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"Freedom Fuel"�that's President Bush's hook for a $1.2 billion plan to
produce cars that run on fuel cells powered by the world's most
abundant element�hydrogen.

Don't turn in your gas-guzzler just yet, though. Fuel-cell vehicles
are at least a decade away, according to experts, and long before then
we'll see the proliferation of hybrid cars that run on small gas
engines aided by electric motors.

The hybrids are coming

After the successful debut of Toyota Motor's (TM) Prius and Honda
Motor's (HMC) hybrid-powered Civic, a wide range of automakers is set
to roll out cars that run on gas engines assisted by electric motors.
Ford (F), DaimlerChrysler (DCX), and General Motors (GM) will all have
hybrid vehicles on the market in the next 24 months. Right now, there
are 50,000 hybrids on the road, and industry watchers think that
figure may rise to 500,000 three years from now.

As companies refine their hybrid technologies, they'll get a better
sense of what challenges lie ahead for the fuel-cell cars of the
future. General Motors' game plan is typical: The company announced
that it expects to introduce as many as twelve hybrid vehicles through
2007, a move that will "take it along the path to mass-market
fuel-cell introductions by 2010," notes Salomon Smith Barney's David
Smith.

Hybrid cars are a long-touted first step in the drive toward energy
independence. The electric motors help the car to accelerate and can
power such systems as braking, steering, and air conditioning�all of
which enables automakers to build smaller, more efficient gas engines.

To handle the change, automakers are ditching the traditional 12-volt
electrical systems in favor of a more robust, 42-volt system. And
analysts think automakers will adopt a range of new technologies that
can yield improvements in efficiency and power. This transition should
benefit auto-parts makers such as BorgWarner (BWA) and Johnson
Controls (JCI). UBS Warburg's Robert Hinchcliffe, for one, thinks
Borg-Warner is especially well-positioned. "Its product base is geared
more toward the emerging trends in the market, such as performance and
fuel economy," he recently told the Wall Street Transcript.

In the small-cap arena, investors may want to take a closer look at
UQM Technologies (UQM), which already sells "mini-hybrids" that yield
fuel-efficiency gains of up to 20 percent, according to the company's
president, Bill Rankin. UQM is also working with the U.S. Army to
build a new generation of Hummers that can run silently on electric
motors. Once parked, the vehicles' motors can serve as generators for
a small encampment. Rankin concedes, however, that the motors "are a
lot more expensive, which is why automakers aren't going in this
direction."

Fuel cells�no cost savings "until mass production kicks in"

Fuel-cell technology involves separating water into its components,
hydrogen and oxygen. The hydrogen gets burned in the motor and oxygen
comes out the tailpipe. No carbon-based fuels are needed�although some
companies are working on extracting hydrogen gas from natural gas,
which would not be a completely carbon-free energy source.

In addition to reducing the amount of carbon in our atmosphere (carbon
is thought to be behind global warning), the advent of fuel cells
would likely wean the U.S. away from imported oil, which has
far-reaching geopolitical implications. Oil is, by far, our nation's
largest import, and contributes to our chronic trade deficit.

But hydrogen-based fuel cells are still expensive to manufacture.
Toyota and Honda have built a pair of fuel-cell vehicles for testing,
at an estimated cost of $1 million apiece. And, for the moment at
least, "hydrogen is four times as expensive to produce as gasoline,"
according to Adams, Harkness' Eric Prouty.

Costs have been coming down, but it will still be awhile before
hydrogen is ready for its close-up. "We won't really get the cost
savings we need until mass production kicks in," said GM's head of
R&D, Larry Burns, to reporters at a recent Paris auto show. In
addition, the U.S. will have to retool its energy infrastructure to
handle the profound change. "We have an infrastructure developed over
the last 100 years based on fossil fuels," notes George Douglas, a
spokesman with the National Renewable Energy Laboratory. (More than
200,000 North American service stations would need to be outfitted to
supply hydrogen is just one example of what he means.)

Once the process is complete, fuel cells will be a potentially huge
market opportunity. "If fuel-cell vehicles ultimately prove to be
cost-competitive with conventional internal-combustion engines, then
they could conceivably make up more than 50 percent of the global
automotive market by 2020," predicts Morgan Stanley's Stephen
Volkmann.

Fuel-cell stocks�losses may drop in 2003 and 2004

Publicly traded companies working on fuel-cell technology have seen
their shares fall to all-time lows in recent months. Investors soured
on the sector after realizing that these companies would remain
unprofitable for the foreseeable future.

Still, the long-term future remains bright. Despite a stock that has
fallen more than 90 percent from its peak, Ballard Power (BLDP), for
example, is partnering with Ford, Honda, and DaimlerChrysler, to
commercialize the technology. When those automakers eventually produce
fuel-cell-powered cars, those cars will have Ballard Motors inside.
(Ford and DaimlerChrysler each hold a 20 percent stake in BLDP.) And
thanks to a recent cash infusion, Ballard's balance sheet is now solid
enough to support many more years of losses, until the company finally
bags a profit.

Other companies, such as Plug Power (PLUG), are looking to develop
fuel cells for stationary applications, such as powering homes or
office buildings. The company is also partnering with Honda to develop
systems that can refuel a car with hydrogen while it sits overnight in
the garage.

Danbury, Conn.-based FuelCell Energy (FCEL) is also targeting the
stationary fuel-cell market. Right now, the company is working to
provide facilities such as hospitals with its Direct Fuel Cells
(DFCs), which are "akin to very large batteries," according to
chairman Jerry Leitman.

Leitman says the company is now ramping up the size of its DFCs so
they can produce 10 megawatts of power. Leitman concedes that fuel
cells will never be as efficient as large-scale, gas-fired power
plants that can generate up to 300 megawatts of power, but he's
convinced that "we can get these cells to become very competitive
against smaller plants that generate up to 50 megawatts."

FuelCell Energy has more than $200 million in the bank, which should
be sufficient for now. The company burned $55 million in 2002, and
Leitman says that FY2002 was "the main year of product development, so
future cash-burn levels should be lower. FCEL lost $1.24 a share in
2002, but analysts are looking for its losses to start dropping in
2003 and 2004.

Investors can also play the fuel-cell trend by going with a more
established large-cap name: United Technologies (UTX). The diversified
industrial manufacturer, which makes everything from Otis Elevators to
Carrier air conditioners to Pratt & Whitney aircraft engines, is
working with Nissan Motor (NSANY) to develop fuel cells while also
pursuing initiatives with other automakers. UTX has generated nearly
$10 billion in operating cash flow over the last three years, and is
well positioned to absorb any losses associated with its
fuel-cell-development programs.

A wide range of companies is investing heavily in all facets of
vehicle technology. The market opportunities are great, but the profit
potential remains undetermined. For now, intrepid investors have an
opportunity to buy into the sector while it is selling on the cheap.

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Dave Sterman is the Director of Research of Chelsea Research and a
financial commentator for various news outlets.

SOURCE: http://tel.multexinvestor.com/IndustryFocus/Article.asp?target=%2Fstocks%2Findustryfocus%2Farticle&ForumID=64&DocID=13653&nd=0225_IND_AAC_L01

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