Defiance: New ETF Taps Into Hydrogen-Based Energy

Defiance ETFs just launched the Defiance Next Gen H2 ETF (HDRO), an index-based ETF that is the first in the U.S. to offer targeted exposure to the hydrogen-based alternative energy space. Here, Defiance’s Chief Investment Officer Sylvia Jablonski explains why investors should consider the opportunities associated with hydrogen-based fuel that are likely to lie ahead, and how HDRO can help them get exposure to this dynamic industry.

ETF.com: Can you tell me about why investors should care about hydrogen-based fuel?
Jablonski: There are two main reasons why it's appealing. One would be the benefit to the environment and supporting the overall focus of companies, people, governments in general and consumers of energy on reducing the carbon footprint, and creating sustainable alternative solutions.

The second reason why it's appealing is that it is a great investment opportunity. Bank of America’s equity strategist, Chaim Israel recently said that by 2050 they estimate the hydrogen market to reach $11 trillion of investments and $2.5 trillion of direct revenues.

Right now, the hydrogen market is worth around $150 billion-plus. Obviously, that translates into huge upside potential for investors. 90 percent of the world's energy consumption right now comes from fossil fuels, which are not renewable. They're harmful to the environment. They contribute to global warming. They deplete natural reserves. And there isn't really, right now, a clean solution that can meet the demand that we have for energy consumption.

The existing alternative energy sources are solar, wind and biomass, and they're simply not able to provide enough supply for the amount of energy that we need. With the Paris Agreement’s focus on achieving carbon neutrality by 2050 and to better the environment globally, there's been this search for alternative ways to provide energy. Hydrogen is at the top of the list, because hydrogen has the potential to be an entirely green fuel. 

ETF.com:  Storage has been an issue with a lot of alternative fuels. Is that an issue for hydrogen-based energy?
Jablonski:   Hydrogen is isolated through electrolysis. That involves passing electricity through water in order to separate its atoms and allow for the harvesting of hydrogen and oxygen. Once the hydrogen is isolated, it can be stored and thereby act as both a fuel and an energy carrier. It’s storage means that is can be used later to meet peak demand and offer longer duration discharge cycles, which those other sources of energy currently lack.

There are a few factors which complicate the storage of hydrogen, however, the primary one being that it is much less dense than air. Therefore, it does require high quality storage conditions in pressurized containers.

The storage is one of the biggest commercialization challenges, so it's going to be one of the biggest focuses for hydrogen fuel research and innovation. It's already been a huge topic of research for the past decade and will likely continue to be one going forward. But the fuel cell is really what drives the efficiency of hydrogen as a source of energy. After the hydrogen is stored and transported, it gets passed into a fuel cell, to transfer its energy.

The fuel cell is basically working as a catalyst that'll separate the protons and the electrons. With hydrogen, the protons can pass through a selective permeable membrane, and the electrons can't pass. Instead, they get forced through a circuit, creating an electric current. When the electrons and protons reconvene on the other side of the circuit, they re-form into hydrogen. Oxygen is then introduced, and the hydrogen combines with the oxygen in the air to form water. The harmless and environmentally friendly waste product of a fuel cell is water.

Source: “Game Changer: How Green Hydrogen Could Fuel Our Future”, Merrill Analysis. https://www.ml.com/articles/green-hydrogen-climate-change.html

ETF.com: How is hydrogen-based energy used? Why should investors care about it?
Jablonski: The use cases for hydrogen are everything from power generation and distribution across time periods and geographies where there is a shortfall, to industrial fuel, feedstock for industry and transportation fuel, heating, aerospace and shipping. With transportation specifically, we are talking about fuel cell-operated cars. That's pretty much how it's being used now.

The technology, the economics and the political environment, are all basically in favor of hydrogen as a fuel source. The technology is working to make it cheaper to create hydrogen;, that'll make it more commercially viable. If the challenge of safe and effective storage is resolved, as that becomes more efficient, that'll create some economies of scale.

