Hydrogen Vehicles: A Study of Strategic Loss

This article was featured on the DBJ Instablog on Seeking Alpha.

The idea behind patents makes intuitive sense. If a company spends significant resources on researching a new product, it should be granted temporary exclusive rights to its findings. This prevents rivals from stealing those results and profiting from them without paying any costs. Otherwise, the innovative firm would end up losing money for developing new technology.

Keeping this in mind, the Toyota Motor Corporation caused quite a stir when it announced this past January that it is inviting its competitors to use Toyota’s 5,680 patents on hydrogen fuel cell vehicles for free until 2020. After all, a patent is by definition protective. So what’s going on? Have the execs of the car company lost their minds? No, it turns out that Toyota’s move to share its patents is a gamble, but it’s not irrational. The challenges of hydrogen production and distribution have incentivized the company to give away its patents in order to give hydrogen vehicles the “critical mass” it needs to overcome these problems and enter the mainstream market.

Understanding hydrogen vehicles 

To understand hydrogen vehicles, one must first understand the process of electrolysis. Electrolysis is the application of a direct electric current (DC) to induce an otherwise non-spontaneous chemical reaction. For example, the electrolysis of water separates water into its component elements: hydrogen and oxygen.

Hydrogen vehicles rely on fuel cells to perform reverse electrolysis, taking in hydrogen as fuel and oxygen from the surrounding air to produce electricity. They also produce as exhaust water vapor (pure enough to drink), meaning hydrogen vehicles emit no greenhouse gasses whatsoever. Compare this to the 1.8 billion tons of carbon dioxide gas most vehicles release, which the Environmental Protection Agency reports accounts for 28 percent of all greenhouse gas emissions in the United States (second only to power plants). And while a kilogram of hydrogen has the same chemical energy as a gallon of gas, fuel cells are much more efficient than combustion engines such that, functionally, a kilogram of hydrogen is equal to more than six gallons of gas.

Hydrogen vehicles even have advantages relative to hybrids and electrics. Because fuel cells are small and thin, they can be stacked for vehicles of greater size – unlike hybrids, which are restricted by their heavy and bulky batteries. Hydrogens can go farther between refuels than most electrics can between recharges: Toyota’s Mirai has a range of 300 miles, compared to 265 miles of Tesla’s Model S (by far the top range for electrics). In addition, hydrogen vehicles can be refueled in three to five minutes, whereas even the Tesla superchargers require at least 20 minutes for a full charge. Given all this, it isn’t surprising that many experts and industry leaders see hydrogen vehicles as the future of transportation.

Promising but problematic

 The process of electrolysis has been well understood since the 18th century, so why have hydrogen vehicles entered the market only now, two decades behind hybrid vehicles? For much of that time, hydrogen vehicles have been too expensive to manufacture to be of consumer interest. Hydrogen fuel cells need expensive platinum as a catalyst in order to perform reverse electrolysis fast enough for the vehicle’s operation. Furthermore, hydrogen is highly flammable and, like all gasses, expands with rising temperatures (such as those found under the hood of a moving car). Luckily, technological advances have lessened the amount of platinum required, and safe ways of containing hydrogen have been developed. According to Toyota, the cost of making key components of the vehicles has fallen 95 percent in the past seven years, allowing them to sell the Mirai at $57,000 (less than a Model S) instead of the $100,000 it projected in 2008.

But no matter the cost, a hydrogen vehicle will need hydrogen. And although it is true that hydrogen is the most abundant element on the planet, the overwhelming majority of it is free in the atmosphere. Therefore, hydrogen must be derived from other substances.

The two main ways of producing hydrogen are electrolysis of water and a process called steam reformation, in which natural gas is reacted with high-temperature steam to separate out the hydrogen from the hydrocarbons in the gas. For obvious reasons electrolysis can be ruled out, leaving steam reformation. But since natural gas is a fossil fuel, and the point of hydrogen vehicles is to reduce dependence on fossil fuels and their consequences, steam reformation isn’t preferable either.

