Does investing in fuel cells stack up?

So how about fuel cells? They’re very efficient, operate with very little noise, produce just heat and water as by-products at the point of use, and the technology behind them can be scaled to power your mobile phone, your boiler, your car or a major power plant.

Back to the future

Investors in the US seem keen. Shares in stalwart North American fuel cell companies are soaring on the back of recent engineering and commercial breakthroughs. Nasdaq-listed Plug Power (PLUG) has seen its share price rise nine-fold over the past 12 months; the company now has a market capitalisation approaching $1bn. Why? Because after years of expensive development, Plug is finally ramping up production and sales of its environmentally friendly, fuel-cell-powered system for warehouse forklifts. Early deals with Walmart, Coca-Cola, BMW and others have led to frenzied speculation of a cross-country roll-out.

Shares in Canada’s Ballard Power (TSX: BLD), meanwhile, have climbed nearly 600 per cent since the start of 2013. This year the company is poised to post the first profit in its 21-year history as a public company. It sells the fuel cell stacks to Plug Power for the forklift system. It also sells fuel cell systems for buses and telecommunications towers, having previously failed to break into the car market.

Then there is FuelCell Energy (FCEL), another Nasdaq-listed high-flier whose shares are up a comparatively modest 154 per cent since the beginning of last year. The company designs and builds stationary fuel cell power plants and has been expanding rapidly in America and Germany, as well as in Korea under a joint venture with steelmaking giant Posco. The plants can use a variety of fuels, including biogas, making them “ultra-clean”, according to the company.

False dawn?

The snag is that these companies have all enjoyed a huge run-up in their share prices before – only to suffer a spectacular crash. Plug Power had a peak market capitalisation of nearly $8bn before the dot-com bubble burst; Ballard’s share price peaked at $192 in 2000 and is just $4.15 today; while FuelCell Energy’s current share price is just a twentieth of its dot-com peak. High costs and daunting infrastructure challenges slammed the brakes on widespread adoption of fuel-cell technology before it even started, leaving investors with huge losses.

Yet their recent rise testifies to renewed optimism around the industry, which might finally be finding its way. Initial revenues are pouring in from a few big new contracts, even if profitability lags behind. “There’s a momentum behind this now”, says Mark Lawson-Statham, director of corporate finance at Loughborough-based Intelligent Energy (IEH), the UK leader in fuel cells. The former fund manager, who holds a PhD in neutron scattering from Oxford University, helped Intelligent Energy raise £72m in July from blue-chip investors including Singapore’s sovereign wealth fund, GIC. Its shares debuted on London’s main market at 340p a share, valuing the company at over £600m.

Phil Caldwell, the new chief executive of Ceres Power (CWR), agrees that the sector is taking off. “Having been in fuel cells for over a decade, suddenly everything has kicked into life”. Mr Caldwell left Intelligent Energy to join Ceres last year and helped it raise £20m in a July placing. That will cover the company’s expenses while it develops an innovative steel-based fuel cell power generator. Ceres hopes the product will be a big hit in Asia and America because of its lower costs and increased stability. “This technology displaces the need to have grid power – the potential for business use is astounding,” declares Mr Caldwell. New deals with large, third-party equipment manufacturers in Japan, Korea and the US will put Ceres’ technology through tests under joint development and evaluation agreements.

Yet for all these developments, share prices of UK fuel cell companies have so far massively underperformed their US counterparts. Shares in Intelligent Energy have dropped a third since listing, albeit on very light volumes; Mr Lawson-Statham blames the fall on some small shareholders selling their stakes at a profit having been privately invested for as long as 10 years. The wider British fuel cell sector is down 15 per cent year-to-date. This could present an opportunity for speculators willing to bet that one or two UK fuel cell players will be next in line for a dramatic re-rating.

Favourites

Intelligent Energy is undoubtedly the British company closest to monetising its technology – and monetisation is ultimately the key to any fuel cell player’s success. The same core technology is behind each of its products and is simply scaled up or down to suit the requirements. And importantly, it doesn’t have all of its eggs in one basket. Intelligent Energy is bringing three key products to market simultaneously: remote power generation for telecommunications towers in India; niche electronics applications such as mobile phone chargers; and fuel-cell-powered vehicles, for which it has partnered with some of the biggest vehicle manufacturers in the world. Ceres Power is a good second choice but it is a few years behind IEH in terms of monetisation.

Outsiders

Not every fuel cell company will be a winner. The companies with best-in-class technology will attract the lion’s share of risk capital and come out on top, so many of the smaller players are likely to struggle to fund their expensive development programmes. Consequently, we would steer clear of the smaller Aim-listed outfits such as Proton Power Systems (PPS), ITM Power (ITM), AFC Energy (AFC), Ceramic Fuel Cells (CFU) and Acta (ACTA).

IC view:

The main problem now for fuel cells is adoption, rather than proving the concept works. We’re doubtful fuel cells will be widely adopted in the car market in the near- to medium-term, as there is a viable alternative readily available: electric and hybrid-electric vehicles are already widely used. Yet we expect fuel cells to achieve success in a few other niche markets very soon, even if that success is mostly thanks to government subsidies. Fuel cell systems have been supported in Asia for some time now, they’re growing in popularity in the US for powering data centres and forklifts, and there’s major growth in India for fuel-cell-powered telecommunications towers. Overall, we see near-term upside for the share prices of the British fuel cell leaders as they play catch up with their American rivals.

Fuel Cells Explained

So what exactly is a fuel cell? Answer: a device that generates electricity by a chemical reaction. In simple terms, it converts chemicals such as hydrogen and oxygen into water, and in the process produces electricity and heat – with very little or no pollution. As long as there is a continuous flow of chemicals into the cell, it will never ‘go dead’ like a battery. But like batteries, fuel cells can be stacked in a row or on top of each other to boost the supply of power.

There are several variations of fuel cells, and each operates a bit differently. The key difference is the material used for the electrolyte, which carries electrically charged particles from one electrode to the other. The two most common electrolyte types used today are PEM (proton exchange membrane) and solid oxide (also known as ceramic).

PEM fuel cells work with a solid but flexible electrolyte that’s like a thin, permeable sheet. They’re mainly used in applications for the transportation industry. They typically run on pure hydrogen, though, which can be difficult to access regularly if you’re running your car on it. A platinum catalyst is also generally used on both sides of the membrane, raising costs.

Solid oxide fuel cells are where the latest engineering breakthroughs are happening. They’re more efficient and can often run on natural gas. However, they come with their fair share of challenges. Solid oxide fuel cells use a hard, often brittle, ceramic compound of metal as an electrolyte. They can produce more power, but some reach temperatures of around 1,000 degrees Celsius doing so, or work best when they’re in constant use. Some companies now say they have solved the heat problem by using more robust materials as a substitute or cooling the whole system down with the water that is created.