For qualified institutional investors only

Japan Value Insights:
Hydrogen to help
identify hidden value
6 September 2021

Japan’s drive to embrace hydrogen as an alternative energy source is an opportunity to identify
hidden value in firms that are willing to tackle and resolve social issues.
By Shigeru Aoyagi, Japan Value Chief Portfolio Manager

Opportunities presented by firms with technologies to reduce GHG
Gone are the days when all a company had to do was increase profits for its share price to rise. Social responsibility
has become a key factor in the investment world and firms now need to link returns and growth to social issues toboost their shares. The growing importance of social responsibility presents an excellent opportunity for firms
willing to tackle and resolve social issues.
Reducing greenhouse gasses (GHG) is one such theme, and hydrogen has drawn a significant amount of attention
as a clean alternative to carbon-emitting fossil fuels. GHG reduction also represents a large market that can benefit avariety of firms. Many Japanese companies possess the technologies necessary to reduce GHG and utilise hydrogen.
However, the technologies are either still intangible and yet to be represented in data or they are only in theirexperimental stages, and any profit firms derive from such technologies have yet to be expressed as concrete
financial information.
An example of a Japanese firm with cutting edge hydrogen-related technology is Kawasaki Heavy Industries. The
company might be better known to the public as a manufacturer of industrial equipment ranging from motorcycles
to ships. But after playing a role in helping Japan become an industrial powerhouse in the 20th century, Kawasaki
Heavy has its sights set firmly on the 21st century with its emphasis on hydrogen.
Kawasaki Heavy is the only company in the world to possess core technologies related to every stage of thehydrogen supply chain. The company is capable of producing, storing and transporting the notoriously volatile fueland then using it to generate power. The company has technology few others can replicate; for example, earlier in
2021 it unveiled the world’s first tanker capable of shipping liquid hydrogen. The firm is aiming for net sales of JPY
500 billion (USD 4.5 billion) in its hydrogen segment by 2040.

Japan’s carbon neutrality goal puts hydrogen in focus
The primary reason hydrogen is in the spotlight in Japan is the government’s ambitious goal for the country toachieve carbon neutrality by 2050. Hydrogen is expected to play a key role as Japan tries to reshuffle its energy mix
and reduce its reliance on fossil fuels, especially when nuclear power is no longer a viable alternative.
As Chart 1 shows, the government’s interim goal is to achieve a 46% GHG reduction by 2030 relative to 2013 levels.
Japan emitted 1.4 billion tons of GHG in 2013 and only managed to reduce emissions to 1.21 billion tons by 2019.
The country therefore has to drastically step up its efforts if it wants to reach its interim goal.

Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in the strategy’s portfolio, nor constitute a recommendation to buy or sell.

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Japan Value Insights

2018
CO2 1.06 bln tons
(GHG 1.25 bln tons)

2019
CO2 1.03 bln tons
(GHG 1.21 bln tons)

Consumer
1.1 bln tons

Consumer
1.1 bln tons

Industry

0.3 bln ton

0.28 bln ton

Transport
0.2 bln ton

Transport
0.2 bln ton

Electricity
0.44 bln ton

Industry

Electricity
0.45 bln ton

Electricity(GHG from thegeneration ofelectricity)

Non-electricity(GHG from sources
other than thegeneration ofelectricity)

Chart 1: Japan’s roadmap towards carbon neutrality

Electrification
Consumer*Extensive promotion of energy
conservation through regulation andsubsidies* Reinforcement of steps to create ahydrogen society*Promotion of renewable energy a key
electricity source*Restructuring of nuclear energy policy*Reduction of thermal power while
keeping stable power supply*Electrification from decarbonised
sources

HydrogenIndustry*New options such as hydrogen,ammonia, CCUS/carbon recycling

Synthetic fuel,methanation

Transport*Afforestation, DACCS and BECCS
where decarbonisation is difficult

Biomass*Maximum utilisation of renewableenergy*Utilisation of nuclear power
Electricity*Utilisation of hydrogen, ammonia

Carbonremoval2050
Emission+removal=
net zero (-100%)2030
46% reduction in
GHG from 2013