And even if this challenge was overcome, there exist little infrastructure for delivering that hydrogen. Gas stations are of course everywhere and the number of charging stations for hybrids and pure electrics continue to increase, but there are virtually no hydrogen fueling stations. As of when this article was writen, fewer than 70 such stations exist in the entire United States –most of which are in California, where the Mirai will begin to sell later this year. Clearly, having a hydrogen car is one thing, but being able to drive it is another.

“Critical mass” solutions

Fortunately, there is work being done on both of these problems. On the hydrogen production front, new technologies such as fermentation, photobiological water splitting, and renewable liquid reforming are being developed. A hydrogen fueling station in Fountain Valley, a suburb of Los Angeles, has already employed one of the newest techniques. The station uses human waste from a nearby wastewater plant as its hydrogen source by adding bacteria to turn waste into carbon dioxide and methane, which is then converted to electricity, heat, and hydrogen.

More recently, scientists at the University of Glasgow published a paper in Science this past September explaining how they created a method based on the electrolysis of water, which produces hydrogen 30 times faster than the current best processes. This method needs much lower currents than traditional electrolysis, making it possible for renewable energy to power the method and thus making the use of hydrogen vehicles completely emission-free. But while these results are promising, they will require a significant amount of capital for further research and implementation testing before they can be commercialized.

As for hydrogen delivery infrastructure, California has invested $200 million to build 100 hydrogen fueling stations, and is willing to invest more in stations if successful. Toyota has also loaned $7.3 million to FirstElement Fuels, Inc., to build 19 stations in California. The company is also working with Air Liquide S.A. to build 12 more stations in New York, New Jersey, Massachusetts, Connecticut, and Rhode Island, where it will begin selling the Mirai next year. Though these prices sound high, they are actually cost-competitive with gas stations on a cost-per-mile basis, since fewer are needed due to the higher efficiency and thus greater range of hydrogen vehicles. As long as the state or private companies are willing to invest in building these stations, the country could conceivably go hydrogen.

But the key words here are “as long as”. If hydrogen vehicles remain a fringe technology, it risks being pushed out of the alternative niche by hybrids and pure electrics, which already have established infrastructures. Furthermore, hybrids and pure electrics lack the problem of energy source production, so they are already favored and more likely to be further developed. Simply put, if hydrogen vehicles don’t gain significant awareness soon, they will be outcompeted by their alternative bedfellows.

This problem explains Toyota’s actions. Although a major player in the auto industry, Toyota understands that its bid in hydrogen vehicles alone is not large enough to draw the critical degree of attention needed. By giving free access to its patents, Toyota effectively lowers other companies’ entry costs by paying for their research in hopes of interesting more automakers, cell part suppliers, and energy companies to enter the market. This would in turn increase the volume of hydrogen vehicles and related support, which could push hydrogens into the spotlight and attract investors and capital to solve the production and infrastructure challenges discussed above. At or near that point, which Toyota judges to be in five years according to the duration of its offer, Toyota will close off access to its patents and begin focusing on its own research and business. Essentially, Toyota believes that the cost of bringing hydrogen vehicles into the spotlight is more than its profits if hydrogens does not become mainstream.

This isn’t the first time Toyota has employed such a strategy. In 1997, Toyota licensed its patents for hybrid technology to Ford, Nissan, and others, who paid for that access. As Toyota hopes will happen again with hydrogen vehicles, this move increased the volume of hybrid activities and steered significant attention. And sure enough, when hybrids entered the mainstream market in the late 2000s and early 2010s, the Toyota sold nearly a quarter million Prius a year, making the Prius the world’s third best-selling car make in 2012. Toyota is hoping for a repeat performance with hydrogens.

Right now, hydrogen vehicles are starting out small. Toyota plans to sell 700 Mirais this year. Hyundai, which is preparing to sell its Tucson, plans to sell just 60, and Honda just entered its final marketing stages. Meanwhile, General Motors, Ford, and Audi are all in the development stage on their own hydrogen vehicles. As Toyota expands the Mirai market to the five states listed above next year and the other automakers make their own market entrances and extensions, time will tell whether Toyota will succeed in pushing hydrogens into the mainstream market with its strategic loss plan.