(FORTUNE Magazine) – AS IF IT DIDN'T HAVE enough to do on its quest for bigness, BMW has also decided to reinvent the internal-combustion engine. For chairman Panke it is more than a diverting engineering exercise. He believes that the end of the oil era is near, and he wants to get ready. "All of us in the industry should admit, as if we're sitting in court, that the endgame will be 20 years," he says. "We need hydrogen."

BMW could save itself a lot of trouble and expense by tagging along on the hydrogen-fuel-cell research by companies like General Motors and Toyota. But a fuel-cell car drives like a fast, battery-powered golf cart, and Panke figures that's unacceptable for BMW customers. So it is developing an engine that burns hydrogen. Like fuel cells, the hydrogen engine consumes nonfossil fuel (although it can also burn gasoline if the driver chooses) and produces no emissions. But drivers get to enjoy the familiar thrills of a high-performance internal-combustion engine with all the moving parts.

It is a long-term project for BMW--the company has been at it for 30 years, and no one there expects hydrogen cars to conquer the market anytime soon. Wolfgang Strobl, general manager of BMW's Clean Energy project, observes that diesel engines needed 50 years of refinement before they were acceptable for use in passenger cars, and he expects hydrogen power to take equally long. Still, BMW has already launched a test fleet of hydrogen-gasoline cars and will produce a car for consumers in 2007, when it will install a convertible-fuel engine in the redesigned 7 Series.

Some fundamental problems must be solved before hydrogen becomes practical. Stored as a gas, it doesn't contain enough energy to drive a car very far; used as liquid, hydrogen provides more range but must be kept at 459 degrees below zero. The cars can go fast, though. At the Paris Auto Show, BMW showed a bulbous-nosed racecar that reached 185 miles per hour during secret testing at a racetrack in France earlier this year.