Finally, the political will for this is huge. Particularly with the election of President Biden, there's such a global focus right now on reducing the carbon footprint. It's on the minds of every country in the EU. It's certainly on the minds of citizens and leaders of the US. The level of government investment commitment will be huge, which will be critical in terms of moving things forward. The US Department of Energy’s funding for hydrogen has ranged from $100 million to $280 million per year. For Japan, it's around $560 million. In China it's $17 billion until 2023. For Germany, it’s $110 million. There are big investments moving into this space, in terms of helping develop and support the growth of hydrogen and the hydrogen industry.

ETF.com: Is HDRO going to be an opportunity for investors to get in at the ground floor of an alternative energy resource that hasn't really been exploited that much?
Jablonski: What's great about the ETF is that investors will get access to global equities that generate at least half of their revenue from their involvement in hydrogen-based energy resources, fuel technologies, fuel cell technologies and industrial gases. So HDRO allows investors to express a view on—it'll be what I would consider the next generation sector of energy. It's what energy is going to look like 10 years from now. You're going to get exposure to the full spectrum of the hydrogen economy. And, if Bank of America’s estimates are correct, you're hopefully going to get the exposure to that growth of $150 billion to $11 trillion of investment.

It's a real opportunity to get targeted access to the hydrogen economy, which includes companies that I don't think most investors have heard of either. Take Plug Power, Bloom Energy, FuelCell—these are companies that have power plants, local hydrogen production, onsite power generation, the cleanest and most efficient onsite electrical power stations in the world. HDRO includes all of the companies that will support the ultimate infrastructure and build-out of this alternative energy source.

Source: “Roadmap to a US hydrogen Economy,” Fuel Cell & Hydrogen Energy Association, 2020, p.17. https://static1.squarespace.com/static/53ab1feee4b0bef0179a1563/t/5e7ca9d6c8fb3629d399fe0c
/1585228263363/Road+Map+to+a+US+Hydrogen+Economy+Full+Report.pdf

ETF.com:   Can you tell me more about those largest companies in the fund?
Jablonski:   Plug Power develops hydrogen and fuel cell technology. Some of their customers include NASA, Amazon, Home Depot, Boeing, Walmart, BMW. You have Bloom Energy, and they do onsite electric power solutions. They’re considered to be one of the cleanest and most efficient onsite electric power stations in the world. You have FuelCell, which provides local hydrogen production, onsite generation, and then storage. You have ITM, which has seven hydrogen refueling stations already in the UK. And they're aiming to reach 100 within the next couple of years.

ETF.com: What is future development likely to look like for the hydrogen energy space?
Jablonski: Whenever you have a new technology, scaling that technology up has its challenges. But if you look at hydrogen, the stars are aligning for it. It's been around for a really long time, but now it's at the point where there's a falling cost of electrolysis. It's cheaper than ever before to produce green hydrogen, and it's estimated to become more and more cost-efficient. You have all of these technological efficiencies and developments that make it more usable and applicable to the various industries that it's going to be a source of energy for.

Source: https://www.cas.org/blog/hydrogen-fuels-research

And then, again, you have the global focus on it. Political will to create the financial incentives and backing to support the rollout. All of the factors that go into this investment are lining up really well. It's just something that the planet needs to move forward with. It’s something that large corporations and governments will invest in. And that creates an opportunity for investors.

We're going to see cheaper electrolysis costs, lower production costs and declining renewable energy prices . Further, the mandates for carbon footprint reduction are going to be really strict. There simply has to be some overall investment in this space, due to the demand that will be created by complying with those requirements.

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Investing involves risk. Principal loss is possible. As an ETF, the fund may trade at a premium or discount to NAV. Shares of any ETF are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. The Fund is not actively managed and would not sell a security due to current or projected under performance unless that security is removed from the Index or is required upon a reconstitution of the Index. A portfolio concentrated in a single industry or country, may be subject to a higher degree of risk. Specifically, the Index (and as a result, the Fund) is expected to be concentrated in hydrogen and fuel cell companies. Such companies may depend largely on the availability of hydrogen gas, certain third-party key suppliers for components in their products, and a small number of customers for a significant portion of their business. The Fund is considered to be non-diversified, so it may invest more of its assets in the securities of a single issuer or a smaller number of issuers. Investments in foreign securities involve certain risks including risk of loss due to foreign currency fluctuations or to political or economic instability. This risk is magnified in emerging markets. Small and mid-cap companies are subject to greater and more unpredictable price changes than securities of large-cap companies.