Fuel cells have been one of the hottest investments on the market in 2014, but there's debate about what the future of fuel cells looks like. Will small emerging companies like Plug Power (NASDAQ:PLUG) and Ballard Power Systems (NASDAQ:BLDP) be able to grow adoption in forklifts and small vehicles? Will big automakers like Honda and and Hyundai continue to invest in fuel cells for the masses? Will FuelCell Energy (NASDAQ:FCEL) be able to grow the hydrogen backup power market? And where is all of this hydrogen going to come from?

To discuss the potential of this new market, fellow Fools Travis Hoium and Tyler Crowe debated their thoughts on the potential for fuel cells and where they think the market is headed.

Travis's take
Let's start this debate with a simple explanation of what a fuel cell is. At its core, a fuel cell is an electrochemical energy conversion device, which basically means it uses a chemical reaction to convert hydrogen and oxygen into water. This reaction gives off an electron, or electricity.

This reaction is similar to a battery but instead of the system being contained and the battery running out of chemicals when it goes dead, a fuel cell can constantly be refueled and producing electricity. The system is also cleaner and more efficient than a combustion engine, which is why companies are exploring fuel cells for automobiles.

But before we go out and call fuel cells the future, there are some other factors to consider. First, hydrogen needs to be manufactured somehow and a vast majority of hydrogen is produced from natural gas, making it susceptible to price swings as well as giving off greenhouse gasses. The electricity from a fuel cell also needs to be stored somewhere, which usually means that a fuel cell vehicle has a large battery as well as a fuel cell.

So, where are fuel cells competitive today? I'll focus on one of the biggest market where fuel cells are gaining traction: Forklifts, highlighted by Plug Power's 1,738 unit sale to Wal-Mart earlier this year. Wal-Mart's distribution centers currently use standard battery-powered forklifts, and the conversion to fuel cells and hydrogen means the elimination of battery change outs as well as the battery charging room. Typically, in factories or distribution centers, the battery is physically changed out for a freshly charged one since forklifts run 24/7. Hydrogen just requires a fill up, just like a car.  

There are a few other natural markets for fuel cells, like airport vehicles, or really any small vehicle network that's used constantly in a relatively small space. Once you leave those parameters, the fuel cell market starts to face challenges.

If fuel cells were going to grow beyond contained vehicle systems, we would have to assume a huge increase in infrastructure spending, which is only profitable if the vehicles who demand the fuel are on the road. It's a chicken and egg conundrum that faces challenges, particularly from electric vehicles.

The problem Honda, Hyundai, and Toyota will face versus electric vehicles is the ease of charging. A charger can be installed for less than $1,000 in your home, and there are tens of thousands of public charging points versus a grand total of five in the U.S. as of March 27, 2012.

Hydrogen Station Map

The hydrogen station map of the United states is sparse to say the least. Source: U.S. Energy Information Administration.

To think that hydrogen will leapfrog electric vehicles for consumers, you would have to assume that battery technology won't improve beyond a limit of a 250-300 mile range. I'm not betting against that range jumping to 500 miles or more in the next five years and charging times falling. If that happens, fuel cells have no chance to compete in consumer vehicles because they'll be more complex (remember, they have a battery, too), more costly to run, and have less accessible infrastructure.

So, how big is the potential market for Plug Power, Ballard Power Systems, and FuelCell Energy? I think it will be contained to vehicles like forklifts and airport vehicles, which severely constricts the market opportunity. Depending on the year, 800,000 to 1 million lift trucks are sold around the world, and if fuel cells could capture 10% of that market, it would be a huge win.

Fuel cells have the potential to grow from a small base, but the upside potential is in the tens of thousands of units annually, not the millions, in my opinion.

Tyler's take
I think it's difficult to call this a debate, because I generally agree with just about everything Travis is saying about the market for hydrogen powered fuel cells. I think the aspect missing from this debate so far, though, is the other addressable markets out there for fuel cells that both Ballard and FuelCell Energy are looking to capture: backup and emergency power, and combined heat and power.

