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Hydrogen (Part I)

Hydrogen (Part I)
– The missing piece of the jigsaw?


Is hydrogen the holy grail in our desire to decarbonise? Based on the amount of attention it is now attracting, and based on the performance of dedicated hydrogen companies on various stock exchanges in recent months, one would certainly be forgiven for thinking so.

The story is relatively simple. You make hydrogen by passing an electrical current through water (H2O). When doing that, you split the two components of water, hydrogen (H) and oxygen (O). This process is known as electrolysis. If the electricity in the electrolysis process comes from renewable energy sources like wind or solar, you have created what is called green hydrogen but more on that later. When you burn the hydrogen (for example in an aircraft) or pass it through a fuel cell (in, say, an electric car (EV)), the only by-product is water. Very simple and, in principle very attractive. However, in practice, it is not as simple as the green lobby likes us to think it is, but more about that later.

Another attractive feature of hydrogen has to do with the unreliable nature (intermittency) of renewable energy forms. Sometimes the sun doesn’t shine and, at other times, there is no wind. If renewables account for a high percentage of the energy mix, this variability is difficult to manage. Hydrogen offers a solution to that problem as it can be used as a storage of energy.

One more point before I start. I would like to thank Andy Lees of Macro Strategy Partnership LLP for providing invaluable advice on what is a very complex topic. You can read more about Andy and his company here.

Setting the scene

In the years to come, EVs will replace most petrol and diesel cars. Likewise, homes and businesses will gradually switch to electric heating, leaving only vehicles not suited for electrification (for example HGVs, ships and aircraft) looking for another alternative to fossil fuels. Everything else will be electrified.

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Liquid hydrogen, provided it is green, is frequently mentioned as a solution to this problem – the missing piece of the jigsaw so to speak. However, you are confronted with loads of challenges when trying to convert the entire world to clean energy more or less simultaneously. I have already mentioned one of them – the fact that not all vehicles are suited for electrification – but there are others.

The biggest one of them all is probably the fact that renewables are not even close to fossil fuels in terms of energy efficiency relative to the capital cost embedded in the energy transition. This has had the effect of slowing down GDP growth, as much capital is misallocated every day rather than being deployed productively.

To put it simply, the cost of these new technologies is still disproportionately high. That said, the cost of almost all new technologies is high when first introduced. Allow me to share a couple of example with you. Take for example lithium-ion batteries which form a critical part of almost all EVs today. Only a few years ago, the lithium-ion technology was way too expensive when compared to an internal combustion engine but, now, we are not far away from an EV being cheaper to run on a per mile basis. Another example: hydrogen fuel cells. According to the US Department of Energy, a few years ago, it cost more than $1,000 to produce a single KW of power from hydrogen fuel cells. By 2019, the cost had dropped to $53 per KW.

Another challenge we are faced with when rolling out green hydrogen has to do with storage, transportation and distribution. Hydrogen, when still a gas, is explosive, but that problem can relatively easily be dealt with by turning the gas into liquid hydrogen (more on that later). That said, for hydrogen to stay liquid, it must be kept at a very low temperature (-253˚C), creating significant storage and transportation challenges. Furthermore, the supply chain (petrol stations) must be reconfigured, which will come at a significant cost (carried by whom?). Private cars and vans, although in principle suited for liquid hydrogen, will therefore most likely stay electric for some considerable time.

The final challenge I will mention today (but there are others) has to do with the fact that a significant proportion of all electricity generated comes from coal-fired power plants. Modern petrol or diesel cars are actually polluting less than EVs running on electricity from those power plants. This problem will gradually go away, as all coal-fired power plants will be phased out eventually, but it will take longer than many realise. In most countries, the commitment to go carbon neutral is not until 2050 and, in the case of China, not until 2060, and the environment could be beyond repair long before then.

Why you must take the CO2 problem seriously

CO2 controls the amount of water vapor in the atmosphere. In other words, the more CO2, the more pronounced the greenhouse effect and the higher the temperature is. Now, if you look at Exhibit 1 below, CO2 emission levels have exploded since the early days of the Industrial Revolution. The chart has only been updated through 2017 but, according to the UK Met Office, CO2 emissions in March 2021 averaged 417.14 ppm (parts per million). In other words, CO2 emissions continue to rise explosively.

