Wednesday, March 15, 2006

VCs and the hydrogen economy: An update

With the National Hydrogen Association conference in full swing this week, complete with lots of talk of "hydrogen highways" and emissions-free cars and fuel cells, it seems like a good time to check in on the hydrogen tech market from the venture investors' standpoint.

The short answer appears to be that hydrogen-economy investments are limping along. Note that this is not to be confused with any general statement about fuel cells fueled by anything other than direct hydrogen, but instead I'm referring only to the generation, storage, and use of hydrogen as a fuel, unreformed out of methane, etc. We'll deal with SOFCs another day...

By my count (and it's likely an incomplete look, but probably indicative), there have been only two hydrogen economy venture investments announced so far this quarter (ClearEdge and Safe Hydrogen), with the quarter almost over. In first quarter 2005, there were six or so. Not real compelling data points, two isolated quarters' worth of data, true. But amid all of the hype in the public realm now about the hydrogen economy, it's intriguing to see relatively low activity among investors.

This lack of activity comes while there are important technological and market developments being announced all of the time, such as recent mentions of:
  • 33 states have announced plans for some kind of support for hydrogen economy infrastructure, and in California fueling stations are already being built.
So why aren't investors funding a huge portfolio of hydrogen economy startups, as is happening in solar right now? There are several possible answers to this question:

1. The first possible answer is to refute the question -- certainly some investors are actively looking at and investing in hydrogen economy startups. The numbers may not be huge, but it's still happening.

Nevertheless, the numbers are low. And some hydrogen/ fuel cell focused venture firms have talked about how they are looking to now move beyond the niche into other, broader areas. So while it's an overgeneralization to say that investor interest in the hydrogen economy has fallen off entirely, it's certainly waned a bit.

Someone's going to take issue with that statement, that things are "limping along" in terms of venture investments in this market, which is fine, it's all relative and somewhat subjective -- but again, compare it with the activity in solar right now. Even if you re-phrase the question as "why is solar getting so much more investor interest than hydrogen tech," it's still largely the same issue.

2. Another answer I've heard mentioned is that the entrepreneurial activity has passed beyond the startup stage, to publicly-traded companies and the likes of GE.

A few early startups in the market took advantage of friendly investment environments to go public at huge valuations early in their lifespan, taking them out of the venture investment stage before they were fully commercialized. Meanwhile, larger players with bigger names have gotten into the act, and have been consolidating the industry a bit and pushing their own internal innovation efforts, making it tougher for new startups to compete. Unfortunately for this argument... The market I'm talking about is the solar market, which continues to be white-hot for VCs. So it's hard to put a lot of weight behind this argument.

In reality, if companies like GE and Air Products are taking leadership roles in the development of a hydrogen economy, it should serve to both legitimize the market opportunity and improve exit potential (via trade sale) for investors.

3. Another potential answer is that the potential for IPO exits is low.

Certainly, publicly-traded hydrogen economy stocks have fallen dramatically from their peaks. But even at the lower prices, individual investors are still driving pretty attractive multiples (from the company's perspective). Take Ballard Power -- sure, it's down to $6 or so from a high in 2000 of over $100/share. But it's still trading at more than 12x ttm revenues. And public market appetite for new hydrogen-economy issuances remains high, as the IPO of Hoku Scientific shows -- while down from its post-offering peak, it's still trading above where it debuted, and at around 15x ttm revenues.

With these and other examples, and all of the media and political hype, it's hard to argue that a hydrogen economy startup that was doing well wouldn't get a good reception as an IPO.

4. The answer perhaps most heard is that VCs think the hydrogen economy is going to take a long time to arrive, if it's going to develop at all.

This argument has a lot of merit -- VCs I speak to tend to talk about the infrastructure and market adoption hurdles facing the emergence of a "hydrogen economy." They talk about how the likely market adoption period is longer than their funds' investment periods. They talk about how they don't want to invest in markets that are heavily dependent upon government subsidies. All of which are probably true for hydrogen tech. Even the most aggressive program in the U.S., California's, talks about 50-100 fueling stations statewide by 2010. Compare that to the 11,000 retail gas stations in California. The solar industry is growing 30%+ a year off of a nice base, whereas hydrogen and fuel cells remain mostly at a beta stage, as a generalization.

