Hydrogen hype is upon us.
A couple weeks ago a friend called me and said, essentially: “Hi Joe, hope you’re safe and happy, no corona and all of that. Hey, quick question for you: my father's brother's nephew's cousin's former roommate has made a ton in Nikola, and you know something about hydrogen, do you think I should invest too?”
When Nikola’s valuation hit $20 billion in June plenty of people took notice and many articles were written that debate the current and future prospects of the company. I’m not going to evaluate Nikola in this article, nor am I going to pontificate on the (dis)connection between a corporation’s technology and its market value.
Instead I’m going to describe a simple way to determine the validity of a hydrogen technology company’s claims with respect to its core technology and its market assumptions. Because while hype can drive share prices high in the short term, I still believe that long term viability of a technology company depends on the viability of the technology itself. Whether you use this guide as a way to figure out into which company you will invest in the first place, or to decide when to exit investment in a hype-driven company, the principles are exactly the same.
Let’s start with the market. The key driver of market viability of any hydrogen related business is the cost and price of hydrogen itself. And the cost to make hydrogen is tied directly to the cost of the “feedstock”, i.e., the energy source used to make it. Today, hydrogen can be produced from natural gas (methane) in large scale reformers for around $2/kg, and the cost is directly related to the cost of natural gas. Hydrogen can also be made by splitting water using electricity in electrolyzers, in which case the cost is directly tied to the cost of electricity. At larger scales, the cost of retail electricity today leads to a hydrogen cost of around $7/kg this way.
If you’re seeing assumptions on hydrogen cost or price that are significantly lower than either of these markers, then some questions about the process and the technology are in order. There are a few ways to legitimately reduce the feedstock cost. For the reformer-production route, that can be done by capturing methane from landfills or digesters or producing it by some more exotic methods like partial oxidation of coal and crude oil. If any of these methods are used, potentially the cost can be lower so it warrants checking the cost of the captured methane or the cost of the extraction technology is needed.
For the electrolysis-production route, the most common way to achieve lower hydrogen cost is through negotiation with the electricity generator for (very) favorable rates. To reach $2/kg, however, the cost of electricity would need to be around $0.04/kWh, about 2-5 times less than retail rates. Fortunately, the dropping prices of wind and solar electricity make this viable today, but the hydrogen production company would need to either have their own solar or wind farm, or have a long-term power purchase agreement with an existing one. If this is the claim, then check: What is the status of power purchase agreements, what is the electricity rate, or what is the electricity cost from a company’s own facility?
Production cost numbers are helpful to do a first-cut evaluation of companies in the hydrogen production business, but hydrogen cost numbers are also extremely important to companies that are using the hydrogen or producing technology that uses hydrogen. Just don’t make the mistake of assuming the price point for the consumer is the same as the producer, even neglecting margin. The consumer company would only get this price if it were located next door to the production facility, could tap into their pipeline at marginal cost, and use it at its (relatively low) production pressure. Any other scenario adds cost. For example, for hydrogen dispensing stations that fuel vehicles, the cost of transporting the hydrogen to the dispensing station and compressing it to the pressure needed for these vehicles will roughly increase the cost of the hydrogen produced at the plant anywhere from double to 10x. So be wary if a consumer company, or company selling hydrogen-consuming technology, is claiming a hydrogen purchase price less than $6/kg. They would either have to (a) be located next door to the production facility and able to use the hydrogen directly at low pressure, or (b) have a way to reduce the feedstock cost at the production side. In which case questions need to be asked about exactly how they are doing this.
Which leads to the second part of this article, assessing the core technology. Inevitably, a company claiming a much lower hydrogen cost will have a unique “innovation” enabling this advantage. Over the 20+ years since I started work in hydrogen years I’ve been subjected to all kinds of pitches and claims about “new” and “innovative” ways to make cheap hydrogen and have yet to see any of them come to fruition. The most common claim revolves around drastically reducing or eliminating the feedstock cost. The second is a convenient or ignorant neglect of some of the processes and/or process costs to produce and distribute the hydrogen. How can we separate truth from fiction?
Hydrogen is a form of energy, so from a technology analysis point of view it makes sense to start with an energy balance. This is simply an accounting of the energy needed to make the hydrogen, which has to equal the energy of the hydrogen that was made. It’s sort of like adding up expenses and income on a balance sheet, and making sure they match. We can do this with energy because energy can never be created or destroyed, it can only change forms. So if we have 100 energy units of natural gas coming in, we’d better have 100 energy units of hydrogen (and/or something else) going out.
Let’s apply this to an example. I recently saw news about a company that is “creating free hydrogen” from underground for “less than $0.65/kg.” I became suspicious, as always. Did someone discover a reservoir of hydrogen underground – never known to occur naturally on earth? Because besides that, the hydrogen has to be made from something. In other words, we have 100 energy units of hydrogen coming out but where are the 100 energy units going in? More details from the company describe how they inject oxygen-enhanced air into an underground reservoir containing hydrocarbon “gases, coke, and heavier hydrocarbons” which are then oxidized via in-situ combustion. The byproduct of this combustion is reacted with water and produces hydrogen and heat in a similar way to a conventional natural gas reforming process. Aha! The feedstock here is actually the hydrocarbon fuels below the earth, and the energy equation makes sense: 100 energy units of fossil fuels goes to 100 energy units of hydrogen and heat. Pricing-wise, $0.65/kg is 33% of our $2.00/kg rule of thumb, so presumably the company has access to the fuel for around 33% of the cost of natural gas. Although I don’t quite agree with the marketing jargon “free hydrogen” and “completely clean and green”, it appears the technology is legitimate. The cost of the injection and extraction infrastructure and the cost of the fossil fuel resource just needs to be checked to make sure this is not Hype.
A different hydrogen production company claims (according to their materials) to harness the powerful forces observed in nature to produce hydrogen anywhere from water on-demand without the use of chemicals or electrolysis, at cost-competitive prices. Sounds exciting, so let’s check the energy balance: 100 energy units of “powerful forces” goes to 100 energy units of hydrogen. With no additional details given on the source of energy, we don’t have enough information to evaluate either the technical claims nor the market viability. Verdict: Hype – I’ll pass and re-evaluate if more information becomes available.
There are many more nuances to assessing a market opportunity besides hydrogen cost, and other tools to evaluate technology than an energy balance. But hopefully, with a few benchmark numbers and a quick way to check the most common claim of technological innovation, you can wade through the Hype and find some targets worth spending time getting to know further. For anything deeper, shoot me a note and I’ll give you my take!