Exhibit 1: CO2 emission levels over the last 800,000 years
Note: Samples from sea bed sediments and ice cores allow researcher to go back millions of years.
Source: NOAA, NCEI, Robeco

Researchers at the Potsdam Institute for Climate Impact Research have found that last time CO2 levels were as high as they are now, was during the Pliocene era some three million years ago. At that time, average temperatures were 2-3˚C higher than pre-industrial levels and average sea levels about 25 metres higher than they are today.

Should sea levels eventually rise that much, entire countries will be wiped out and billions of people will be in great trouble. Fortunately, that is not likely to happen anytime soon, but a rise of only a metre or two will still cause huge problems. Now to the bad news. If governments don’t start to take this problem seriously – and some will say they do but, as you will see in a moment, they don’t – new data from IPCC suggests that average sea levels will be about 1.1 metre higher by the turn of the century. That’s enough to wipe many islands around the world and flood some of the most populous cities in the world. In no particular order, I can think of London, New York, Rotterdam, Shanghai, Mumbai and Jakarta, but I am sure there are many more.

The challenge planet Earth is up against is that, whilst most of our political leaders talk the talk, few of them walk the walk. At the climate conference in Paris in 2015, it was agreed to take measures to limit the rise in average, global temperatures from pre-industrial levels to max. 2˚C (which has since, in a subsequent summit, been reduced to max. 1.5˚C).

As it turns out, some 5 years later, the gap between what was agreed in Paris and what is actually going to happen emission-wise, assuming the current policy regime doesn’t radically change, is not pretty reading (Exhibit 2). Therefore, something drastic needs to happen sooner rather than later.

Exhibit 2: Emissions gap between current efforts and the Paris agreement
Source: Goldman Sachs Asset Management

The solution?

Hydrogen (symbol: H) offers a solution to this problem. It is the lightest and most abundant chemical element, estimated to account for 75% of the mass of the universe (source: National Grid). Much hydrogen is contained in water (H2O) and in plants. Even the human body contains plenty of hydrogen atoms. The challenge is, and has always been, to harness the hydrogen on a large and cost-effective scale to fuel homes, businesses and transportation vehicles.

Vast resources are now allocated to this challenge – i.e. how to turn hydrogen into a source of clean energy. So far, efforts have been stymied by the high costs involved, but it finally looks like progress is being made. Below, I will update you on the latest developments and, in part II, I will assess the implications for both wind, solar, nuclear and fossil fuels, all four of which will be affected, should we begin to roll out green hydrogen-based energy on a large scale.

Hydrogen in different colours

Hydrogen, when produced today, is divided into grey, brown, blue and green hydrogen. Grey and brown hydrogen is essentially one and the same thing – hydrogen made of fossil fuels, the only difference being that grey hydrogen comes (mostly) from natural gas and brown hydrogen from coal, but the processes are identical.

Today, 95% of all hydrogen produced is either grey or brown (mostly grey). It is produced in a process that strips hydrogen out of natural gas or coal, which is a very dirty process, environmentally speaking. According to my source (Pictet), as much as 11 kg of CO2 is emitted for every 1 kg of hydrogen produced this way.

As a consequence of the large carbon footprint from grey and brown hydrogen, blue hydrogen has gained in popularity. When producing blue hydrogen, the earlier stages in the process are no different from producing grey/brown hydrogen – it still comes from fossil fuels; however, there is an additional layer involved, designed to reduce CO2 emissions. A process called CCS (Carbon Capture and Storage) is deployed, whereby the carbon bi-product is buried in underground reservoirs. This process is not cheap, though, nor is it 100% carbon-free. Pictet reckon that the carbon price (i.e. the price of a permission to emit 1 tonne of CO2) must rise to at least €60-70 before blue hydrogen makes financial sense. It is currently trading around €50 (Exhibit 3).

Exhibit 3: Price of permission to emit 1 tonne of CO2 in the EU.
Source: The Daily Shot

More recently, much has been invested in turning hydrogen completely carbon free – so-called green hydrogen. In the following, I will review the leading green hydrogen technologies and shall ignore the fact that green hydrogen is not (yet) 100% carbon-free but close enough to be labelled green.

Of the two hydrogen technologies referred to below, which one will prevail is probably a little early to speculate about, but they are both likely to have a massive impact on the environment. The commitment to green hydrogen is already substantial – particularly in the EU, where the plan is to install up to 80 GW of green hydrogen capacity by 2030 at an estimated cost of €44Bn. By 2050, cumulative investments in green hydrogen in the EU are expected to approach €500Bn, and for green hydrogen to account for 13-14% of Europe’s energy mix (source: Pictet).