Unlike the fuel cells used in Plug Power's systems, both Ballard and FuelCell manufacture cells that do not require fueling from hydrogen gas. Instead, they convert methane gas into hydrogen gas without combustion. There are some ancillary benefits to this tech, such as being hydrogen fueling stations, but more importantly is that they can consume a fuel that has a much more robust infrastructure: natural gas. FuelCell Energy operates exclusively in this sector with no hydrogen gas fueled cells, and Ballard has both the hydrogen gas based and methane based cells.

In fact, methane based cells have a much larger addressable market than the materials handling market today. To get a clearer picture of this, let's look at Plug Power and Ballard Power Systems. Plug Power is by far the leader in developing fuel cell systems for the materials handling market, but for the past several years, Plug Power hasn't manufactured fuel cells. Rather, they build the system that makes a fuel cell stack compatible with forklifts to replace the existing batteries, and have had an exclusive supplier agreement with Ballard to manufacture the actual fuel cells. So, every sale Plug Power has made, it's a sale for Ballard as well. But, the fuel cells Ballard supplies to Plug represented only 10.6% of Ballard's total sales in 2013.

The reason Ballard has limited interest and FuelCell is completely avoiding the materials handling market is because it is so small. Ballard openly admits that the entire North American materials handling market is less than 1/5 of the backup power market for just the telecom industry alone. With combined heat and power, fuel cells could capture a market around $10-$12 billion.

Then again, this market isn't without its challenges, either. Even forgetting for a moment that Ballard's proton exchange membrane fuel cells require platinum & palladium -- two of the most rare and expensive elements on the planet -- these fuel cells need to basically compete with any other stationary power system that can run on natural gas. Today, fuel cells cost at least 20% more on a per kilowatt installed basis than other options such as natural gas turbines.

That is the rub with fuel cell companies. Aside from having the word "fuel cell" in the business description, all three have very little in common. The market Plug Power wants to capture with material handling and potentially some fleet based vehicles is the smallest one, which is fine because it's a pretty small company and has room to grow. The other markets that both Ballard and FuelCell are looking at, though, could be pretty big.

Travis's rebuttal
There's no doubt the potential addressable market for backup power is huge, but as Tyler alluded to, it faces similar challenges to more widespread vehicle adoption. The first challenge is that fuel cells are really just a different way to turn natural gas into energy. If there's no cost advantage, why would a large percentage of industrial sites that need backup choose fuel cells over natural gas turbine backup?

The greater challenge long term is that new technology that will provide cleaner, lower cost, and more reliable backup in the future. Solar energy providers are already testing battery backup systems, powered by solar energy, and the cost for both solar installations and batteries are falling rapidly. For something like the telecom industry, solar with battery storage is a great alternative backup source and can even provide energy when batteries are fully charged.

Bottom line, if FuelCell Energy and Ballard Power Systems can't make money today, how will they make money as alternative energy sources rapidly cut costs and prove to be better alternatives? I hear a lot of words like "potential" when discussing fuel cells, but that's all investors are buying in these stocks today. It'll have a place in niche markets like materials handling, but when we start talking about billion-dollar markets, I have one thought: prove it.

Tyler's rebuttal and conclusion
I'm not completely sold on the idea that any of these companies will actually be able to capture all of this potential market, or even a large fraction of it, either. This is quite possibly one of the most challenging times for new energy concepts to enter the market. Between natural gas being relatively cheap and the cost for wind and solar on a steady decline, the path forward for fuel cells will certainly be a challenging one.

The most critical thing I'm going to be watching for companies like FuelCell Energy and Ballard is cost per kilowatt installed metric. As long as that installation cost premium is there, I can't see fuel cells making lots of headways beyond 2016, when the 30% fuel cell tax credit expires. To be fair to these companies, though, the price per kW installed is 75% less than what it was 10 years ago.

Overall, I guess you could say I'm rather ambivalent to their prospects. I'm not ready to write them off yet because the technology is still developing and costs are coming down, but I do want to see some more tangible results before considering fuel cells as a viable option for our energy needs.
