How to invest as we move to a hydrogen economy

Not so very long ago, the idea that fossil fuels might be replaced by hydrogen – which when burnt or used in fuel cells to provide energy releases no pollution, but water vapour – was for the birds. It was just too expensive to produce and inefficient when compared with the already-available alternatives, and hence all the investment needed to develop the technology and roll out the necessary infrastructure was unlikely to be forthcoming.

Today, hydrogen is rapidly becoming global policy, as Leigh Collins points out on Recharge, and set to become a multi-trillion-dollar industry. China recently approved a massive power project to produce hydrogen. Australia is planning to build a renewable energy hub ten times the size of Greater London to power electrolysers that produce hydrogen. Countries accounting for more than a third of the world’s population, including India, Russia and the EU, have hydrogen strategies in place. The US is introducing one “by the back door”, as Collins puts it, with a clause in the country’s giant infrastructure bill. And the UK’s long-awaited hydrogen strategy was finally announced in August. So when will Boris Johnson finally flip the switch on our greener future?

A blue bridge to a green future

Those nervous about the implications of our current energy crisis will be hoping that he treads carefully. Some will even be seeking to weaponise it to force a U-turn away from all the “green crap”, as David Cameron once called it. But that is unlikely, says James Kirkup in The Spectator. Sceptics of “net zero” – the legally binding commitment that Britain be carbon neutral by 2050 – are a small minority among Tory MPs, most of whom support the prime minister’s green ambition.

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In a recent speech, Johnson talked passionately about the need to “grow up” and take responsibility for the kind of planet we will leave our grandchildren. It was the speech of a politician “burning his boats and giving himself no room to retreat on the environment”, says Kirkup. Besides, what our current energy crisis shows is that we rely too much on gas. Net zero is the answer to this problem, not a barrier to its achievement. Indeed, even as gas prices surge and winter looms, the government is pressing ahead with its plans to impose a green surcharge on household gas bills in an attempt to nudge them to lower-carbon alternatives.

Eventually, hydrogen may be one of those alternatives. The UK’s hydrogen strategy is part of the prime minister’s vision for a “green industrial revolution” and lays out plans for reaching 5GW of low-carbon hydrogen production capacity by 2030 – enough to power about 1.5 million homes – from around zero today, with a similar subsidy mechanism to the one used for the expanding offshore-wind sector. Billions of pounds of taxpayers’ money and from higher bills for consumers will be funnelled into the industry.

By 2030, the government hopes hydrogen will play an important role in decarbonising energy-intensive industries that could not easily be run on electricity produced by renewable energy – industries such as chemicals and oil refineries, steel and cement making, and in heavy transport such as shipping, lorries and trains. It might also heat our homes and fuel our cookers and even cars – the plan is to expand the infrastructure that’s needed for more people to switch to hydrogen-powered vehicles. Up to 35% of the UK’s energy consumption could be hydrogen based by 2050, according to the strategy document, and that changeover will be critical if the government is to meet its net-zero target.

The hope is that the subsidies will boost the industry and lead to a reduction in costs – currently one of the biggest barriers to the widespread adoption of the fuel, since hydrogen must itself be produced through energy-intensive, and often carbon-producing, processes. Most of the key decisions about the development of a broader hydrogen economy have, however, been pushed into the future, says Collins. Decisions about the extent to which hydrogen will be used in domestic heating, for example, and exactly how it is to be produced in a low-carbon way, have been kicked down the road.

That last point in particular sparked controversy. Most hydrogen is currently made using natural gas, so committing to a hydrogen-fuelled future is one way for fossil-fuel companies to cling onto a role for themselves in the energy transition, says Josh Gabbatiss for Climate Brief. The government has committed to pursuing a “twin track” approach, which will include the production of both blue hydrogen (made from natural gas with carbon capture and storage technology) and green hydrogen (made using renewable electricity and hence producing zero carbon emissions).

There is a risk that the strategy will cause Britain to commit too heavily to the blue stuff and so keep the country locked into fossil-fuel-based technology, says Jess Ralston of the Energy and Climate Intelligence Unit. But the thinking in government is that blue hydrogen could be a useful bridge, replacing fossil fuels while there is not enough green hydrogen available, and hence giving Britain a competitive advantage in the race to build the coming hydrogen economy and become a global leader in the industry. It will also, as an industry expert told the Financial Times, help break the Catch-22, whereby hydrogen supply remains low without sufficient demand, yet demand stays stuck until supply rises.

