The Future Belongs to Green Hydrogen
The two most common elements in the universe are hydrogen and stupidity.
Harlan Ellison, American writer
More on hydrogen?
As long-term subscribers to ARP+ will be aware, we have written a fair bit about hydrogen in recent years. In 2021, we did our first comprehensive research paper on hydrogen. It was a two-part paper, published in May of that year. You can find those two papers here and here. Then, a year later, we did a comparative analysis of hydrogen fuel cells vis-à-vis lithium-ion batteries. You can find that analysis here.
In addition to those papers, we have referred to green hydrogen, and to its promising outlook, in numerous other research papers. You are therefore entitled to wonder why we visit the topic again. It happens that, last autumn, President Biden announced a new, green investment programme. Perhaps even more importantly, last summer, the so-called Inflation Reduction Act of 2022 (IRA) was passed in Congress in Washington DC, and the ramification of that act have only recently become clearer. I am not convinced the importance of that act has dawned on the majority of investors, though! The act is probably the most ambitious legislative tool ever introduced in the US on climate change and is likely to have profound implications for many years to come.
In practical terms, the act favours various green energy sources by introducing meaningful subsidies and tax credits. As you can see in Exhibit 1, once the applicable tax credits have been applied, green hydrogen is very cost-effective vis-à-vis conventional sources of energy. That is more than likely to put the US firmly on the green hydrogen map within a few years – something it is not today, as current US tax rules make it unattractive to invest in green hydrogen. For that reason, we believe it is worth re-visiting the topic; i.e. how far down the road are we now, and where should investors focus?
Why we are still far away from the UN’s climate goal
As you may recall, it is the ambition of António Guterres, Secretary-General of the UN, to limit the global increase in the average temperature to 1.5° C when compared to pre-industrial times. I will argue in this paper that going electric when heating your home or driving your car won’t be nearly enough to meet that target. It is certainly part of the solution, but it is not a panacea.
First and foremost, EVs are not as environmentally friendly as generally perceived. According to the IEA, the average petrol-fuelled car creates 41.9 tonnes of CO2 from manufacture to retirement. The equivalent number for the average EV is 19.7 tonnes, i.e. an EV is almost half as dirty as a combustion engine vehicle is (see here). Adding to that, many types of transport vehicle are not suited for electrification – more on that later.
Therefore, another solution shall be required, and pretty much the entire world seems to agree what that solution is, namely green hydrogen. Goldman Sachs have, in a recent research paper, mapped already announced green hydrogen projects against three different climate scenarios – net zero by 2050, 2060 and 2070 respectively. As you can see in Exhibit 2 below, already announced green hydrogen projects won’t get us even close to the UN target of +1.5° C. Although that is alarming, it is also an investment opportunity.
Hydrogen – an almost endless resource
Hydrogen is the most abundant element in the universe and offers more than a credible alternative to electricity as transportation fuel. Many of the disadvantages associated with electricity (e.g. lengthy charging times) are effectively dealt with, if liquid hydrogen is used instead. Therefore, it would be a grave mistake to assume, and to build your portfolio on the assumption, that all cars will soon go electric.
As a gas, hydrogen is highly explosive, though, and considered unsuitable as a fuel in transportation vehicles. The gas must therefore be turned into a liquid first, which is perfectly safe to use (very similar to diesel). This is achieved in a process called water electrolysis. In very simple terms, when performing water electrolysis, you separate H (hydrogen) from O (oxygen) in H2O (water). As we have plenty of water (salt water will do), only the amount of electricity available will limit how much liquid hydrogen we can produce.
Hydrogen comes in a variety of colours. Take for example blue hydrogen, which is produced from a methodology called carbon capture. We published this paper on carbon capture a few months ago. If you haven’t read it yet, I suggest you do. Liquid hydrogen is deemed green if the electricity used in the electrolysis process comes from a renewable energy source like wind or solar. Today, no more than 1-2% of all liquid hydrogen produced is green.
There can be no doubt that the future belongs to green hydrogen, as that is our best get-out-of-jail card. So many politicians have promised net zero by 2050, probably without realising what it will take to deliver it, but the rollout of green hydrogen could quite possibly make the difference – it could be the factor that makes net zero by 2050 a feasible target. This is another reason why I have decided to zoom in on green hydrogen in this research paper.
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The many advantages associated with hydrogen
Hydrogen has several important attributes. The most obvious advantage of hydrogen relative to lithium-ion batteries is its much higher energy density. Whereas a lithium-ion battery has a density of only 200 watts per kilogram, the density of hydrogen is no less than 35,000 watts per kilogram (source: MotorBiscuit.com). The implication of this is that vehicles travelling over longer distances will need a disproportionately large battery to cope, an issue of great relevance to most transportation industries. Take for example Airbus, which plans to launch its first green hydrogen-fuelled aircraft in 2035.
