Years from now, will people be watching Netflix or using Facebook? Nobody knows. But I think it is a near certainty there will still be high demand for energy. As new forms emerge, could that be a long-term investment theme for my portfolio? Could buying lithium or hydrogen shares now help me ride the wave?
First it is worth understanding more about what investing in an emerging industry can look like. Whether it was cars a century ago or internet companies 20 years ago, some broad trends are common.
Investing in future energy sources
Often the market will identify a customer need that is set to boom in future. Lots of businesses will race to satisfy part or all of the need. Often, some are new companies formed especially for the opportunity, like Tesla or NIO in electric vehicles. Others may be long-established businesses that try to use their experience to exploit a new opportunity. Examples in the electric vehicle field include companies such as Ford and General Motors.
Developing a new industry can be very expensive. Research and development costs, publicity and initial sales efforts by companies with no real market experience can be very costly. So a new industry often sees a rash of companies seeking to raise capital. Some may turn out to do exceptionally well and make shareholders handsome rewards. Some will do okay before being taken over by a competitor. Others will swallow up vast sums of money, maybe seeing their share prices surge for a while, but get no real commercial traction and end up going bust.
That broad model will likely apply to alternative energy in my opinion. So when considering lithium or hydrogen shares, I need to bear it in mind. First I would want to decide what I think the prospects are for hydrogen and lithium as energy sources. Then I would look at the prospects of individual companies within those areas.
Hydrogen or lithium?
I think demand for both lithium and hydrogen energy is set to increase markedly in years to come.
But I think it is helpful to understand the relative merits and downsides of each. Although they are not fossil fuels, both can be environmentally damaging. Lithium mines, like most extractive industries, scar the landscape. Hydrogen may be touted as a clean, green energy, but its carbon dioxide footprint means that hydrogen energy usage could lead to more greenhouse gases being released.
I think that matters because for development of alternative energy sources is not just energy security, but environmental impact. If alternative energy sources turn out to be damaging to the environment, that could hurt the case for their adoption even if they are less damaging than fossil fuels.
I think the obvious, visible impact of lithium mines could hurt the green credentials of that industry more than the less immediately tangible environmental impact of hydrogen energy. For that reason, I am a bit more optimistic about the long-term commercial market size for hydrogen than I am about lithium. Some producers are also trying to develop what they call green hydrogen energy, with a reduced environmental footprint. On top of that, hydrogen should be commercially scalable without the exploration costs of developing new mines.
Hydrogen shares to buy now
Given that I see strong possible prospects for hydrogen energy in future, does that mean that I ought to buy hydrogen shares for my portfolio now?
I am open to the idea, but at the moment I feel the development stage of the industry makes it hard to separate likely winners from losers. Take ITM Power (LSE: ITM) as an example. Its technology is promising and seems to be attracting growing customer interest. The company’s order book more than quadrupled between January last year and the same stage this year. It has an operational factory and a second one is already being planned.
Despite all that, to date the company has been a money pit. In its most recent half-yearly report, revenue rose to £4.2m. But cash burn remained stubbornly high, at £11.8m. The company reported cash of around £390m, so I do not see short-term liquidity risks. But over time, high development costs, continued cash burn and small revenues are not a promising recipe for shareholder rewards, in my view. Over the past year, the ITM Power share price has fallen 18%.
Yet the company still has a market capitalisation of almost £1.9bn. Without evidence of a dramatic improvement in commercial performance – including profits as well as sales – these hydrogen shares do not strike me as an attractive addition to my portfolio.
International hydrogen shares
What about other hydrogen shares? I think many are also struggling with profitability. For example, US firm FuelCell Energy is valued at around £1.2bn. Its revenue last year was much bigger then ITM, at around £56m. But it also posted sizeable losses, as it has every year in the past decade.
Australia’s Fortescue Metals Group has been attracting headlines for its ambitious hydrogen energy plans. Its subsidiary Fortescue Future Industries is set to become the UK’s leading supplier. But the share price has lost 20% of its value over the past 12 months.
Hydrogen is just a small part of the huge mining company’s operations. Fortescue says green hydrogen could be a US$12trn industry by 2050. For now though, the company is spending heavily on development.
My next move
What a lot of these hydrogen shares seem to have in common is that the businesses remain in a development phase. They are burning, not earning, cash. That is consistent with the early development stages of a new industry, as I outlined above. Today’s loss-making company could turn out to be a successful industry pioneer that ends up being very valuable.
But for now, I do not see attractively priced hydrogen shares in a business with the sort of competitive advantage I think could make it succeed where dozens of competitors end up failing. So while I am open to buying hydrogen shares for my portfolio in principle, in practice I am waiting for the industry to develop more before making any purchases.
