done some excellent research on batteries and how the cost will drop over time. 37% of the hydrogen cost reduction comes from LCOE reduction from wind and solar. Whilst that in itself is not an issue, the 37% cost reduction is equally applicable to alternatives i.e. batteries.
In the ensuing 3-5 years, batteries would also be subject to cost reductions from improved scale, more efficient use of cobalt and lithium, raw material recycling. In addition, power densities would also continue to improve and make long haul mobility more feasible.
There are some excellent videos on YouTube from Real Engineering comparing the end-to-end efficiencies of fuel cells and batteries. In summary, fuel cells are fundamentally disadvantaged because of chemistry.
To make matters worse, the learning rate of hydrogen is actually much lower versus competing technologies. Forecasted learning rate for PEM electrolysers is an annualized rate of 13%, and 11% for commercial vehicles. Far lower than the historical 35% for solar and 39% for batteries. I would have fully expected that hydrogen, as a relatively new but under-invested area, would have learning rates significantly higher due to all the low hanging fruit that is available. I guess not.
In addition to batteries, another key substitute to hydrogen will be natural gas. Use of natural gas in compressed or liquid form is already fairly prevalent in long haul trucking and fleet vehicles. The exact same segment that hydrogen is targeting. We are starting to see limited use of natural gas in shipping, and I would expect that to pick up traction as IMO MARPOL Annex BI begins to be enforced (note I said enforced and not comply, because I am sure tons of shipping companies are not complying).
Given that 37% of the cost reduction in hydrogen is due to reduced LCOE, can that same power be used for CCS? Would it be possible that carbon air capture would make financial sense at similar carbon taxes as hydrogen? If that is the case, why bother with hydrogen in the first place? Why not use natural gas and with CCS? The answers to these merit a separate article, but as investors, we must consider these questions.
Who are the players that can execute successfully?
This question is the most difficult one, and frankly the deal breaker for me when it comes to hydrogen investing. In general, I can divide the field of hydrogen players into two group. On one hand, there are the has-beens of the industrial age – think oil and gas companies, automotive companies, turbine manufacturers. On the other, old school pure play hydrogen companies – think Plug Power (PLUG), Fuelcell Energy (FCEL), etc.
How disappointing.
I struggle to even consider the has-beens of the industrial age as credible players in the hydrogen space. We are all well versed with the innovators dilemma. How soon do I disrupt myself? Should I increase my dividend or invest in new technologies? Can I manage my shareholder register churn? Admittedly some of them will make the leap successfully to hydrogen, history tells us most of them will fail. In addition, I cannot help but take this cynical view that all these companies have missed the EV and battery boat, and are hoping to jump onto the next green energy bandwagon. To add fuel to the fire, if you ever find yourself believing that that oil and gas companies are serious contenders in the green energy transition, please do yourself a favour and take a look at how BP, the supposedly most green of the oil giants, allocate their capital.
That being said, I do agree that capabilities for manufacturing and designing components in natural gas value chain, can also be applied to the hydrogen value chain. This puts natural gas players in prime position to lead. To clarify, I do not mean leveraging natural gas infrastructure for hydrogen use. Hydrogen infrastructure is highly incompatible with natural gas infrastructure due to the chemistry differences.
This leaves us with the next group of companies, what I would call first wave fuel cell companies. Plug Power (PLUG), Fuelcell Energy (FCEL), Bloom (BE), etc. all fall into this category. These companies have very common characteristics. Most have been around for two or more decades, have never made a profit, and have been perpetually diluting shareholders to pay for their operations.
Out of all these companies, I think Plug Power (PLUG) probably has the most complete and encompassing vision. My perspective is that vertical integration is the right strategy, given that adjacent parts of the market are still undeveloped. There are also synergies for PEM electrolysers when it comes to hydrogen generation, and converting hydrogen to electricity. I find Nel (NEL.OL) also very interesting, primarily for their focus on electrolysers, which I believe is the cornerstone technology for hydrogen. Its definitely possible to go further up the value chain into the chemical companies such as DuPont (DD) or Chemours (CC), who make the raw materials for electrolysers. However, players in that space are diversified and provide what I believe is too much exposure to non-hydrogen sectors.
Judging from the investor presentations from these companies, they are predominantly focused on scaling up production in order to drive costs down. This is absolutely the right decision. What really upsets me is the absolutely R&D spend ramp-up across the sector. Scaling is not an easy challenge, how are these companies supposed to solve the engineering challenges of transitioning to an in-line manufacturing approach, improve their electrolyser efficiency, whilst reducing R&D spend?
Who is the Tesla (TSLA) or Apple (AAPL) or Netflix (NFLX) of the hydrogen world? Who has the vision, and more importantly, a team with a track record of successful execution? If you have any suggestions please let me know.
Closing Thoughts
Hydrogen will be critical to decarbonizing our economy. However, hydrogen’s share of the overall energy mix is likely to be lower than what many make it out to be. There are competing technologies such as batteries and natural gas that need to be considered. In addition, the same enablers that would help drive hydrogen costs down, are also applicable to competing technologies. The deal breaker is that there does not appear to be any public company that is laying the foundation for success.
Analyst's Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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