CCUS (carbon capture, utilisation and storage)*Utilisation of new options such ashydrogen, ammonia, CCUS/carbon
recycling

Decarbonised
sources ofelectricity
Renewables 50-60%

Afforestation, DACCSDACCS (direct air capture with carbon storage)
BECCS (bioenergy with carbon capture and storage)

Source: Ministry of Economy, Trade and Industry data compiled by Nikko AM

Chart 2 highlights the two measures Japan will employ to reduce GHG: energy conservation and the introduction ofalternatives to fossil fuels. Energy conservation plays a critical role in the power sector’s effort to cut its carbon
emissions, and power utility companies have significantly raised public awareness towards the issue. That said, thepower sector only accounts for 36% of Japan’s CO2 emissions. To tackle the remaining 64%, the adoption ofalternatives to fossil fuel becomes imperative.
Chart 2: Measures to reduce GHG
Energyusage1) Enhancement of energy conservation

Energy from fossil fuels

2) Expanded use of energy from non-fossil sources Placing renewable energy as core power source Restructuring nuclear energy policy Reassessing thermal energy's place in the future

2013

2030

Source: Ministry of Economy, Trade and Industry data compiled by Nikko AM

Nuclear power is of course one such alternative. However, the government will likely run into opposition if it tries toexpand its usage as the 2011 accident at a nuclear power plant in Fukushima caused by a devasting earthquake andtsunami remains fresh in public memory. With few other options available—and this is a key point to remember—
Japan is trying to embrace hydrogen to meet its energy needs.
Hydrogen can be produced from natural gas and coal. It can also be extracted from water through electrolysis,
which is the process of using electricity to split H2O into hydrogen and oxygen. The former produces CO2, which issequestered in a process called carbon capture and storage (CCS) while hydrogen is extracted for usage. The latter
uses enormous amounts of CO2-free electricity generated from renewable energy sources, mostly solar. Since Japan
does not possess the required natural resources nor have the space to build large-scale solar farms for electrolysis, itwill have to acquire hydrogen from Australia and the Middle East, which have abundant natural resources, land andsunlight for solar farming.
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Japan Value Insights

Ammonia: Cheaper alternative to hydrogen
Shipping hydrogen produced in Australia and the Middle East to Japan currently presents a big technologicalchallenge as it has to be turned from gas into liquid by cooling it to minus 253 degrees Celsius before it can betransported. This is why ammonia is currently in the spotlight as the chemical, which is produced by combininghydrogen with nitrogen, can serve as a hydrogen carrier. Roughly 18% of ammonia’s weight consists of hydrogen,which can be extracted from ammonia with relative ease. Compared to hydrogen, ammonia liquefies at a moremanageable minus 33 degrees Celsius and is therefore much easier to store and transport. Ammonia is also a very
widely used chemical (Chart 3) with the storage and transportation infrastructure already in place. We therefore
believe that ammonia will be used extensively as an alternative to hydrogen until the technology and infrastructure
for the effective transportation of hydrogen is developed.
Chart 3: How ammonia is used around the world (as at 2012)

Source: The Institute of Energy Economics, Japan and NEXANT data compiled by Nikko AM

The key to hydrogen becoming a mainstream energy source depends on whether the associated costs can bebrought down. Currently, the cost of generating electricity with hydrogen is more than four times that ofgenerating it with ammonia (Chart 4). This high cost is likely to be reduced through various efforts, but the Japanesepublic may have to initially shoulder some of the burden through higher taxes and utility bills.
Chart 4: Cost of generating power by hydrogen and ammonia compared

Source: Agency for Natural Resources and Energy data compiled by Nikko AM

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Japan Value Insights

Conclusion
The changes currently taking place in Japanese society, notably the move to develop hydrogen amid the country’s
ambitious bid to decarbonise, have opened the door for companies with the knowledge and technology to tackle
and solve social issues. The drive towards adopting hydrogen has only just started, meaning there are many
companies with technologies and ideas that are yet to be discovered by the market. Our aim is to actively identify
such firms before their strengths and expertise are reflected in their share prices.

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