Ballard Power Systems BLDP S W
April 20, 2006 - 1:29pm EST by
2006 2007
Price: 10.46 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,180 P/FCF
Net Debt (in $M): 0 EBIT 0 0
Borrow Cost: NA

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This is a short sale recommendation. I previously recommended this as a short on September 29, 2003 at a price of $13.64. It subsequently dropped to $3.40 by May 2005. Recently BLDP has rallied strongly, since it is viewed as a leading alternative energy play, a field once again in vogue because of the rising oil prices. BLDP is nothing more than a “play”. I believe it will never actually make any money from alternative energy; its technology, PEM fuel cells primarily aimed at automotive applications, is doomed to failure for at least the next couple decades by the necessity to overcome some very basic laws of physics and economics.

Some of this report will be summarized or plagiarized from my previous one. Why not? Nothing fundamental has happened in two and a half years. Yes, there is new management since then, and there has been considerable reshuffling of BLDP’s joint ventures with various car makers. But much more important is what remains the same: the hydrogen atoms of the world, the ones that have to be persuaded to more easily release their bonds with oxygen or carbon so they can be fed into BLDP’s fuel cells much less expensively, really don’t care who runs BLDP or what its contracts are; they are holding on as tight as ever.

Hydrogen is the problem—creating it, storing it, and transporting it. Once H2 gets into a fuel cell, it efficiently combines with oxygen to produce water plus electricity, and the electricity can power a car or be used in the grid. “Hydrogen economy” advocates like to brag about this efficiency, and how the reaction in the fuel cell is pollution free, but rarely mention how massively inefficient and dirty it is to create the H2 in the first place. The cheapest way to make H2 is to start with natural gas (a non-renewable hydrocarbon) and put it through a energy intensive process called high temperature steam reforming. This process insures that H2 always is many times more expensive per unit of energy it contains than gasoline, natural gas, or any other conventional fuel. In fact, the rise in energy prices that is fueling the boom in BLDP’s stock, is actually making hydrogen even more expensive relative to conventional fuels. And let’s not forget that H2 must be pressurized or liquefied for transport to its site of use, both of which processes are, guess what?, quite energy intensive, which further adds to the cost of H2.

Perhaps some day solar energy might efficiently split water to get H2, but it would take
major breakthroughs in photovoltaics just to bring the cost of H2 produced that way
down to that of conventionally produced H2. And if solar energy advanced so dramatically, that would vastly reduce the need for fuel cells, since this would solve the main problem with battery powered cars, which are much cheaper and simpler, and don’t require carrying around a pressurized H2 tank ready to explode on any crash bigger than a fender bender.

With H2 produced as it is presently, the US would need to double its electrical generating capacity to produce enough energy to manufacture enough H2 to power fuel cell cars, were they to completely replace gasoline powered ones. Who would make that investment? What would the extra demand for fuel to run those power plants, and demand for natural gas to turn into H2, do to the price of energy? Moreover, making the H2, and making the electricity needed to make the H2, would actually increase air pollution and greenhouse gases on a national basis, although reduce it in few car intensive urban areas.

The inherent high cost of H2 is a serious problem, but so is the necessity of someone investing billions in a retail H2 infrastructure. This is a classic chicken and egg problem: No one is going to buy a car unless it can be refilled anywhere they might drive, and no one (outside of a spendthrift government) is going to invest in H2 filling stations unless there are a lot of fuel cell cars around as potential customers. H2 service stations won’t come cheap. H2 must be kept in high pressure tanks, or kept very cold in liquid form, and will need special dispensers to move the H2 into high pressure tanks within the cars.

Besides the cost and availability of H2, fuel cell powered cars as presently designed, even were they mass produced, are still many more times expensive (most estimates—at least ten times) than they need be, to be competitive with conventional cars. There are serious technical hurdles to overcome, most of which are potential showstoppers. Freezing temperatures could destroy a PEM fuel cell, or at best require a lengthy warm up period before the car will operate. Conventional H2 storage at 3600 psi will barely get a car 125 miles before requiring refueling; 10,000 psi will require a lengthy refueling process, and turn the car into a bomb. The necessary platinum catalysts, already expensive and even more so if PEM fuel cells become widespread, get poisoned easily. Durability of the fuel cell stack is substandard. The balance of plant is complicated and costly, etc.

