In 2019, the UK government passed legislation to reach net zero greenhouse gas emissions by 2050. With many other governments and huge swathes of businesses adopting similar or more ambitious targets, the scope of what is required is becoming clearer. Several technologies need to be developed rapidly to transition the global economy away from carbon-based fuels. Mass adoption of renewables, battery technology (to store energy from these ephemeral sources) and upgrades to the electricity grid are all part of the mix.
Yet the picture is not complete. Heavy transport and shipping aren’t able to effectively use battery technology used in cars. In these areas hydrogen technology is being eyed as a potential solution and an essential component in reducing emissions from transportation, which accounts for around a third of total emissions in the UK. Europe is looking to spend €500bn and develop 40gw of hydrogen power generation capacity by 2030 and we anticipate further government commitments to the building a hydrogen economy.
Hydrogen is potentially a very green fuel as burning it produces just water as a by-product. How green it depends very much on the method used to produce and store it, though. Well-established, cheaper technologies produce it using fossil fuels, either as a fuel source in the electrolysis process of separating water into hydrogen and oxygen (grey hydrogen) or directly in the chemical reaction itself (brown hydrogen). 95% of hydrogen production in 2019 was achieved under the grey method according to the International Energy Agency.
This carbon-intensive process is clearly far from ideal given the need to reduce emissions, which is where newer, albeit currently more expensive, technologies step in. ‘Blue’ hydrogen is similar in process to grey in that non-renewable energy sources are the input, but carbon emissions are captured and not released into the atmosphere. ‘Carbon Capture Storage’ involves collecting the excess carbon and storing it deep underground. There are also early systems of ‘Carbon Capture, Utilisation and Storage’ which seek to take the stored carbon but use it for industrial processes. This is in keeping with a ‘circular’ economy and may become less costly relative to traditional production as carbon taxes rise.
Hydrogen can also be produced using zero emission renewable sources, which is known as ‘green’ hydrogen – or in some circles ‘yellow’ in the case of utilising only solar energy in the electrolysis process. Producing hydrogen in this way can be virtually emission-free but it’s very expensive, albeit the cost is expected to fall considerably over time.
Adding to the complexity, there are a variety of technologies used in the electrolysis process: Two low temperate techniques, Alkaline and Proton Exchange, which are currently the more popular and advanced technologies; and Solid Oxide, which uses high temperature technology and may have the best large-scale potential when fully developed. Some techniques lend themselves to intermittent electricity supply, and hence work well with renewables, while others need a constant supply. The issue of chemical recycling also needs to be considered, especially regarding alkaline-based methods.
Hydrogen business models
The wide variety of production methods is mirrored in the wide variety of businesses involved. There are early stage companies with ‘pure’ exposure to hydrogen, but they tend to be reliant on one form of technology or another. Lots of these will require further investment to keep them going on the path towards commercialisation and, eventually, profitability meaning potential dilution for existing shareholders in the meantime. However, it’s possible that among these companies lie some large future players in the market, which could generate excellent returns.
There are also various large producers of hydrogen that mainly use grey methods currently but are transitioning to green and blue methods. These tend to be incumbent, profitable industrial gas manufacturers with other areas of exposure and not ‘pure play’ hydrogen names. In addition, various other large industrial companies are looking to refocus, reposition or diversify into hydrogen and similarly offer only watered-down exposure to the theme at present. Other hydrogen-related stocks include network and infrastructure operators as well as suppliers of chemicals and metals vital to production.
How to invest in hydrogen
In combination with clean energy from renewables and battery storage, a strong case can be made for hydrogen becoming a significant part of the transition away from fossil fuel dependency. While it is still early days, there are likely to be stocks that perform exceptionally well within this theme, the challenge of course is identifying them at an early stage and at a reasonable valuation. The universe of investable shares is quite small and is, as implied above, dominated by smaller, riskier companies alongside more mature businesses where hydrogen isn’t necessarily the primary driver of revenues in the shorter term.
One option for adventurous investors wishing to dip a toe in the area is the L&G Hydrogen Economy UCITS ETF, which aims to identify and track the performance of companies that are ‘enablers’ in hydrogen technology and not those who are merely consumers of it. Companies in industries such as electrolyser manufacturers, hydrogen producers, fuel-cell manufacturers, specialist mobility providers, fuel-cell component suppliers, key industrial and utility companies, and others in the supply chain are included in the equally-weighted-index tracked.
As it stands it is an imperfect means of exposure. L&G estimate that approximately 45% to 50% of the underlying holdings have 90% to 100% revenue from the theme, but the other holdings included have smaller overall related revenue, in some cases much smaller. However, in L&G’s view these businesses are still integral players in global green hydrogen, even though their overall revenues might not necessarily reflect that at this stage. Ignoring such players would, in the managers’ view, yield an insufficient exposure to the companies with the know-how and ability to meet the future demands of the hydrogen ecosystem. The ‘purity’ may grow over time as the industry evolves, but there is no guarantee of this. It is also worth noting that the ETF doesn’t have a particularly high ESG rating (‘BBB’ with MSCI), which reflects that the production process can still be carbon and energy intensive while the transition to green hydrogen takes place.
For many portfolios a specialist hydrogen fund will be too niche, so it may worth considering a broader clean energy fund instead. For instance, iShares Global Clean Energy UCITS ETF contains a wide range of clean energy production and clean energy equipment and technology businesses. There is some hydrogen exposure among this and overlap with the L&G Hydrogen Economy UCITS ETF is around 17%.
For those seeking an active approach that offers broad exposure to the theme of decarbonisation, Schroder Global Energy Transition Fund could be worth considering. It invests across the entire sustainable energy industry from production to end-use but adopts a selective, disciplined and value-conscious approach that aims to avoid overly expensive stocks in an area where there has been a lot of exuberance recently. It doesn’t invest significantly in hydrogen at present but there are stocks on the manager’s radar should the right opportunities present themselves. There is more on the Schroder Global Energy Transition fund here.
These broader funds should also be considered high risk, adventurous options more suitable for ‘satellite’ positions in a portfolio, even though they are more diversified than a purely hydrogen-related fund.
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