It seems like a forgone conclusion that electric vehicles will eventually replace all gas-powered automobiles. And investors have begun looking for alternatives investments, and not just in the battery space.

Many industries looking to go green still need a kind of explosive, high-heat power that batteries can’t yet provide. Hydrogen fits the bill.

“The appeal of hydrogen energy is that the only by-product from combustion is water,” says Tim Nash, CFP and founder at Good Investing. “To the end-consumer, it's a clean-burning fuel that doesn't cause any air pollution.”

“There is a great opportunity for hydrogen to decarbonize power generation, a major source of global greenhouse gas emissions,” agrees Morningstar energy and utilities strategist Stephen Ellis.

Who wants hydrogen?

“Areas that currently use coal and require a lot of heat such as steelmaking or other industrial processes are difficult to replace with electricity alone—hydrogen could help in those cases,” says Horizons ETFs’ Vice President and Portfolio Manager Nick Piquard.

“Hydrogen can also be used in combustion engines and in fuel cells and the growth into these applications should get society and investors excited about the potential to help decarbonize a big area like transportation,” says Mike Dragosits, Portfolio Manager at Harvest ETFs.

Hydrogen can supplement and improve the emissions efficiency of existing combustion solutions—or it can wholly drive an electric engine using a fuel cell that mixes hydrogen with oxygen to generate electricity. In fact, the US Energy Information Administration says the hydrogen fuel cell can be 2-3x more efficient than a gasoline engine.

Hydrogen also beats charging batteries. “Unlike a lithium battery that needs to be recharged, hydrogen-powered vehicles can typically be refuelled quickly and have greater energy storage density and output, offering several clear advantages over the current state of on road electric vehicles,” adds Piquard.

“Fuels cells are already being used in motive applications, such as forklifts and in light-duty vehicles with plenty of additional growth potential, but there are other growth areas as well, mainly in other transport applications, such as trucking, airplanes, buses, marine shipping, amongst others,” says Dragosits.

Who supplies hydrogen?

While many industries may benefit from hydrogen, the opportunities are on the supply side. “From a public markets perspective, we see companies involved in the area of hydrogen production, the manufacturers of hydrogen electrolyzers, the manufacturers of hydrogen infrastructure equipment, such as fueling stations, and the producers of hydrogen fuel cells,” explains Dragosits.

“Fuel cell companies are one of the big investment opportunities for the transportation sector, and there are several companies competing in that space,” says Piquard. “Chemical companies that currently produce hydrogen could benefit as well if demand picks up—however they may have to adapt to changing production methods from production involving coal and natural gas to emission-free ‘green hydrogen’ production,” he adds.

“Most investors looking for exposure to the hydrogen theme invest in 'pure play' companies that produce electrolyzers and fuel cells, says Nash. “These companies tend to be classified as Industrials or Information Technologies, and are usually micro/small-cap and have negative earnings as they invest heavily in R&D.”

“Electrolyzer manufacturers would also be ones to watch,” adds Piquard, “as costs come down, this could drive more adoption as we saw with batteries in the past ten years.”

Looking ahead, Ellis says consensus expectations are for the hydrogen market to grow between 5 and 8 times larger than today’s by 2050. But he cautions, “this bright outlook ignores our concerns about costs, infrastructure, and regulation.”

But hydrogen is produced from fossil fuels

“The big obstacle to overcome for the hydrogen economy to take-off is adequate supply,” says Piquard, “Currently, hydrogen is mostly produced from fossil fuels, so increased production doesn’t really get us much closer to reducing global emissions.”

“Green hydrogen produced from renewable energy is the future, but currently, costs are still high,” adds Piquard. Ellis also highlights the obstacle of cost. “Even if hydrogen costs decline to meet consensus expectations of $1.50–$2/kilogram (or $11–$15/mmBtu), we would also need carbon taxes well above consensus expectations to make the economics truly work.”

“The good news is costs are coming down and as electrolyzers (used for green hydrogen production) get cheaper, it could drive more adoption,” says Piquard.  “Blue hydrogen is also being talked about lately - it involves using natural gas as an input with carbon storage to reduce emissions,” he adds.

Nash also points to possible solutions with blue hydrogen. “We are learning that an abundance of methane is currently being wasted throughout the natural gas supply chain. Energy companies recognize that regulations from methane emissions are on their way, and hydrogen production becomes an attractive way to turn this liability into a revenue stream.”

Hydrogen picks

With the promising signs that hydrogen will perform an important role in the energy ecosystem of the future, there's been a lot of hype. "Investor enthusiasm for hydrogen stocks has exploded over the past year, with many clean energy exchange-traded funds up several hundred percent and substantial investor interest in pure-play hydrogen companies such as PlugPower (PLUG) and FuelCell Energy (FCEL)," says Ellis, however, "Given the nascent nature of the hydrogen market, we view these increases more speculative than considered."

In Canada, Dragosits points to the popularity of Ballard Power (BLDP). "The company was founded in 1979, and headquartered in British Columbia. They are a leading fuel cell company that is primarily focused on the bus, truck, rail and marine markets. To help drive fuel cell adoption they have collaboration agreements with companies like Weichai Power, a top Chinese engine manufacturer, and MAHLE, a German automotive supplier."

Ballard Power’s fuel cells currently power 1,000+ transit buses, 2,200+ trucks and 12,000 forklifts, with 4 rail projects and 5 marine projects in development, notes Dragosits. “Over its history, BLDP has delivered 670 MW of fuel cell products”, he notes, “Ballard Power claims that when comparing a fuel cell system with 25 kg of hydrogen vs. 260 kwh battery, the attractiveness of the fuel cell is that it has twice the range, 15x faster refuelling and is 10x lighter.”

In this promising, yet still blossoming industry, investors should be careful if deciding to gain exposure to to hydrogen through individual stock selections.

"Another option is to look for larger, more diversified companies who are investing heavily in hydrogen technologies. Examples that come to mind are Toyota (TM), Cummins (CMI), Air Products & Chemicals (APD), and Enbridge (ENB). These companies are much safer investments, but provide less exposure to the hydrogen theme," says Nash.

Nash is also wary of making individual stock selections when it comes to emerging green technologies. “The market for hydrogen is evolving rapidly, and any attempt to pick winners and losers is a gamble. I would suggest investors look at purchasing an ETF to diversify their exposure across the hydrogen supply chain.”

Always remember, though, hydrogen is a theme, and when investing in a theme, you are making a trifecta bet. You bet that you are: 1) picking a winning theme; 2) selecting a fund that is well-placed to survive and harness that theme, and 3) making a wager when the market hasn't already priced in the theme's potential. It is difficult, if not impossible, to consistently get all three right.