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Investment Institute

Hydrogen and the energy transition: One molecule to rule them all?

  • 04 October 2022 (10 min read)

  • Hydrogen is not a climate change silver bullet, but it can be a credible part of the strategy to decarbonise our energy system, if it is itself produced without carbon

  • The objective should be to develop a hydrogen ecosystem, built around green hydrogen. This will require investments in transport and storage infrastructure

  • We argue that opportunities for investors arise more in renewable electricity and integrated hydrogen supply chain areas than in equipment suppliers

The Intergovernmental Panel on Climate Change (IPCC) made clear in its August 2021 report that humankind is making a dramatic contribution to global warming through emissions of greenhouse gases, mostly carbon dioxide (CO₂) and methane (CH₄).1 To contain the increase in temperature and limit disruptions to our planet’s ecosystem it is necessary to reduce those emissions by moving to a decarbonised economy.

Right now, and despite increasing efforts from governments, businesses and investors, we remain locked in the fossil fuel-based economy that has powered our world since the industrial revolution. Coal, crude oil and natural gas – which together account for about 80% of emissions – have offered us high energy density and relative ease of transport and storage.2

As our economies and societies transition, we will pay higher prices as the cost of carbon is made visible. In economist lingo, we will internalise an externality. Living with two energy systems as we transition will be an additional source of costs, but there are investments and growth to be found in this transition too.3

It is also a behavioural and social transition. We will have to make hard choices on what we consume and redefine ‘basic’ and ‘luxury’ habits. The logic of on-tap availability of energy, goods, and services could be questioned, at least in rich countries with high emissions per capita.

In this context, hydrogen – to be precise, di-hydrogen or H₂ – has gained prominence in recent years among the many tools, levers, and broad solutions that can be used to decarbonise.4 Hydrogen can potentially be a carbon-free source of electricity, fuel, raw material or energy storage capacity, but for investors it is always difficult to anticipate the likely pace and scale of change, and how it may affect the companies and industries that we help to finance. Click on the link at the end of this introductory article to read our full research paper.

Grey area

The hydrogen economy already exists. About 90 million tonnes (MT) was produced in 2020 according to the International Energy Agency (IEA).5 This hydrogen is mostly used to remove sulphur from fuels and to produce fertilisers. In most of the world, it is produced by cracking methane – the main component of natural gas – but in China is produced through the gasification of coal. Both processes are carbon intensive, especially the coal route, and it is estimated that hydrogen production generates around 900MT of CO₂ annually, equivalent to 2.5% of global emissions. This is why natural gas-based hydrogen has been labelled ‘grey’ and coal-based hydrogen ‘black’ or ‘brown’. Hydrogen produced from natural gas where CO₂ emissions are captured is called “blue” hydrogen.

But the buzz around hydrogen is really about so-called ‘green’ hydrogen – produced through the electrolysis of water, using renewable electricity. In such a production pathway, there are no CO₂ emissions. According to the IEA, however, green hydrogen accounted for a paltry 0.03% of total production in 2020.6 In addition, green hydrogen is much more costly than grey hydrogen, with most analyses pointing to a cost difference of a factor of three or more.

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Source: AXA IM

In all energy transition scenarios, the hydrogen market is expected to grow – from doubling to multiplying sixfold by 2050 – as hydrogen is deployed in markets beyond its current applications, and as the cost of green hydrogen declines drastically. Greater scale will contribute to cost reduction, as will an expected steady reduction in the cost of renewable electricity and the proper industrialisation of the electrolyser industrial chain.

Current cost projections forecast green hydrogen to become cost competitive in a decade or so. If a cost of carbon is added, ideally globally and at a high enough level, this would further enhance the relative attractiveness of green hydrogen by making grey hydrogen dearer.

Hydrogen could also join the debate about the need for strategic metals in the energy transition. There are two dominant electrolysis technologies – alkaline and proton exchange membrane or PEM – and they require large quantities of nickel and iridium respectively, implying large investments by the mining industry.

However, the most critical element for the development of green hydrogen is the need for massive quantities of renewable electricity as water electrolysis is a very electro-intensive process. While renewable electricity capacity is growing fast, and this growth is expected to further accelerate, green hydrogen could be a large chunk of demand. In its net zero scenario, the IEA expects green hydrogen to consume 10% of the world’s electricity by 2050, from virtually zero today.

The consanguinity of green hydrogen and renewable electricity raises several issues:

  • Crowding out: Renewable power used to produce hydrogen will not be available for other uses, in a context where renewable power is a key lever to decarbonise our economy
  • Energy efficiency: Hydrogen is a relatively inefficient energy carrier given the energy required to produce and transport it. Direct electrification is a superior proposition to hydrogen and should be favoured whenever possible
  • Application: Hydrogen is too-often hyped as a magic solution to all energy problems. Beyond greening existing production, it is important to ensure that new hydrogen production is dedicated to applications where there are no better alternatives.

We believe hydrogen will be best used to decarbonise heavy-duty, long-haul road transportation, long-haul shipping, steel making, and potentially certain industrial processes requiring very high heat. As it can be stored, typically in underground salt caverns, hydrogen could also play a role in managing power grids where intermittent sources will be dominant.

In addition, competing technologies must be monitored. For instance, progress in battery technologies could change the attractiveness of hydrogen in certain applications

Opportunities for investors

A hydrogen economy would have the advantage of being local – wherever there is wind, sun and water – and could help to reduce dependency on imported fossil fuels. Although it appears that water availability is not a technical and cost roadblock – with brackish or sea water desalination as a credible alternative to freshwater in water stressed regions – it could easily be more challenging to gain social acceptance at local community level.

More broadly, the overall acceptance and the risk perception of hydrogen are important factors to take into account. Its chemical nature means it ignites easily and is prone to leaks, and it is complex to handle along existing value chains thanks to the need for high compression and/or very low temperatures. There is a physical footprint to consider too, through the massive need for wind and solar farms.

We believe that investors should be very careful when assessing the opportunities and risks of the hydrogen space.

Renewable electricity is a clear and obvious route to gain exposure to the growth potential of green hydrogen. Greater use of electricity and the electrification of many processes promises decades of development for solar and wind power, and while we acknowledge that green hydrogen is one of many growth drivers, it also means that risks are spread. Electric utilities with strong credentials in renewables ought to benefit from the rise of the hydrogen economy.

We have seen that hydrogen is not an easy molecule to handle. As such, we believe companies already active in the production, and especially the logistics, of hydrogen – namely industrial gas producers – may have a competitive advantage. Their know-how in managing a complex value chain could set them ahead of would-be competitors, in our view. A few, mostly western, integrated oil and gas companies have started to invest in hydrogen. Their experience in complex energy value chains and chemical processes could make them credible hydrogen players, although they will primarily remain fossil fuel producers for many years.

Equipment providers may be an area where risks could trump the opportunities. Most notably, producers of electrolysis technologies are likely to see very strong volume growth, but also strong price pressures and sharp competition. We expect in time to see commoditisation arising for those selling the shovels and picks of the green hydrogen industry.

Hydrogen and the energy transition: One molecule to rule them all?
Download the full research paper (2.75 MB)


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