New hydrogen-based technologies underway

A couple of game-changing technologies are currently under development. In the following, I will summarise how they work, and how they will impact the world as we know it. The two technologies are based on the same underlying technology, but they are not identical, hence they both deserve a mention.

Both technologies have one overriding feature which could put a stop to years of global warming. CO2 will become an asset rather than the liability it is now, and we can begin to reverse the CO2 emission overload, which has taken place since the early days of the Industrial Revolution but more on that below.

#1: Power-to-X

The Power-to-X technology is about converting electricity to liquid hydrogen. Although governments all over the world are keen to electrify as much transportation as possible and as quickly as possible, not all transportation vehicles are suited for electrification. The current battery technology is not powerful enough to fuel vehicles that travel over longer distances. A sustainable solution other than green electricity for those types of transportation vehicles is therefore needed, and hydrogen could offer a solution.

When you produce hydrogen through electrolysis, at first, the hydrogen released is a gas but, by having it react with CO2, it is turned into liquid hydrogen (methanol) which is safe to use in transportation vehicles (Exhibit 4). Assuming the electricity used in the electrolysis process comes from a renewable energy source, and that the CO2 required comes from power plants that burn fossil fuels or biofuels, the net result is a drastic reduction of anthropogenic CO2 emissions.

Exhibit 4: The Power-to-X technology
Source: DW

The technology works already but is deemed too cost-ineffective to be commercialised. According to my source, Technical University of Denmark (DTU), fuel produced this way is still about 2.5 times more expensive than the fossil fuels used today, mostly because the catalysts used in the electrolysis process are disproportionately expensive. As per Jens Kehlet Nørskov, professor at DTU, the way forward is to identify more cost-effective catalysts, so that’s where DTU’s research is focused at present.

One could argue that the CO2 problem hasn’t been addressed by burning e-fuels rather than fossil fuels. Whatever we burn, CO2 will be the outcome. However, the researchers at DTU argue that is a silly argument. If anything, we won’t have enough CO2, if we fully convert from fossil fuels to e-fuels, they say.

Interestingly, Power-to-X is no new concept. During World War II, the German army had only limited access to fossil fuels but, by using a method known as Fischer-Tropsch, it created liquid fuel out of coal. Towards the end of the war, the entire German army used this fuel. The economics were poor, but Hitler had no choice. The economics of Power-to-X are similarly poor today, but it is still early days, and the technology will almost certainly improve.

The “X” in Power-to-X implies that this technology can not only be deployed to manufacture transportation fuels. Various chemical products can be produced this way and, likewise, plastics, all of which require oil in the manufacturing process today, can be manufactured when using liquid hydrogen rather than oil.

The opportunity set is even wider than that. Take for example the escalating demand for protein-rich food which is a function of rising living standards across emerging markets. Rising living standards is great for society, but it stresses the world’s freshwater resources, as more than 60% of all freshwater consumed worldwide every day is consumed by the agricultural industry. Researchers have found that, by combining CO2 with various bacteria, electrolysis can be used to produce protein.

#2: Air-to-Fuel

Another promising technology, not dissimilar to Power-to-X, is called Air-to-Fuel (Exhibit 5). The Air-to-Fuel technology has been around for a few years but has not been able to compete with more energy-efficient fossil fuels yet. In 2009, a British company called Air Fuel Synthesis made petrol from atmospheric air to prove the technology. Although the technology worked as expected, it was uneconomical, as it used 60 kWh of electric energy to make 9 kWh of petrol energy (source: MacroStrategy Partnership LLP).

Air Fuel Synthesis extracted CO2 from the atmosphere and combined it with hydrogen extracted from water, both of which are available in virtually unlimited quantities. However, the key to commercialisation was, and still is, cheap energy, and renewables do not tick that box. The only source of clean energy I can think of which would make this technology financially viable is fusion energy, as the marginal price of electricity is close to zero when coming from a fusion reactor. Therefore, we are probably at least ten years away from being able to commercialise the Air-to-Fuel technology.

Exhibit 5: The Air-to-Fuel technology
Source: Air Fuel Synthesis

A major advantage of Air-to-Fuel, which Power-to-X doesn’t benefit from, has to do with the fact that the end-product can vary. Simply put, the technology can be adapted so that the end-product – the green fuel – is either synthetic petrol, diesel or kerosene (aviation fuel). This would save trillions of pounds as the global fleet of transportation vehicles would not need to change.

