Impact Investments in Hydrogen Fuel
Part Three: Why hydrogen fuel in transportation is an irresponsible investment, and where venture capital can help develop the hydrogen fuel market.
“If the policy goals for zero-emission vehicles are to eliminate tailpipe emissions, then both [electric and hydrogen] vehicles score equally… But if the goal is to radically reduce the emissions of the greenhouse gas carbon dioxide associated with road vehicles, electric cars will always be better unless all hydrogen is produced renewably but most batteries are charged using non-renewable energy.”
-John Voelckler, Green Car Reports.
In the conclusion of part one of this series, I stated that the limiting factor to hydrogen’s adoption as a fuel source, is its inefficiency in converting hydrogen fuel to electricity. This comment reflected a bearish opinion on the future of hydrogen in transportation. Part three, and the final article in the series, provides the investment perspective to my previous conclusion — that hydrogen has little short-term future in transportation — and provides the investor with potential ‘alternative’ investments in the growing hydrogen fuel industry.
TRANSPORTATION & FUEL CELL INVESTMENTS
The electric vehicle
Despite millions of dollars flowing into hydrogen fuel cell efforts over the past few years, these efforts could largely be considered a failure, due to their inability to compete with battery powered electric vehicles (BEV).
BEV’s have seen an observable increase in frequency on our roads in the past 10 years. While some still argue over range, and reliability of BEVs, hydrogen offer’s few benefits over the BEV in the short-term, deterring any potential adoption of hydrogen fuelled cars. Factor in the spend on fuelling infrastructure required to lend hydrogen a slight advantage, and the likelihood of seeing more than a handful of hydrogen fuel cars on the road anytime soon seems increasingly bleak.
This is not to say we should abandon our (hydrogen) research efforts.
Hydrogen as a feedstock
Hydrogen, biofuels, and other zero emission energy sources, are not being touted for their performance abilities compared with fossil fuels. At best, these fuels are able to compete on par with petrol and diesel. Instead, the focus is sustainability. Yet, the ability for hydrogen to reduce (carbon) emissions — which experts conclude is required for our collective sustainability — in transportation, fails in comparison to the potential impact hydrogen can have in reducing emissions in the industrial sector.
As Lux Research reports, hydrogen’s primary use is as a feedstock (raw material) for refining and chemical production. Thus, the largest opportunity for hydrogen adoption lies in production. Mercer’s (2019) research supports the argument, stating “95% of the emissions generated from petrochemical production are associated with feedstocks and processes, [so] the scope to reduce emissions through renewable electricity is limited.”
The production tipping point
While the innovation focus in transportation is in fuel cells, the innovation focus for industrial cases rests at the point of production. This could be crucial widespread hydrogen use. Thus far, hydrogen adoption in transportation has faced huge barriers, as it requires both efficient (fuel cell) engines, and low-cost hydrogen (gas or liquid). But, without efficient engines, scaling production has been too risky for investors as the engines can’t attract an acceptable level of user adoption, and without scale, the engines become unattractive on a cost basis (compared to fossil fuels).
If we can focus innovation at the point of production for industrial use cases, then we can more rapidly scale hydrogen production, without the constraint that fuel cells create. Since hydrogen must compete on a cost basis with other fuels, it’s important that we can scale production to the point where economies of scale can reduce the cost per kilo of production, to being competitive with fossil fuels. Furthermore, cost effective hydrogen lends itself to easier transitions into subsequent industries (such as transportation and industrial heating), as we remove the cost advantage fossil fuels currently hold.
PRESENT DAY INVESTMENTS
So far, prominent moves (in New Zealand) have come from both international and domestic partnerships. 8 Rivers Capital, a US-based investment firm partnered with Toshiba, proposing to develop a urea production facility in Taranaki, using carbon capture and storage (CCS) to separate the carbon and hydrogen in the process of urea production.
Hiringa Energy has made similar strides in the Taranaki region in partnership with Ballance Agri-Nutrients. While Hiringa is personally focussed on developing fuelling infrastructure across New Zealand, the partnership has seen $50 million (NZD) committed to producing green hydrogen, for use as a feedstock in the local ammonia-urea plant. Included in the $50 million, is the construction of four large wind turbines, putting the emphasis on the desire to create green hydrogen (as opposed to blue or brown).
