Hydrogen had a breakout year. Why are some VCs still skeptical?

Hydrogen startups are on pace to raise more VC funding in 2023 than in the prior two years combined, according to PitchBook's 2024 Industrial Technology Outlook.

Hydrogen companies headquartered in the US closed 28 deals totaling $1.4 billion between January and mid-November of this year, compared to $973.8 million raised in all of 2022.  

The industry has been propelled by a swath of federal funding that rolled out this year, from Inflation Reduction Act tax credits to the Department of Energy's $7 billion bet on hydrogen hubs.

Even as the VC dealmaking market cooled, there's been a mad rush to invest in startups working on renewable hydrogen energy development, processing and storage.

Take Electric Hydrogen, a startup building fossil-free hydrogen systems backed by Microsoft's Climate Innovation Fund, Energy Impact Partners and Fifth Wall. In July, it raised a $380 million Series C at a post-money valuation of $1.08 billion—more than doubling its $440 million Series B valuation in just 14 months. Or Koloma, a Breakthrough Energy-backed startup planning to drill natural hydrogen that emerged from stealth with $91 million in July. Investor jitters Despite the buzz, some climate VCs are holding fire on new deals. They're wary of an especially crowded market, untested commercial viability, and the risk of highly emitting hydrogen energy leaks.

"There are some who think hydrogen is a panacea. I disagree," said Victoria Beasley, partner at impact climate firm Gigascale Capital.

One of the most prominent climate-tech VCs in the game, Lowercarbon Capital, is also more hesitant to invest in hydrogen energy than its peers, the firm's operating partner Ashton Rosin told a panel at the SuperVenture North America 2023 conference.

Lowercarbon Capital is reluctant to go all-in on hydrogen in part because hydrogen energy leaks are a potent greenhouse gas when they occur, according to Rosin.

Another reason is just how nascent the green hydrogen economy is and uncertainty around future regulation. Ongoing disputes over whether projects fueled by existing nonrenewable energy sources should be eligible for hydrogen tax credits have delayed Treasury Department guidance.

"You are finding far more hesitation today [from investors] than you did at the beginning of the year," said Laureen Meroueh, founder of steel decarbonization startup Hertha Metals. M&A ahead Optimism for hydrogen has been fueled by the oil and gas industry. Gray hydrogen, which is produced in a process that uses natural gas, comprises the majority of hydrogen fuel that's on the market today. Another process, dubbed blue hydrogen, pairs gray hydrogen with carbon capture technology.

"It's an inferior-performing fuel. But that hasn't stopped the incumbent petrochemical industry from embracing it, and that should tell you something," DCVC managing partner Zachary Bogue said in a report published by the VC firm in early December.

In spite of hesitance from some investors, there's a huge amount of money being directed into the space by the US Department of Energy and oil and gas companies alike. That investment could pave the way for a flurry of strategic M&A by utility and oil and gas companies in 2024.

"Oil and gas companies are best positioned to build the infrastructure needed and some of them will need to close those [knowledge] gaps quite quickly," according to John MacDonagh, a senior emerging technology analyst at PitchBook.

Read more: 2024 Industrial Technology Outlook

Featured image by Allen J. Schaben/Getty Images

This article originally appeared on PitchBook News