Nevertheless, take a look at this fascinating survey of "alternative energy industry" members and experts. Note that the survey concludes that these experts feel it will take until 2014 for solar power to achieve competitive prices (which I assume to mean unsubsidized). Mass-produced hydrogen-powered cars only take a couple more years after that, in the minds of those surveyed. So according to these industry experts, in many ways solar is just as far away from unsubsidized economic competitiveness as the hydrogen economy. Plus, there are niches (such as industrial hydrogen) where hydrogen tech innovators can find early beachheads in the market. And sure, solar is getting a lot of near-term subsidies that are driving the market right now -- but so are hydrogen techs. So it's still a bit of a funny contrast.

One analyst report recently stated, "Investors in solar companies are rewarding these firms for their ability to commercialize products, increase production capacity and exhibit a path to profitability. Failure to exhibit these same characteristics is the main reason that most other U.S. alternative energy companies continue to trade at multiples below their solar peers." Probably true. There's a lot of venture investor interest in solar technologies that seem to be a long way away from profitability today, and relatively less interest in similarly early-staged hydrogen tech companies. But investors have an easier time seeing the path to commercialization of those early solar technologies.

5. Finally, another answer people point to is that most venture investors (aside from seed/ early stage VCs, in some cases) really need to see markets today, and that a) hydrogen and fuel cell markets remain relatively small; and b) what's often called a "herd mentality" for VCs reflects the fact that seeing other investors' activity in a given technology area helps to legitimize that sector.

This answer, along with the "it's beyond my investment horizon" answer from above, probably explains a lot. CleanEdge recently concluded that global wind and solar markets are over $11B each, while fuel cell markets total around $1B today, "primarily for research contracts and demonstration and test units." And it's much easier to invest in the technology that other firms are investing in, that's already a 10x bigger market, than a market that's smaller and less covered by your colleagues. Nevertheless, in other venture sectors there are early stage/ seed investors willing to bet on market creation when there's enough positive signs that it will take place (think Web 2.0). Either most VCs don't see those signs in hydrogen tech right now, or they're not acting on them as they do with other markets.

That having been said, there are definitely seed and early stage investors in cleantech who are looking into these technologies and taking stakes in various possible market development scenarios. Remember, this is all a discussion about relative activity levels...

In the end, the answer is a bit of all of the above. Many venture investors remain somewhat uncertain about the market and science risk in hydrogen tech, their colleagues aren't legitimizing the opportunity for them, and the near-term market is relatively small versus other clean energy investment areas. There are exceptions to all of the preceding statement, but it remains a broadly applicable generalization.

So the next question is... will the media, government and political attention, as well as the continual announcements of technological innovations, start to attract more venture investor attention anytime soon?


Anonymous Jim from The Energy Blog said...

I think you were very kind to the hydrogen economy. The solar industry has a very defined path to sucessful large-scale commercial utilization, while the hydrogen economy is still stymied with many technological barriers especially in hydrogen storage and low cost fuel cells.

Likewise there is a clear path in using batteries for vehicle propulsion. New low cost batteries are only a few years off which will improve the performance of HEVs, PHEVs and EVs.

Low cost ultracapatitors are on a steady path of development for use in vehicles and the electrical utility industry.

The only thing holding back the wind power industry from even greater growth are extensive opposition to location of wind farms.

Biofuels are already supplying about 3% of our transportation fuels and are only waiting for larger scale demonstration of cellulosic ethanol, which will eliminate concern for land usage, and permit an explosion in ethanol use.

Even the virtually unknown ocean power industry has economical viable commercial scale demonstration projects under constructiion, while there are no economical viable, commercial scale hydrogen projects on the horizon.

10:06 PM  
Blogger Rob Day said...

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1:34 AM  
Anonymous drmartin said...

The trouble with technologies is that they become products - and then there is nothing but margin to validate the investment.
The solar industry (at least the PV part of it) might not sustain the growth seen in 2005:
But PVs are might be worst part of the solar industry from many perspectives and the complete solar scene does have some promise. Solar thermal long ago broke through the competitive barrier; but the market is too small for big-time VCs.

And we would all like to think that Ultracaps are almost there, but read a press release from Maxwell from 2000 or so ( and you can see that almost is still almost.

And then the topic of batteries, "New low cost batteries are only a few years off" has to be the most over-used phrase in this industry! Can you really say that with a straight face?

But I am the first to admit, there is only one group worse than battery-liars and that is "fuel cell" liars.

Now, take the 4-door passenger car out of the picture and fuel cells might actually have something going.
There are a few (not all public) that have seen the benefit of wise investments and could do partial justice to the hype:
Medis which has nothing at all to do with Hydrogen
ITM Power

but then you get this and you really have to wonder:
Fuel cell mixes with old porn company for pseudo IPO

Good debate, let's keepit up.

7:15 PM  

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