This “blue bridge” will help ensure the sector attracts the vital investment needed for the long term and create the scale necessary to build the ecosystem of a plausible hydrogen economy, says Ambrose Evans-Pritchard in The Daily Telegraph. The twin-track approach will also exploit Britain’s competitive advantage in the form of “pipelines and disused fields in the North Sea, half a century of offshore engineering skills and an oil and gas industry seeking a new purpose in life”.

Green hydrogen may well win out over blue in the long term. But “in the meantime there is a huge gap to fill and the lucrative hydrogen prize will go to those who move fastest, in the right sequence… Britain’s twin-pronged blue and green strategy is a calibrated hedge that plays to this island’s North Sea strengths. It is well-judged and legitimate.”

Despite all the announcements and excitement over new technologies and the shiny green future, it would be as well to remember that global production of green and blue hydrogen is currently minimal and not one single country has yet put policies in place that would help to make hydrogen cost-competitive with grey hydrogen (produced from unabated natural gas or coal), says Collins.

In fact, no nation has definitively decided what its policy should be, with every strategy published to date pushing key decisions into the future. The strategies thus “offer a direction of travel to potential investors that can encourage investment”, but so far represent “merely ambitions or wishful thinking”.

How to invest

Still, it’s hard to imagine that the political winds behind the sector will abate – the broad direction of travel is supported by all the main political parties – and investors remain excited by the story. Research group BloombergNEF says that last year investors poured more than $500bn into the so-called “energy transition” to greener tech generally, twice as much as in 2010. The PWC consultancy estimates that between 2013 and 2020 venture-capital investments in climate tech grew at five times the rate of overall global start-up funding, reports The Economist. This flood of green money has lifted hydrogen-related investments.

The hydrogen plays we suggested in the past – Ceres Power (Aim: CWR), ITM Power (Aim: ITM) and McPhy Energy (Euronext: MCPHY) – have all soared since, though have fallen back from their peaks since February of this year. AFC Energy (Aim: AFC) is another option. It remains likely that hydrogen will find some niche application within the overall transition away from fossil fuels– especially if, as expected, costs come down – even if the more ambitious visions of an entirely hydrogen-based economy don’t come to fruition. But buying hydrogen-related stocks is a gamble that you are getting on the right side of that transition and choosing the companies that will make progress (and hopefully profits) over the next 20 to 30 years.

There are a number of other ways to ride the boom while hedging your bets. One is to buy the bigger engineering groups whose fortunes are not entirely tied to the rise of the hydrogen economy, but which might profit from it should it take off at a later date – Siemens (Xetra: SIE), for example, which is a world leader in the manufacture of hydrolysis equipment for the large-scale production of hydrogen and has its fingers in many promising pies; and Johnson Matthey (LSE: JMAT), which has been investing to expand its exposure to hydrogen.

The second is to get exposure to green energy more generally. Hydrogen can only live up to the hype if it is able to ride the coattails of a more general transition to a post-carbon future, so the hydrogen we’re talking about will have to be of the “green” variety, which will in turn depend on the growth and development of renewable energy. You can play this theme with exchange-traded funds such as iShares Global Clean Energy (LSE: INRG) and the Lyxor New Energy (LSE: NRJL). Among investment trusts, consider the Renewables Infrastructure Group (LSE: TRIG).

But perhaps the most intriguing option is suggested by Evans-Pritchard, who says he owns shares in oil giants because he considers them hydrogen plays: BP has announced plans for the UK’s largest blue hydrogen facility; Shell has already opened Europe’s largest electrolyser to produce green hydrogen in Germany; all the other big oil majors have similar plans. And as Cris Sholto Heaton pointed out for MoneyWeek recently, markets are putting little value on the long-term prospects of Shell (LSE: RDSA) and BP (LSE: BP) in particular. With dividend payouts starting to rise, then “so long as the world doesn’t abandon oil faster than seems likely, both look extremely cheap plays in a cheap sector”. All the more so if they get a lift from hydrogen.