China's state-backed hydrogen vehicle industry

The recent announcement that global auto giants including Toyota Motor and Hyundai Motor will start selling hydrogen fuel-cell passenger cars in China later this year has jolted the fledgling sector.

Though both emphasized that the sales would be small-scale at first - Toyota's local partner will start with 50 cars - it could mark a turning point for the local hydrogen vehicle market, which has so far mostly involved commercial trucks, public buses and tractors.

The announcements come months after China's top economic planner set specific new targets for how many fuel-cell electric vehicles (FCEVs) should arrive on the country's roads in the coming years. These high-level blueprints have ignited market and investor interest in the emerging technology, which has primarily seen take-up from government-linked entities so far.

The push comes as Chinese policymakers explore new options to meet their ambitious dual carbon goals, as hydrogen cells produce only water as a byproduct. But questions remain about the sustainability of subsidies, overdependence on government support, and weak private sector demand for the pricey products. Meanwhile upstream raw materials, production and storage are presenting challenges.

Flood of investment

"The competition was fierce." That's how a state-owned investor described the pre-IPO financing of Shanghai Hydrogen Propulsion Technology Co. Ltd. (SHPT). "Even the 'number-one boss' of a central-government owned oil company visited SHPT. Eventually, more than a dozen state-owned enterprises, leading private equity funds, and venture capital funds joined SHPT's 880-million-yuan financing plan."

SHPT, a fuel-cell battery manufacturing unit which is being spun off of state-owned auto giant SAIC for a future listing, completed five rounds of financing since it was established in 2018 through September 2021. After these rounds, its valuation reached approximately 4.13 billion yuan (S$834 million), 9.6 times the value of its net assets at the end of 2020. On June 28, SHPT filed an IPO prospectus with Shanghai's STAR Market, with the goal of raising over 1 billion yuan.

Most of the interest can be explained by the firm's powerful parent, which can ensure stable sales for an industry which lacks market-driven demand. Many of SHPT's other investors also have government connections which can help boost otherwise weak demand. A state-owned investor that only invested 50 million yuan was able to grow its stake and snag a board seat because it was able to generate a significant number of sales.

SHPT is far from alone in deriving much of its support from the government. Its peers such as Refire, Dongyue Future Hydrogen, GuofuHee, Shanghai Zhizhen and SinoSynergy have all completed several rounds of financing and put forward listing plans. All have received policy support from hydrogen vehicle pilot programs operating in cities around China.

Policy support

In March, the National Development and Reform Commission announced a plan for the development of hydrogen energy until 2035. The economic planner's goal is to have a fully-fledged hydrogen energy industry within the next 15 years and 50,000 hydrogen fuel-cell vehicles on the road by 2025, up from about 9,000 last year.

This kind of state-led industry development is not new in China. Years of hefty government support were crucial for the success of the country's electric vehicle industry. In September 2020, five ministries including the Ministry of Finance launched a FCEV pilot project in which five "city clusters" were chosen to develop an FCEV industrial chain and related technologies.

The five pilot zones include the Beijing-Tianjin-Hebei zone, a separate but overlapping Hebei pilot led by the city of Zhangjiakou, and pilots in Shanghai, Guangdong, and Henan. City clusters that meet the targets set in the national plan can receive up to 1.7 billion yuan in fiscal bonuses from the central government.

The clusters' plans in total aim for the production of more than 30,000 FECVs by 2025, most commercial vehicles such as medium- or heavy-duty trucks. Hydrogen fuel cells have an advantage over electric batteries for these commercial vehicles because of FCEV's longer range and shorter refueling time.

Government dependence

Fuel cell battery companies also face challenges. Depending too much on local governments for sales could be risky. "Almost every local government promotes its local companies.

For example, Beijing-based SinoHytec has a dominant position in the Beijing-Tianjin-Hebei cluster, getting many orders from the Beijing Winter Olympics. SHPT mainly takes orders from Shanghai," the venture capital investor said.

This "single-customer structure" also poses challenges to companies' sustainable growth. SinoHytec's annual reports have consistently pointed out the risk of excessive customer concentration. In 2021, revenue brought from the company's top five customers accounted for 84.16 per cent of the total. Sales to the largest customer, BAIC Foton, accounted for 54.01 per cent, mostly related to the Winter Olympics.

Investors are not ignoring these risks. With downstream demand mainly driven by the government, the competition has transformed into one for government resources rather than technological achievements.

Overcapacity concerns

As is often the case with industries propelled by state subsidies, overcapacity is emerging. A person in charge of renewable energy investment at a leading venture capital firm pointed out that the current production capacity far exceeds national policy targets, and many local governments still want to draw investment into their region to build more factories.

"In 2021, the domestic sales of FCEVs were only around 1,600. Even if sales double this year, it would only be a few thousand vehicles. If you look at domestic production capacity for [hydrogen fuel cell] stacks that's already built or under-construction, it's enough to supply 100,000 FCEVs," said Teng Yong, head of energy and technology practices at consultancy Kearney Greater China. A fuel cell stack is where the energy-generating reaction which powers the vehicle takes place, similar to a battery in an electric car.

Overcapacity is contributing to a price war. In October 2020, SynoEnergy announced a "lowest strategic cooperation price" of 1,999 yuan per kilowatt (kW) for one of its fuel-cell battery stacks, becoming the first stack product cheaper than 2,000 yuan. A month later, Nowogen pushed its price down to 1,699 yuan/kW. Just a week later, HydraV set its price as low as 1199 yuan/kW.

Green, or greenwashed?

While hydrogen-fueled vehicles emit only water, how you get the hydrogen matters - especially when it comes to whether shifting to vehicles fueled with the universe's most abundant element will actually help with China's carbon emission goals.

Most of China's hydrogen is cheaper "grey hydrogen" which is either an industrial byproduct or made from coal. Extracting it from coal is a dirty process that produces a massive amount of carbon dioxide and other pollution.

Another option is to use relatively cheap coal power as the source of energy to split water into its components of hydrogen and oxygen, in a process known as hydrolysis. Such processes have been an attractive option for fossil fuel firms seeking to "greenwash" their product.

Producing "green hydrogen," on the other hand, costs more because the energy source for the hydrolysis needs to be renewable. China's green goals have given new impetus to the approach, but large-scale and economical green hydrogen production technology is yet to be developed.

Different from FCEVs that have not yet observed a market driven demand, green hydrogen already has its established customers. The key challenges come down to cost, technology, and power of existing players.

At this stage, green hydrogen production projects are mostly in the pilot phase, led by traditional energy enterprises like the State Power Investment Corp. and Sinopec. The venture capital investor pointed out that this means the green hydrogen market also relies on government and state-owned enterprises. The big players also have large-scale manufacturing capabilities and strong customer resources. However, they do not have advantages in technology, which could still mean opportunities.