Missing in the Hydrogen Economy Pitch: The Tax Credit Cliff for Fuel Cells

Investors dreaming of a hydrogen economy should circle a date on their calendars: December 31, 2021. This date connects the existing fuel-cell businesses of Bloom Energy (BE -1.93%) and Plug Power (PLUG -6.95%) to each company's ambitious plan to become a large-scale manufacturer of hydrogen fuels.

How so? In the United States, the investment tax credit (ITC) for fuel-cell systems abruptly phases out on the last day of 2021. That means Bloom Energy and Plug Power need to both drive down the costs of existing fuel-cell products and seek new growth opportunities by 2022.

However, there's an unappreciated risk of financial disaster if the ITC isn't extended and the hydrogen economy fails to materialize, as expected. It's more likely than investors or Wall Street analysts seem to think.

Image source: Getty Images.

How does the ITC apply to fuel cells?

The ITC provides a financial incentive for companies to utilize cleaner energy systems, including small-scale solar arrays and fuel cells. It also phases out in a predictable manner to incentivize the manufacturers of clean-energy technologies to increase operating efficiency and drive down costs. 

Specifically relating to fuel-cell systems, adopters can claim the lesser of $3,000 per kilowatt of the purchased system or a percentage of the overall system cost. The ITC can be claimed for five years after a system enters service and extends to both stationary energy systems (such as the primary product offering of Bloom Energy) and mobile energy systems (such as the GenDrive forklift offerings central to Plug Power). 

The current ITC legislation outlines when construction of a fuel-cell system must begin to claim each level of incentive. Regardless of when construction begins, all systems must be placed in service by the end of 2023 to be eligible for the corresponding tax credit.

Data source: Internal Revenue Service.

What happens when the ITC phases out?

Right before the ITC phases out, investors can expect customers of Bloom Energy and Plug Power to increase purchases of fuel cells to reap the financial incentives. Identical trends have been observed in wind, solar, solar microinverter, and other industries affected by tax credits. That should support revenue growth for fuel-cell manufacturers through 2021.

A few scenarios are possible after that, although each involves a reduction in selling prices to offset the loss of tax credits available to customers. Consider the disastrous consequences faced by the fuel-cell industry the last time the ITC lapsed in 2017. Bloom Energy was forced to postpone its plans for an initial public offering (IPO) and reduce the selling prices of its fuel-cell products. 

Since many customers monetized the value of the tax credit upfront, which was 30% of the system cost in 2016 (the most recent ITC level at the time), the company had to reduce selling prices by more than 30% in 2017 to make up the difference. Full-year 2017 billings for accepted product decreased 52.5% compared to the previous year.

To be fair, Bloom Energy has made considerable progress reducing manufacturing costs since 2017 and should continue to do so through 2021. But the phase-out of the ITC is likely to reduce selling prices once again, resulting at the very least in a significant reduction in gross margin for product revenue. That's a risky position for a business on pace to generate a full-year 2020 operating loss of at least $150 million.

Image source: Getty Images.

Can hydrogen operations offset the ITC phaseout?

It appears Bloom Energy and Plug Power are each professing their hydrogen ambitions at least in part to offset the negative effects of the ITC phase out. There are a couple of holes in that logic. 

First, there are major technical and economic obstacles facing the emergence of a hydrogen economy. Fuel cells might be efficient at the point of use, but it's not very efficient to manufacture, distribute, and store hydrogen fuels. What's more, it's difficult to see hydrogen fuels and fuel cells competing with renewable electricity and next-generation batteries by the end of the 2020s. They're not competitive now.

Second, if the phaseout of the ITC results in a reduction in fuel-cell product revenue beginning in 2022, then that needs to be factored into growth projections. For example, Plug Power's current five-year plan expects $1.2 billion in total revenue in 2024. Does that remain realistic if Amazon and Walmart significantly reduce purchases of fuel-cell-powered forklifts when tax credits dry up?

Imagine a worst-case scenario: the ITC phases out on the last day of 2021, fuel-cell product revenue and gross margins decline significantly beginning in 2022, the hydrogen economy fails to materialize as projected, and the slow-and-steady improvements of batteries prove insurmountable. Individual investors simply can't overlook these risks.

Image source: Getty Images.

Are there any silver linings?

The ITC for fuel cells could be extended, or new legislation supporting the use of hydrogen fuels could become law. Some states already have incentives in place, although they extend to technologies competing with fuel cells, too.

An extension or amendment of the ITC could provide a lifeline and buy more time to drive fuel-cell product costs lower. For example, solar power enjoys an ITC of 10% in perpetuity, never dropping to zero. Could fuel cells be granted the same favorable status? It wouldn't necessarily guarantee hydrogen-powered fuel cells will mature into a dominant market technology and effectively compete with battery-based energy storage or transportation, but it could keep customers invested in the technology platforms of Bloom Energy and Plug Power -- for a little while longer, anyway.

Simply put, investors must resist giving into the technological hype driving up the prices of fuel-cell stocks in 2020 and objectively assess the near-term challenges and opportunities. A lack of tangible accomplishments in manufacturing hydrogen fuels, a history of steep financial losses in core fuel-cell product lines, and the inescapable uncertainty of the ITC cliff and proposed hydrogen economy warrant caution.