Outside of Taranaki, we’ve also seen the joint venture between Tuaropaki Trust and Obayashi Corp. Together, the two firms are focussing on zero-carbon (green) hydrogen production through geothermal energy, utilising the Mokai geothermal power station near Taupo, that’s been in production since 2000.
Funding the fuel
The New Zealand government in particular, has devoted significant time and effort into assessing what the future of hydrogen could hold for New Zealand, with some going so far as to say New Zealand has the potential to be a market leader. This has seen multiple funding channels be created. Investors and entrepreneurs have access to grants, and more commercial vehicles, such as venture capital (VC) firm’s, focussed on impact investments, that can generate self-sustaining returns for the fund. A non-exhaustive list of funding vehicles include:
The Endeavour Fund is a grant available to a wider breadth of applicants, and offers between $0.4–1 million (NZD) over a 2–3 year term. The grant primarily funds research backed science and technology projects that focus on impacting New Zealand’s environmental, economic, or social well being.
Low emissions vehicles contestable fund is a co-funding grant offered by the New Zealand government, which matches up to 50% of the applicants project. $7 million (NZD) was offered across multiple projects in 2019. The grant has since been used to develop EV charging stations, and hydrogen fuel cell buses since inception.
Callaghan Innovation is a technology incubator, and large R&D grant issuer for firms of all types across New Zealand. Depending on the nature and stage of the business, firms have access to student, getting-started, project, and R&D tax incentive grants, each offering different compensation levels with different applicant requirements.
The Provincial Growth Fund is a government led initiative, established with $3 billion (NZD) specifically for funding economic development in the regions. The fund welcomes applicants whose projects focus on regional, sector, or infrastructure-based work, that increase jobs and encourage environmental sustainability (among others).
New Zealand Green Investment Finance (NZGIF) is a government-created venture capital firm, loaded with $100 million (NZD) and the goal of “[accelerating] low emissions investment in New Zealand.” The firm co-invests with private investors in commercial activities that provide investment returns, enabling the firm to be self-sustaining over time, much like any other venture capital company.
Soul Capital, is an independent venture capital firm, focussed on impact investments that tackle societal or environmental problems. Soul is sector agnostic, but requires business validation prior to investments, whereas many grant options can support earlier research-phase companies.
It should be noted, there are restrictions on funding. The New Zealand government in particular has previously been strict on green hydrogen production, denying grants such as 8 River Capital’s request for a $20 million (NZD) research grant that would have assessed the feasibility of a power station that operated using CCS — CCS produces blue hydrogen as opposed to green hydrogen. This may not be the best stance — see part one of the series for further explanation — but, should be kept in mind for those looking utilise external funding in the sector.
ON INVESTMENT RISK & POTENTIAL PATHWAYS
Venture risk
Venture capital (VC) is risky. Long time horizons, illiquidity, and potentially low probabilities of success mean the median investment may not make much money. In an ideal world, venture investments would thus be diversified across multiple companies, reducing the investors risk, and compensating the investor generously. The general risk of business failure is systematic across all companies and industries, meaning there is risk involved in every investment VC’s make. They can however, look to minimise their non-systematic risk — the industry and company specific risk.
We have attempted to understand risks contained within hydrogen-specific investments, that would allow the hydrogen investor to minimise their non-systematic risk.
Opportunities in history
Hydrogen and fossil fuels serve a similar purpose; to be used as an energy medium that allows human’s to power various equipment. Given this, we expect that — excluding operation differences in production (i.e. combustion vs electrolysis, etc.) — the future supply chain of the hydrogen industry will largely mimic the supply chain of today’s fossil fuel industry (not foreseeing future technological advances).
Since the hydrogen supply chain is currently undeveloped, we forecast investment opportunities in fields analogous to current fossil fuel supply chain activities. A self-conducted analysis of the fossil fuel supply chain offers insights into potential hydrogen investments for the venture capitalist.
