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There is a lot of hype surrounding green hydrogen, with claims that it is a magical solution for decarbonizing heavy transportation, steel production, and cement manufacturing. While hydrogen is versatile, like a Swiss army knife, it is not necessarily the best at any specific task.
Green hydrogen faces additional challenges, but one of the most significant ones is its energy efficiency, or rather the lack of it. When converting renewable electricity to hydrogen, approximately 30% of the energy is lost in the process. Furthermore, if the end-use is for mobility, the fuel cell, which converts hydrogen back into electricity for the electric motors, incurs another 30-40% energy loss. This means that more than half of the clean energy is lost. In comparison, fully electric mobility experiences total energy losses of less than 10%.
Despite these efficiency concerns, the European Union remains optimistic about hydrogen as a key driver of decarbonization. Similarly, in the US, the Inflation Reduction Act (IRA) offers attractive credits to hydrogen producers who can minimize emissions. While we still await specific details from the IRS on the IRA, the basic premise is clear—the tax credits are strictly tied to emission targets during hydrogen production, without considering its end-use.
To qualify for the maximum credit, a staggering $3 per kilogram of hydrogen produced, emissions must be a mere 0.45 kg of CO2 per kg of hydrogen, or less. However, current hydrogen production relies heavily on steam methane reforming, which emits around 10 kg of CO2 for every kg of hydrogen. This means that when the US government pays $3/kg for hydrogen with CO2 emissions below 0.45 kg, the implied carbon abatement cost is more than $300/tonne. In comparison, transitioning from coal to natural gas costs less than $50/tonne of CO2. To make it worse, keep in mind that there could be additional costs depending on how the hydrogen is consumed.
Another critical aspect to consider is the concept of "additionality" – is the renewable energy generation truly new – i.e. additional? Will producers of green hydrogen be required to utilize only new renewable power sources to collect subsidises, or can they simply tap into the existing grid or purchase electricity from already established renewable plants? If only new renewable energy can be utilised for green hydrogen production, the costs and risks will be significantly higher, and mass production of green hydrogen will surely take more time.
On the other hand, if producers can connect to the grid or utilise existing renewable energy, we would essentially be diverting clean power from its original consumption, forcing fossil fuel plants to increase output to meet the rising demand. This of course undermines the overall decarbonization effort. The solution, both in the EU and in the US, should probably be to allow some usage of existing renewable energy during a relatively short transition period.
There is no doubt that there are many challenges on hydrogen’s path to success and this is where our fund's perspective becomes relevant. We strongly support the energy transition, but we recognize that it will be expensive and there are significant risks of misallocation of resources. This could have dire consequences, not only economically but also in the loss of public trust and support of the energy transition. That is why our investment strategy focuses not only on finding technologies and companies with the greatest potential for decarbonization, but it also aims to take short positions in those that divert capital and expertise down the wrong path. Within the hydrogen sub-sector, we believe there are some companies with solutions that fit that description.
Joel Etzler is Portfolio Manager and Founder of the Coeli Renewable Opportunities fund and has more than 13 years in the industry, with investment experience from both the public and private equity side. Etzler joined Kalvoy at Horizon Asset in London in 2012 and spent five years before that within Private Equity at Morgan Stanley. Etzler started his investment career within the technology sector at Swedbank Robur in Stockholm, 2006.
Vidar Kalvoy is the lead Portfolio Manager and Founder of Coeli Renewable Opportunities fund. He has 25 years of experience from portfolio management and equity research. For nine years he was responsible for the energy investments at Horizon Asset in London, a market neutral hedge fund. Kalvoy also did energy investments at MKM Longboat, another hedge fund in London. He started his financial career as a sell side equity research analyst focusing on the technology and telecom sector, working six years in Oslo and Frankfurt. Prior to working in finance, he was a second lieutenant in the Norwegian Navy.