At risk of overkill, I’m having a second look in a month at HydrogenOne Capital Growth (HGEN ) after the investment trust’s day with analysts and investors in the City last week.

This saw presentations from each of the 10 unlisted companies that are the core of the fund, accounting for 83% of net assets at the end of December. The relatively small (3%) listed portfolio is just a way of parking liquidity ahead of it being deployed into unlisted investments.

Any scepticism over my repeat visit reflects its small size with a £93m market value following poor share price performance that has seen the stock tumble to 72p from £1 at launch in July 2021, with no dividend declared and amid a collapse in the share prices of green hydrogen providers such as ITM Power (ITM). More than once over the course of the presentations, the word ‘bubble’ was used to describe the hydrogen sector, and it seems clear that the bubble has burst.

To be fair, this is a sector that attracts more than its fair share of hype. The numbers bandied around for the potential addressable market over the next few decades run into the high billions/trillions depending on who you talk to. Yet, across HGEN’s 10 unlisted stocks, which were valued at £104m at end December 2022, aggregate revenue for 2022 was about £30m and none of the companies is profitable. However, I am increasingly convinced that there is real substance to what it owns.

Within the constraints of its 10-stock portfolio, HGEN has a broad spread of exposure to the sector. My last article discussed its investments in two hydrogen production companies – HH2E (and its Thierbach plant) and Gen2Energy. In the Q&A session that followed presentations from these two companies, it became clear that there are two major constraints to their future growth. First, is the availability of capital. Second, is the supply of key components, especially electrolysers.

One way of solving the capital shortage and accelerating the transition to green hydrogen is the provision of state support for investment. Around the globe, governments recognise that the production of grey hydrogen, which produces carbon dioxide, must be phased out and that green hydrogen offers a way of decarbonising industry and heavy transport (trucks, ships, and aircraft) – creating substantial additional demand. In the US, the Inflation Reduction Act provides significant support for the development of a domestic green hydrogen industry with production tax credits of up to $3 per kg of hydrogen.

The EU recognises that it must respond to this. Its Repower EU initiative last year acknowledged the importance of promoting hydrogen development as part of the solution to its goal of independence from Russian fossil fuels well before 2030.

Talking to Jean-Hugues de Lamaze, manager of Ecofin Global Utilities and Infrastructure (EGL ), he thinks the EU will press ahead with the implementation of its own version of the Inflation Reduction Act, the Green Deal Industrial Plan. He thinks that the support structure for the renewables industry, including hydrogen, will resemble the US. He also acknowledges that the hydrogen sector, while relatively small now, will play an increasingly important role.

The UK may be lagging in its support for the sector, not helped by a revolving door at the top levels of government, and then fragmentation of the Department for Business Energy and Industrial Strategy, but this does not much matter for HGEN whose UK-based investments are addressing global rather than domestic markets.

The manufacturers of electrolysers stress that the cost of production will fall as they achieve scale. Their concern is that the EU fails to support the development of the sector before it goes the way of solar photovoltaics, where currently production is dominated by China, although Jean-Hugues suggests the US has ambitions to wrest back leadership.

In the electrolyser/fuel cell space, HGEN has investments in Germany’s Sunfire and Estonia’s Elcogen. Both acknowledged the shortage of production capacity across the sector, but this means they are comfortable there is demand for their product. Sunfire will soon be able to produce alkaline electrolysers in decent volumes, but longer term wants to do the same with solid oxide electrolysers which are more efficient. Elcogen is already focused on a solid oxide solution and has around 160 customers.

HGEN is also invested in Bramble Energy based in Crawley, which is using a printed circuit board approach to producing fuel cells, and HiiROC, which can make hydrogen from hydrocarbons without producing carbon dioxide, as well as producing carbon black (which has all sorts of useful applications) as a by-product. ITM Power, which HGEN has a small exposure to within its listed holdings, uses another technology – proton exchange membrane or PEM.

These various approaches to producing hydrogen are competing against each other and it seems likely that not all of them will succeed. Customers HH2E and Gen2Energy are sticking with proven alkaline technology for the moment.

HiiROC’s technology has some different applications – the company in Hull is partnering with large industrial companies to develop these. One attractive application is to produce hydrogen from biomethane, which has the effect of sequestering carbon dioxide from the atmosphere.

Like most growth capital investors, HGEN does not need every investment to work. Those that do should more than make up for those that do not. It also stresses that it does not need the flotation market to reopen to achieve exits. It thinks that trade buyers, many of which are already big players in the grey hydrogen market, will provide the most likely source of the fund’s first exits and some may not even wait for companies to become profitable before making their move.

It feels to me as though, after years of false starts and disappointments, the hydrogen sector is on the verge of taking off. The catalyst is probably the new subsidy regimes in the US and EU. That £30m of revenue for HGEN’s unlisted portfolio was up 110% on the previous year. Within a couple of years investors may be flocking back. However, as in other emerging growth sectors, some of the best opportunities may be in the unlisted market. HGEN offers the only route to accessing these.

James Carthew is a co-founder and head of investment companies research at QuotedData. Any opinions expressed by Citywire, its staff or columnists do not constitute a personal recommendation to you to buy, sell, underwrite or subscribe for any particular investment and should not be relied upon when making (or refraining from making) any investment decisions. In particular, the information and opinions provided by Citywire do not take into account people’s personal circumstances, objectives and attitudes towards risk.