(FORTUNE Magazine) – Bright-eyed, his silver hair a little wild at the fringes, Dr. Ferdinand Panik, 56, clearly relishes piloting a very special Mercedes vehicle briskly past the apple orchards on the outskirts of Nabern, Germany. The 40-foot ultramodern Nebus (for "new electric bus") is virtually silent under way. In the engine bay normally occupied by a growling diesel are several "stacks" of fuel cells that, without combustion, make electricity to drive the motors that turn the wheels. From a hilltop nearby, a castle looks down on new labs and workshops that automaker Daimler-Benz is equipping for a top-priority fuel-cell development program that could make the noisy, polluting piston engines that power the world's cars, trucks, and buses as obsolete as the steam locomotive.

The work at Nabern is the most visible evidence of an accelerating wave of R&D by automakers and component suppliers around the world that have committed more than $1 billion to fuel-cell power systems. The concept has always had an arresting simplicity. Remember the high school chemistry experiment in which, through the addition of a bunch of electricity, water is electrolyzed into its constituent hydrogen and oxygen gases? A fuel cell is a device that accomplishes precisely the reverse. It combines hydrogen and oxygen electrochemically to form water, giving off heat and electricity. The juice can power whatever you want to plug into it.

Fuel cells have long supplied electricity on spacecraft, but they are priced like crown jewels. The car people are excited by a different kind of fuel cell. Development work has shrunk the price of this version by roughly a factor of ten in the past decade. The cost is still more than ten times too high. But encouraged by the progress to date, industry is hoping that big-ticket R&D will bring down the cost much further, along with that of related "drive train" hardware such as fuel-processing devices, electronic controls, and motors.

Those who love the macho roar of piston engines needn't fear for their imminent demise, for the fuel cell's success is definitely not guaranteed. Nevertheless, executives at Daimler-Benz and other automakers are confident they can pull off the remaining development work and apply the needed mass-production wizardry. Panik, a senior VP who has been running Daimler-Benz's fuel-cell effort full-time for the past year, says he has few doubts on that score. He foresees power sources with far fewer moving parts than today's engines. Says Panik: "In the end I believe the fuel cell can be done for the same price as the piston engine, or lower. And I believe it can let the owner travel 50% farther for the fuel used, with an engine that will be truly maintenance-free."

It will also pollute less, auto folks point out. They're hoping that fuel-cell cars will be an acceptable alternative in jurisdictions like California that have mandated that substantial numbers of "zero-emissions vehicles" be available early in the next century. And carmakers are confident that fuel-cell cars will outperform other environment-friendly vehicles--the battery cars and battery-piston hybrids that are already in limited production.

Daimler is so stoked about the fuel-cell drive train that it plans to have production versions of the Nebus rolling off an assembly line in 2004. Even more eye-popping is the company's goal of having fuel-cell cars on sale that same year. That will require an extra set of solutions. The Nebus is fueled by compressed hydrogen carried in roof-mounted tanks. That's okay for bus fleets that return to a central garage for refueling. But the family flivver will need to run on a liquid fuel such as gasoline or methanol, dispensed at ubiquitous filling stations. To do this the car will need a micro-chemical plant onboard capable of extracting hydrogen from the fuel as it rolls along. We're working on that too, say Panik and his colleagues as they escort a visitor to a demonstration model of a fuel-cell car, the methanol-powered Necar 3, which has already logged time on the road.

The Necar 3, along with the Nebus, is one of four demonstration fuel-cell vehicles that Daimler-Benz has engineered and put on the road in just three busy years. The largest such collection any motor company is known to have, it underscores the seriousness of Daimler-Benz--one of whose founders in 1885 invented the first automobile--as it proclaims its goal of being the first auto company to mass-market the piston engine's successor.

Daimler-Benz is teamed up with other companies. Late last year Ford joined its partnership with Ballard Power Systems of Vancouver, B.C., which has done some of the most impressive work in improving fuel cells. The three-company alliance will develop and build fuel-cell "engines" and power trains, which the automakers will use in their own vehicles and sell to other car companies. Ford's commitment of $430 million to the alliance comes on top of the $320 million Daimler has already allocated to its longer-running partnership with Ballard. "We want to be leaders in bringing these fuel-cell vehicles out," says Gary Heffernan, Ford's corporate technology manager.

Not to be left behind, other carmakers and technology companies have large-scale development programs under way:

--General Motors has a fuel-cell program "at least as big as" its research into hybrid and battery-electric cars, says Byron McCormick, executive director for global alternative propulsion. He won't cite a number but says that the program represents "significant dollars." He adds, "We are totally serious. The fuel cell is so compelling because of its enhanced efficiency and low pollution that we just have to go after this aggressively."

--Toyota, which already sells a hybrid car in Japan, has a development program under way there that's estimated by outsiders to involve some 200 researchers. Last year at two major auto shows, the company exhibited a version of its RAV4 sport-utility vehicle, equipped with a demonstration fuel-cell electric power train of its own design.

--International Fuel Cells, part of United Technologies' Hamilton Standard unit, is launching a venture to commercialize fuel cells for cars. Already a builder of fuel-cell systems for the space shuttle and for stationary power generation, IFC has 60 people in its automotive program and will soon add more.

