Tens of billions in federal tax credits could build a vital low-carbon hydrogen industry — or increase carbon emissions. We tackle the complexities in a series.
A monthslong debate over the future of the U.S. clean hydrogen industry is about to reach the boiling point. At stake is whether tens of billions of dollars of federal tax credits from last year’s Inflation Reduction Act will go to support a domestic clean-hydrogen sector that reduces carbon emissions — or one that actually increases them.
On one side is a loose coalition pushing to make hydrogen production in the U.S. as close to zero-carbon as possible, made up of climate scientists, energy analysts, environmental groups and a subset of would-be hydrogen producers. The only way to do that, they say, is for the federal government to set strict rules for the tax credits that would require hydrogen to be made with electrolyzers powered entirely by new sources of carbon-free electricity supplied on an hour-to-hour basis. Without such rules, they warn, the tax credits could bolster projects that result in more than twice as much carbon pollution as projects making hydrogen from fossil gas.
“This is a huge subsidy,” said Rachel Fakhry, who leads the hydrogen and energy innovation portfolio at the Natural Resources Defense Council. Allowing money to flow to hydrogen production that increases emissions would be a “perversion of the intent of the law.”
On the other side of the debate stand a host of companies with big hydrogen plans such as BP, Shell, NextEra Energy and Plug Power that say overly restrictive rules could strangle a nascent and still cost-uncompetitive industry in its cradle. They want tax credits to go to hydrogen made from clean electricity that’s accounted for on an average annual basis from across the country’s grid — including through the use of controversial unbundled renewable energy credits — or made using already existing resources such as hydropower and nuclear energy rather than newly built clean power sources. Even if looser rules don’t extend through the 10-year lifespan of the tax credits, this camp argues they’re needed at least during the early years of the industry’s growth.
The debate has been raging in hundreds of comments submitted late last year to the Internal Revenue Service and the U.S. Treasury Department, which are tasked with writing the rules for how the tax credits will be administered. Industry-watchers say draft rules could be issued as early as April.
“There’s a lot of money at stake here,” said Mona Dajani, head of the hydrogen and ammonia practice at law firm Shearman & Sterling. How it will be spent “depends on how the Treasury Department and the IRS are going to hash it out.”
“On one hand, if it’s regulated too tightly, clean hydrogen will be too expensive, and it will be difficult to get it started,” Dajani said. “On the other hand, if there’s not enough regulation, then the whole purpose of clean hydrogen to save the planet is not really happening.”
The case for ambitious rules for hydrogen tax credits
But proponents of stricter rules say that hydrogen production can be both low-carbon and economically competitive. This column will focus in detail on the arguments supporting this conclusion and the proponents’ demands for strict carbon-accounting rules. Tomorrow’s column will walk through the counterarguments in favor of looser standards.
The case for strict carbon accounting is summed up in this letter from the Natural Resources Defense Council and other environmental groups, energy analysts, and hydrogen and clean energy companies, which they sent to the White House and the Treasury and Energy departments last month. The signatories ask that the hydrogen tax-credit rules do three things:
- Require hydrogen producers to use new sources of clean energy, not existing sources — aka require “additionality.” The U.S. grid will need a lot of clean electricity over the coming years to power increasingly electrified buildings and transportation systems, and the hydrogen industry should not be competing for those electrons, the groups argue.
- Require hydrogen producers to use clean power that can actually reach their production facilities on the grids they’re connected to — aka require “deliverability.” Today’s clean-energy trading regimes allow buyers to claim credit for power generated in places far from where they actually consume electricity.
- Require hydrogen producers to match production and consumption of clean power down to an hourly basis — aka require “hourly matching.” Today, clean energy credits are averaged on an annual basis, which means that a hydrogen producer could, for example, buy enough solar power credits to claim that they’re running on clean energy 24/7 year-round, even when they’re operating after the sun has set.
- These “three pillars” of policy can ensure that the tax credits lead to “truly low or zero emitting hydrogen projects” and support projects that are “extremely competitive from the outset,” the letter says.