The higher energy density of hydrogen makes it far more versatile than lithium-ion batteries. The latter offer a good solution to the commuter but will probably never attract much attention from travelling salesmen and other people who spend much of the day in their car. Likewise, most buses, lorries, trains, ships and aircraft are unsuitable for electrification. All those types of transportation vehicles are more likely to go with hydrogen.
Another issue favouring hydrogen over lithium-ion batteries is the unpredictable nature of the weather – a phenomenon known as intermittency. To achieve net zero by 2050, renewables must account for most of primary energy by then. However, as the percentage of wind and solar goes up, the intermittency problem gets increasingly difficult to manage. Liquid hydrogen offers a solution to that problem, as virtually unlimited amounts of it can be stored and used when required.
The time it takes to fuel a hydrogen car vs. the time it takes to charge an electric car is yet another issue that favours hydrogen. Today, filling up your car with petrol or diesel takes no more than 2-3 minutes, and a car driving on liquid hydrogen won’t be any different. By comparison, charging an electric car takes hours. The industry is working feverishly to reduce the charging time, but the gap between the two is still massive.
In the interest of full transparency, I should point out that liquid hydrogen is not superior to lithium-ion batteries in all aspects. In the comparative analysis I did in May 2022 (see here), I concluded that the two green technologies actually complement each other quite well, as there are strengths and weaknesses associated with both of them.
Where to invest
In 2021, there was not a single electrolyser project bigger than 200 MW under construction anywhere. As you can see in Exhibit 3, the first 1 GW project is now being developed with several more underway. When looking at the chart, it is pretty obvious that activities in this area will explode over the next few years.
According to Goldman Sachs, $5Tn of cumulative investments shall be required in the hydrogen supply chain in order to reach net zero by 2050, with the supply chain being defined as the sum of manufacturing, storage, distribution, transport, applications and integrated hydrogen suppliers. Of the $5Tn, according to Goldman Sachs, more than $2Tn will go towards manufacturing alone, which makes this segment the single biggest investment opportunity in green hydrogen.
Europe is ahead of other parts of the world, as far as already announced projects are concerned (Exhibit 4). That said, Australia is also ramping up quite quickly, and Latin America is less than five years away from becoming a meaningful player in green hydrogen. In a global context, the US is the clear laggard. As you can see in Exhibit 4, between 2026 and 2030, US green electrolysis capacity won’t grow at all, but that was an estimate provided by Goldman Sachs prior to the IRA and before President Biden announcing his new, green investment programme. Therefore, the estimates in Exhibit 4 on US electrolysis capacity are most likely dramatically understated.
Given that the US is an emerging powerhouse in green hydrogen, it is tempting to simply identify the likely winners amongst listed, US companies and invest in a mix of those. However, Europe has such a big lead on the US in this field, that most of the winners could very well be European companies, being paid to export their technology to the US.
It is a poorly kept secret that US diplomats have, in recent months, been busy trying to convince European companies to deemphasize the opportunity set in Europe and instead focus on the bigger opportunity in the US. (I believe the US opportunity is bigger because of the Americans being forced to play catch-up, and that is likely to result in some very attractive contracts being handed out.) In terms of portfolio construction, I would therefore suggest a portfolio consisting mostly of manufacturing companies with corporate Europe being over-represented.
What to invest in
As I pointed out in the 2022 paper, green hydrogen will most likely continue to play a leading role in the transition to a greener future. Eventually, this technology may be replaced by another more efficient energy form but not in the foreseeable future. I have been told by industry insiders that there is no meaningful alternative on the drawing board, apart from lithium-ion batteries, for at least another 15 years.
Going back to my earlier definition of “supply chain”, there are investment opportunities in all supply chain segments. The segment that will get the least of my attention is probably the so-called applications segment, as many of the names in that segment are not pure plays on green hydrogen. Take for example the car manufacturers. As you can see in Exhibit A1 in the appendix, there are quite a few of them on the list; however, by investing in those companies, you become exposed to all sorts of other risks.
How should you play the theme then? For the reasons already mentioned, my primary focus would be on manufacturing companies. In the 2022 paper, I gave four examples. I suggested that:
1. you invest in companies that have developed technological solutions that allow electrolysis to take place and mentioned a UK company called ITM Power, listed on London Stock Exchange, as an example;
2. you invest in blue-chip companies committed to hydrogen one way or the other and mentioned Siemens as an example;
3. you invest in oil majors committed to the green transition and mentioned BP as an example; and that
4. you invest in green energy companies that stand to benefit whether the lithium-ion or the hydrogen technology prevails; take for example Ørsted – a Danish company listed on Copenhagen Stock Exchange.
Of those four suggestions, the only one I have an issue with today is #3 (BP). As a consequence of us signing up to UN PRI (you can read more about that here), we have taken the policy decision not to engage in fossil fuels at all. One could argue that this is a tad unfair to those oil companies that have demonstrated at least some commitment to the green transition, and BP would be one of those, but it is still not even close to being meaningful.