Today's car engines are inefficient because they are subject to unyielding thermodynamic limits first described in 1824 by French scientist Sadi Carnot. A fuel-cell power train has no such limits and is theoretically 1.5 times as efficient as its piston-engine counterpart.

Daimler's experimental vehicles use fuel-cell stacks supplied by Ballard, which began working with the automaker in 1991. The company, whose stock trades on the Nasdaq, had already decided to concentrate solely on making fuel cells viable for small-scale stationary power generation and for low-emission cars. At their simple heart is a solid electrolyte, or conducting material, made of a special plastic known as a proton-exchange membrane, or PEM, which is coated on both sides with a small amount of platinum catalyst material. Today at Ballard's labs, researchers busily put new generations of fuel-cell components though their paces on row after row of instrumented test benches.

When Ballard first started shopping its PEM stacks around to automakers in 1989, they were capable of generating three kilowatts of power per cubic foot of volume. Within a few years power density was up to ten kW per cubic foot, and by the end of 1995 it reached 30 kW. A fourth generation now being developed will have a 50-kW power density, promises financial vice president Mossadiq Umedaly.

Power densities of 30 kW or better interest car engineers, for they imply a set of stacks for a midsized car that would take up no more room than a large suitcase. Once the size problem is out of the way, automakers start asking about cost, which for now is "about an order of magnitude too high," as Umedaly readily admits. But it has fallen drastically, he says, from $5,000 per kW in 1990--a figure that covers the fuel cell only, not the rest of the power train--to less than $500 today.

The automotive types want that number down around $25 to $30. That would require production economies achievable only in a market of 250,000 vehicles a year, Umedaly says, which doesn't look likely before 2008. But significant further cost reductions are achievable, he says. Ballard has already slashed the amount of platinum needed. Automakers say that $225 worth suffices for a midsized car.

So what's it like to drive a fuel-cell vehicle? Necar 2, fueled by compressed-hydrogen tanks, is a minivan with room for six passengers. An electric motor supplies power to the front wheels through a two-speed automatic transmission. A brief test spin on the roads around Nabern shows Necar 2 to be smooth and quiet, like any well-engineered electric vehicle. Driving range between hydrogen fill-ups is an acceptable 155 miles.

Wait a minute. Hydrogen is not sold at any gas stations near me, you might object. Which helps explain Necar 3, Daimler's third-generation prototype that runs on methanol. Under the floor and where the rear seat would normally be, Daimler engineers have crammed in fuel-cell stacks, a tank for methanol, and a mess of boxy hardware making up a "reformer" for extracting hydrogen from the go-blind-if-you-drink-it alcohol. Necar 3 isn't the only methanol-reformer car out there. Toyota's fuel-cell SUV, as well as a GM demonstration car, run on the stuff. Being rich in hydrogen, methanol is relatively easy to "reform" in a low-temperature process.

But methanol isn't sold at stores near me either, you might further protest. Most engineers agree that it would be ideal to convert part of the country's gasoline infrastructure over to methanol for fuel-cell cars, but they also worry that the petroleum industry won't willingly make the investment. Therefore Daimler and other carmakers around the world are struggling to learn how to economically perform onboard extraction of hydrogen from gasoline, the one fuel sold everywhere.

Researchers at Daimler, GM, International Fuel Cells--and quite likely at Toyota too--are at work on systems for onboard gasoline reforming. Chrysler has said it will have a gasoline-reforming fuel-cell demonstration vehicle by the end of 1999, with the critical reformer system, interestingly enough, being built under contract by GM's Delphi Energy & Engine Management unit.

Arthur D. Little, the consulting firm in Cambridge, Mass., announced last year that it had demonstrated a gasoline-reforming process in the lab that could be adapted to cars. That work was done with funding from the U.S. Department of Energy. In February, ADL launched a company called Epyx, with a staff of 30, that will work on a reformer that can handle a variety of fuels.

Gasoline reforming is a complicated task involving higher temperatures and more steps than methanol reforming. The gasoline reformer must use more of the fuel's energy to generate the heat needed to disassemble the complex brew of hydrocarbon molecules found in gasoline. Still, a car with a gasoline reformer would come out ahead of the piston engine, by about one-third, in fuel efficiency. One huge challenge, especially in gasoline reformers, is shrinking the ten minutes or so it takes for a reformer to warm up before the driver can be on his way.

Ford and Daimler-Benz both say they will wait until late next year to determine which fuel--methanol or gasoline--is going to be the winner for fuel-cell cars. Then they will get to work designing the systems needed for a run of production cars in 2004. Buyers won't even venture into the showrooms, of course, unless the cars are affordable. For a fuel-cell power train to compete against those with piston engines, its cost will have to be no more than $5,000, says GM's McCormick.

Getting all the way there will take more than the huge amount of R&D money that industry has put behind the effort. It will take blood, sweat, tears, and repeated frustration. But if the fuel cell makes it, the piston engine could wind up in museums. Except, of course, for a few cars kept running by those who see the same romance in motors that go vroom that steam locomotive buffs see in the old choo-choo.