Rules that fail to incorporate these principles could “force Treasury to spend more than $100 billion in subsidies for hydrogen projects that result in increased net emissions,” the letter warns with italics for emphasis.
Creating rules that support these three policy pillars won’t be simple. Structures that account for hourly matching of clean electricity generation and delivery to its end users do exist and are in use in parts of the country, but haven’t yet been codified by federal agencies or international standards-setting groups. (Part three of this series will dive into hourly matching.) And determining whether clean energy is truly “additional” — that is, built to supply hydrogen production rather than being diverted from other uses — is a particularly complicated task.
But the argument that complying with such rules will be too complicated and costly for hydrogen producers and investors “is demonstrably false,” NRDC’s Fakhry said. “We already have projects in the pipeline that meet these three pillars.”
Those projects include some of the biggest yet announced in the U.S. Hy Stor Energy has targeted Louisiana and Mississippi for a 110,000-metric-ton-per-year hydrogen production and storage complex to be powered by solar and wind farms it will build itself. Energy company AES and industrial-gas producer Air Products have announced plans to invest about $4 billion in a Texas hydrogen production facility to be powered by about 1.4 gigawatts of new renewable energy. And Intersect Power, a renewable energy developer with more than $6 billion in project finance lined up to expand a multi-gigawatt portfolio of solar and battery projects, plans to build renewables to supply the 3 gigawatts of clean hydrogen facilities it has under development.
In comments to the IRS, Intersect joined wind power giants Nordex and Vestas, hydrogen developer Synergetic, and Electric Hydrogen, a well-funded startup developing large-scale electrolyzer technology that is partnering with Intersect, to warn that allowing a lax clean-energy accounting standard would lead to “spending billions of dollars on effectively doubling emissions. Hourly matching, on the other hand, will result in near-zero carbon hydrogen.”
Raffi Garabedian, CEO of Electric Hydrogen, said that his company has focused on building electrolyzers that can cost-effectively ramp up and down to run on clean energy that rises and falls with the sun and wind. He conceded that it could be in his company’s interest “in the short term” to produce hydrogen around the clock with fossil-fuel-generated electricity as well.
But giving hydrogen producers full tax credits if they purchase unbundled renewable energy credits for solar energy and then produce hydrogen overnight when the sun isn’t shining, or if they “buy some wind power in Iowa and run an electrolyzer in Pennsylvania,” won’t lead to truly clean hydrogen production, he said. Allowing the U.S. hydrogen industry to develop in that way “could be a black eye that’s fatal to the industry. We don’t want to take that risk,” he said.
“We want hydrogen to thrive long-term. And the only reason for it to exist is decarbonization,” he said. If we’re not striving for decarbonization, “you should just be pumping more oil and gas out of the ground.” (Check out a Volts podcast and transcript featuring Garabedian talking about electrolyzers.)
The ABCs and 123s of clean hydrogen
Hydrogen will be critical for decarbonizing the world’s economy over the coming years and decades, especially the “hard-to-abate” sectors that can’t be easily powered by clean electricity. It will be a key source of zero-carbon fuel for steelmaking, cement production and other high-heat industrial processes. It could play a vital role in replacing fossil fuels in fertilizer and chemicals production. And it’s expected to become a core input for carbon-neutral fuels for shipping and aviation.
But while hydrogen itself is a fuel that can be burned with no carbon emissions, its usefulness as a climate solution depends entirely on how it’s made. In terms of its carbon emissions, hydrogen production can range from very dirty to very clean.
Today, nearly all hydrogen is made in a dirty way, with fossil gas through a process called steam methane reforming; this is known as “gray hydrogen” on the hydrogen rainbow. Every kilogram produced results in emissions of about 10 kilograms of carbon dioxide. Global hydrogen production currently stands at about 90 million metric tons per year, mostly for use in oil refining and fertilizer production, putting annual global emissions at roughly 900 million metric tons in 2021, according to the International Energy Agency.