A few words on #1: ITM Power (itm-power.com) is based in Sheffield, England. It designs and manufactures PEM electrolysers. “PEM” stands for Polymer Electrolyte Membrane, which is a membrane that is responsible for the conduction of protons, separation of gases and insulation of the electrodes in the electrolyser. As you can see in Exhibit 5, ITM Power has been through a horrid couple of years in the UK stock market and is now trading below £1 after having reached almost £7 in early 2021.
ITM Power is a big user of nickel, which accounts for over one-third of raw material costs. According to Goldman Sachs, the rising cost of nickel over the past 2-3 years has put immense pressure on the company’s bottom line. The fact that the stock is trading at a very high EV-to-sales ratio compared to other hydrogen stocks (Exhibit 6) has made it vulnerable to bad news. However, as you can also see, Goldman Sachs expects ITM Power to grow its revenues much faster than its peer group. In the long run, I believe that will be rewarded.
As far as #2 is concerned, admittedly, Siemens (siemens-energy.com) is not a pure play either. Therefore, in the pegging order, Siemens will come below Ørsted and ITM Power. Ørsted is the western world’s leading provider of offshore wind turbines. In March 2021, it unveiled plans for a large wind-to-hydrogen project in the Dutch part of the North Sea (see here). This project ticks all the green hydrogen boxes, as it turns the electricity it generates in its windfarms in the North Sea into green, liquid hydrogen.
Ørsted (orsted.com) has been a dreadful investment more recently. It peaked in early January 2021 at DKK 1,384. Now, a couple of years later, it trades below DKK 600 – off more than 50% (Exhibit 7). The stock price of Ørsted has suffered from the hangover many green stocks have suffered from after the extraordinary bull market in green stocks in 2020; however, to the best of my knowledge, nothing disastrous has happened to the company. Yes, the company has delivered earnings below expectations a quarter or two, but the real issue is probably something entirely different.
The Danish government owns 50.1% of Ørsted. A leaked document produced by one of the three parties in the current government (Venstre) has revealed that the party may have plans to dispose of the stake to finance the green transition. The uncertainty associated with those plans, and the sheer size of the potential supply (almost $19Bn), probably explains much of the weakness.
Other than ITM Power and Ørsted, companies like Air Products, Ceres Power, Industrie de Nora and Nel Hydrogen all look attractively positioned to benefit from the transition to green hydrogen. Air Products (airproducts.com) is the world's leading supplier of hydrogen (in different colours). The company, headquartered in Pennsylvania, owns and operates over 100 hydrogen plants and produces more than seven million kilograms of hydrogen every day.
Furthermore, it maintains the world's largest hydrogen distribution network. The company is already taking advantage of the IRA by aggressively expanding various hydrogen projects. It has, for example, recently commenced a green hydrogen project in Texas – a JV with AES. The stock has performed reasonably well since early 2021 – two very difficult years for many green stocks (Exhibit 8).
Ceres Power (ceres.tech) is another UK company, engaged in clean energy solutions. Fuel cells for power generation and electrolysers for green hydrogen count amongst the company’s market leading technologies. Ceres Power has adopted an asset-light business model that relies on the protection of its core technology and its strong manufacturing partnerships (source: Goldman Sachs).
The stock price of Ceres Power has also been under significant pressure since the early 2021 peak (Exhibit 9). However, the company is on firm ground with strong corporate partnerships with Bosch and Doosan Fuel Cell, and its business model is more resilient than most of its peers. Not only is revenue visibility better; the company is also less exposed to manufacturing supply chain problems (source: Goldman Sachs).
Industrie de Nora is headquartered in Milan, Italy. It is an electrochemical solutions company, with a focus on two opportunities – the green transition and clean water. Being a global leader in metal-coated electrode technologies, it is ideally positioned to benefit from the transition to green hydrogen and will probably be one of the biggest beneficiaries of the IRA. The company was only listed on Milan Stock Exchange in late June 2022 and has therefore not suffered the same fate as many of its peers more recently, stock performance-wise (Exhibit 10).
Nel Hydrogen is a Norwegian company, headquartered in Oslo. It delivers solutions to produce, store and distribute hydrogen from renewable sources, i.e. its focus is very much on the green revolution. Goldman Sachs expect it to be one of the key beneficiaries of the transition to green hydrogen. Moreover, Nel is superbly positioned to benefit from the IRA, as the company is very US-centric in its focus. Like ITM Power and Ceres Power, Nel has also underperformed since it peaked in early 2021 (Exhibit 11).
The bottom line
As things stand my top picks (in that order), to obtain exposure to green hydrogen, are:
- Industrie de Nora
- Air Products
- Ceres Power
- ITM Power
In terms of how much I would allocate to each of them, until I have more clarity on the eventual (biggest) winners, and that could take years, I would allocate roughly the same amount of capital to each of those six names. Good luck – I think you are on to a long-term winner here!
Niels C. Jensen
14 March 2023