What shall be required to make it work?

Both Power-to-X and Air-to-Fuel are pretty powerful technologies which can put a halt to global warming relatively quickly. That said, commercialisation won’t happen unless (until) costs come down (assuming legislation doesn’t change). If liquid hydrogen is about 2.5 times more expensive than fossil fuels, the impact on economic growth would be severe, should we decide to convert now.

That said, there can be no doubt that, from an environmental point-of-view, this is the way to go. The ongoing conversion of petrol/diesel cars to EVs, assuming they run on green electricity, is going to have a meaningful impact on CO2 emissions, but the global fleet of heavy-duty vehicles actually pollute more than the global fleet of cars do. It is therefore critical that we find a solution that addresses this problem too. If (when) all heavy-duty vehicles run on green hydrogen, it is expected that CO2 emissions will drop by more than 20% (source: Legal & General), as that is how much they account for in terms of their share of total anthropogenic CO2 emissions today.

An important prerequisite, other than the ability to identify cheaper catalysts, is the ability to scale up. The world consumes about 102 million barrels of oil every day – quite a formidable number which is not easily replaced. For that to happen, massive amounts of capital will have to be invested in technologies such as Power-to-X and Air-to-Fuel in the years to come.

In the context of costs, I should point out that, over the past five years, the cost of electrolysers to produce green hydrogen has fallen 50% and is projected to fall a further 40-60% before the end of the decade (source: Legal & General), another indication that it is only a question of time before the Green Revolution will push fossil fuels aside. Having said that, the next few years could, quite perversely, turn out to be very good for OPEC, and the reason for that you can read in the appendix to this paper.

Part II (coming soon)

I will stop now, as this note is already rather long. Having said that, my review of hydrogen is far from complete. The green lobby is thrilled that we are on the verge of being able to produce green hydrogen, i.e. hydrogen based on electricity from renewable energy forms, and that is indeed very good news. However, green electricity is much more expensive than the green lobby likes us to think it is, which is an issue I will dig deeper on in part II of this paper.

I will also look at the implications for other energy forms – particularly fossil fuels and nuclear but wind and solar will also be affected – if (when) hydrogen is rolled out on a large scale. Finally, I will present some ways you can invest in hydrogen at this early stage, even if the technology hasn’t been commercialised yet.

Niels C. Jensen

11 May 2021


A note on fossil fuels

Structural underinvestments in the oil sector in non-OPEC countries, beginning in 2021, will soon begin to have an impact on global oil supplies.  According to Goldman Sachs, as early as this year, non-OPEC oil production will begin to drop.

Following the 2014 downturn in oil prices, non-OPEC producers underinvested in the oil sector (Exhibit A1).  Then came a few years with above average investments, but the growing focus on decarbonisation has resulted in many oil-producing countries cutting back again.

Exhibit A1: Emissions gap between current efforts and the Paris agreement
Note: Exhibit A1 was produced by Goldman Sachs in December 2019, but I have been told that the numbers are still largely correct.
Source: Goldman Sachs Global Investment Research

The fact that the credit-fuelled boom in shale oil production also seems to have run most of its course can only result in increased reliance on OPEC in the years to come.  If the shale boom is mostly behind us at the same time as non-OPEC countries are cutting back on investments, and a full-scale conversion to green energy forms is still (at least) ten years away, OPEC is the only place we can go to for the oil we will need to spin the wheels every day.

IEA expects global demand for oil to reach 108 million barrels per day (mbpd) by 2025, up from 102 mbpd in 2020 (Exhibit A2).  As per Goldman Sachs, non-OPEC oil production will decline by 5.3 mbpd, and alternative sources of supply (shale, biofuels, etc.) cannot meet the combination of rising demand and falling non-OPEC supplies, leaving it up to OPEC to close the gap.  In other words, although I firmly believe that OPEC’s powers will decline over time, the next few years could quite possibly turn into a golden era for them.

Exhibit A2: Key drivers of oil supply growth, 2020-2025 (mbpd)
Source: Goldman Sachs Global Investment Research

About the Author

Niels Clemen Jensen founded Absolute Return Partners in 2002 and is Chief Investment Officer. He has over 30 years of investment banking and investment management experience and is author of The Absolute Return Letter.

In 2018, Harriman House published The End of Indexing, Niels' first book.