Hydrogen is a commodity
Much like there are different types of fuel (91, 95 unleaded and diesel), there will be different levels of hydrogen quality. Ultimately though, there will be little product distinction between various producers. As a result, we anticipate a ‘rush to the bottom’ of hydrogen fuel prices, eliminating the ability for excess profits in production for the average hydrogen seller over the long run. The advantage would thus be given to large producers, who can produce the lowest cost hydrogen.
However, this assumes market pricing for hydrogen, which, at least in the short-medium term, seems unlikely. The lack of market structure, and clear government incentives to scale the hydrogen industry in New Zealand make contractual (potentially subsidised) agreements more likely determinants of price than market demand. Given the government sanctioned, and monopolistic traits of infrastructure public-private agreements, infrastructure investments could be lucrative to investors suited for long holding periods.
Vehicle manufacturers
Following the value chain of fossil fuels, we see car manufacturers as a large tangential investment that has been able to ride the growth of fossil fuels, without being restricted to dealing in commodity products (i.e. oil and gas itself).
The problem with this, is current car manufacturers are already established, making it difficult for new entrants to emerge. Investors may then look at existing car manufacturers that utilise hydrogen fuel, but such investments still generate fossil fuel exposure to the investor through their existing operations. (Re-read paragraph, The electric vehicle for further arguments against transportation investments).
Engines and fuel cells
A following and popularised alternative is engine manufacturers. Or, in the case of hydrogen, fuel cell developers. While possible, the sector is immensely competitive, and lacks a standardised fuel cell model that operates on par with internal combustion engines (the most common fuel cell model is too inefficient to operate economically).
Unless the investor has a strong engineering background, that could compliment or aid the entrepreneur in product development, investments may more appropriately be described as throwing mud against the wall to see what sticks. A diversified investment approach, or omitting fuel cell developers entirely would be advised.
Storage and transportation
For the scientifically minded investor, there is also potential in developing storage technology for hydrogen fuel (post-production). Existing storage units could conceivably be constructed by modifying existing fuel tanks, or from scratch, and could go a long way to developing a structured market for global hydrogen trade. (See part one for more on the barriers to storage and transport).
While specialised storage solutions will likely become commoditised in the long term, patented technologies, or continuous development aimed at reducing the costs of hydrogen storage could develop competitive advantages for the enterprising firm.
Safety, sensors and cleaning
Lux Capital, the US-based venture capital firm, has reported one of their stronger investments was the incorporation, construction, and eventual sale of a nuclear waste disposal firm. If we look at hydrogen from a similar perspective, it’s hard to find attractive opportunities in cleaning and disposal. With less concern over its byproducts and waste (water and air), hydrogen appears to offer fewer business opportunities in product safety, or byproduct clean up and disposal.
One could argue that the need for hydrogen sensor technology could be valuable to industry — from a safety and monitoring perspective. Though, we consider this too far removed from the supply chain, and expect it to have little impact in improving the uptake of hydrogen.
CLOSING WORDS
The hydrogen industry, is a market in its infancy. Defined largely by its lack of market structure, and the immaturity of sector specific (conversion and storage) technology. Nonetheless, the market offers potentially great rewards for pioneering investors, with similarly significant emission reductions over the long-term, as hydrogen is substituted in place of fossil fuels in the shift toward a low-carbon economy.
Our research tells us, there are two potential pathways investors wanting to increase their exposure, and maximise their returns from hydrogen investments can take: (1) investments in infrastructure that seek to develop fuel production. (2) Investments in supply chain activities, that advance the market structure, enabling global growth. Investments in (2) rely on the development of infrastructure (1).
So, for governments, or other firm’s mandated with expanding the local market for hydrogen, they ought to focus on investments in (1) before considering tangential moves into supply chain activities. In this case, we reference the early paragraphs of this article, and recommend selling hydrogen for industrial purposes as a feedstock, as opposed to developing transport infrastructure. Ultimately, we expect this to have the most impact in scaling hydrogen, and reducing the carbon footprint of New Zealand.