Even if all these problems get solved, it will still require production in the hundreds of thousands annually for the unit costs to decline enough to compare to conventional vehicles. Even if that happens, it doesn’t mean that BLDP would have anything close to a monopoly of automotive fuel cells. BLDP has been backed by Daimler and Ford, but General Motors has been working on its own, as has Toyota. A division of United Technologies has been working with Nissan and Hyundai. Every PEM fuel cell developer claims a raft of patents, but it appears there are plenty of “work arounds” that prevent any from getting a big edge.

When all is said and done, a fuel cell used in a car is just another auto part, and will garner the usual tiny margins typical in that field. If anything, margins might be well below average for years after any successful commercial fuel cell car introduction, since it will be such a struggle for them to be price competitive with conventional cars. And the designers of conventional car engines and hybrids are not sitting around doing nothing waiting for fuel cell technology to catch up.

All this stuff is pretty clear, yet Daimler and Ford have invested a lot of money in BLDP and own 30% of it. With every hike in oil prices, intelligent people regularly call for a US “Manhattan Project” to convert the country to a hydrogen economy. Why?
My guess: the usual mix of wishful thinking, ignorance, hypocrisy and corruption. People desperately want to believe that there is a technology solution to our energy and environmental problems. They look at the promised clean and efficient performance of a fuel cell car, and forget to count the massive energy consumption and pollution involved in making and delivering the fuel. The car companies and the government both want the public to keep buying lots of high margin, low mileage SUVs, and their ballyhooed work on fuel cell cars serve to keep consumers from feeling guilty about doing so. In the case of Ford and Daimler, investing money directly in Ballard lets them get the publicity advantage of working on fuel cells, while diverting the R&D expense into an asset, and away from their own income statements. At some point, when they write off their investment in Ballard, the loss will be considered non-recurring, and ignored.
Will there be no market for fuel cell vehicles? No, there are potential applications that might make economic sense some day. For example, buses, delivery vans, and other vehicles. They operate daytime in cities, where smog is a big issue, and return to one central H2 depot which could refuel them over night. But there are only about 5000 buses sold per year in North America. And even if you started replacing local delivery vehicles owned by big organizations, such as the post office, that can be browbeaten into paying multiples of the normal price to get fuel cell powered ones, the market might expand to 50,000 per year, as a guess. That isn’t nearly enough to get the economies of scale that fuel cell vehicles would need to get the costs down to anything close to what would make sense to a non-coerced buyer.

Then there are stationary power applications, but the PEM type of fuel cell in which BLDP specializes is the wrong kind for that. Molten carbonate and solid oxide fuel cells, which run at much higher temperatures, letting them use standard pipeline natural gas as fuel without any expensive reforming to extract the hydrogen first, are much better than PEM for that. Their efficiencies are much higher than PEM, and they produce useful waste heat. BLDP has a project going with Ebara in Japan for this application, but it is doomed, IMO. So far FuelCell Energy (FCEL), the dominant maker of the higher temperature fuel cells, has seen very few orders, and its technology is vastly better than the PEM fuel cells that BLDP makes.

Given all this, the company’s market cap of US$1.2B is absurd. Its EV is “only” $935M because it has $233M in the bank, but it is blowing through that at about $15-20M per quarter. So BLDP won’t be running out of cash any time soon. What it will run out of, though, at some point, is credibility. The car companies will continue to give lip service to the glorious fuel cell car future, and will gladly take any handouts from the government to pay for R&D. But it will be increasingly obvious from their actions that their real bets are elsewhere. Hybrids already can achieve a large part of what one ultimately wants from a fuel cell car, and will be getting much better. At some point its car company partners will end the charade and BLDP will go to low single digits, where it belongs, awaiting its final demise.


Short term: investors reading this report? (just kidding.) Any pullback in oil prices should pull the rug out from under this latest fuel cell stock mini-bubble.
Long term: BLDP's technology will never be economically viable (see report).
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