In less than a decade, the world will need more than twice that much hydrogen — and the added hydrogen will need to be produced cleanly. IEA forecasts the need for 95 million metric tons of low-carbon hydrogen per year by 2030, in addition to the hydrogen already being produced today. Most of it will be made using carbon-free electricity to power electrolyzers that split water into oxygen and hydrogen — a process that results in what’s commonly referred to as “green hydrogen.”
Almost none of today’s hydrogen production is “green.” As of the end of 2021, less than 1 million metric tons of hydrogen electrolysis production capacity existed. And as of September 2022, projects planned and in progress across the world were expected to add up to only 24 million metric tons by 2030. IEA warned in 2021 that the world won’t be able to close the gap between hydrogen plans and hydrogen needs without further policy action.
The Inflation Reduction Act’s Section 45V hydrogen production tax credit is certainly a policy designed to meet the needs of the moment. At its most lucrative tier, offered for the lowest-carbon production, it offers $3 per kilogram of hydrogen produced. That’s equivalent to roughly half of today’s current costs of $5 to $6 per kilogram to produce hydrogen with electrolyzers, depending on the cost of equipment, the scale of production and the price of electricity. The tax credit could bring clean hydrogen within striking distance of the $1 to $1.50 per kilogram cost of gray hydrogen.
Additional tax credits for the clean energy used to produce hydrogen could further reduce overall costs. In an ideal scenario, “If you’re able to claim the entire $3 tax credit for the first five years” and get tax credits for the electricity powering your electrolyzers, the hydrogen being produced could be “essentially free,” said James West, senior managing director and head of sustainable technologies and clean energy research at investment banking firm Evercore ISI.
The Inflation Reduction Act places no limits on the amount of hydrogen that could be eligible for 45V tax credits, which are available for 10 years to qualified production sites that begin production before the end of 2032. That creates the potential for these credits to spur a massive expansion of carbon-free hydrogen to serve a host of industrial needs.
But the only way to make sure all of this hydrogen is clean is to make sure that electrolyzers only run when the electricity feeding them is coming from a zero-carbon source, Garabedian said. “If the market allows bad behavior, if the structure allows bad behavior, we’re very, very concerned that green hydrogen fizzles out for lack of policy and public support,” he said.
Why clean hydrogen needs hourly clean-energy matching
How is it that producing hydrogen using electricity can lead to higher carbon emissions than making it from fossil gas? And why is it that acquiring the renewable energy credits for clean power to make green hydrogen doesn’t reduce those emissions unless the credits are tracked down to the hour?
The answers have to do with the carbon-intensity of the power going into the process, the energy losses inherent in turning water into hydrogen via electrolysis, and whether the electricity is being taken away from other uses that are more effective in reducing carbon emissions.
All of these factors play into a much-cited model that was released in December by Princeton University’s Zero Lab. The model forecasts emissions from hydrogen production using electricity supplies expected to be available across the Western U.S. power grid over the coming decade, including the clean energy mandated by states such as California and likely to be built in other states because it’s the least-cost option thanks to the Inflation Reduction Act’s lucrative tax credits.
This model then subjected its hypothetical fleet of electrolyzers to several different methods of accounting for clean energy to power them. Those included a baseline of “no requirements” — just running electrolysis plants on the power available on the grid — as well as contracts for clean energy on an annual average matching basis, a weekly average matching basis, and an hourly average matching basis.
The results of this model differ from region to region within the study area of the Western U.S. But the high-level findings are clear: Only hourly matching leads to a hydrogen electrolysis fleet that actually reduces net carbon emissions below the level of emissions from the steam methane reforming process that makes hydrogen from fossil gas.
And beating emissions from steam methane reforming is a low bar. Producing hydrogen that meets the emissions limit stipulated in the Inflation Reduction Act for the most lucrative production tax credit of $3 per kilogram would require at least 97 percent carbon-free power.
But that’s assuming the Treasury Department’s rules account for emissions in an accurate way. If the rules allow hydrogen producers to use annual clean-energy accounting mechanisms like unbundled renewable energy credits (RECs) to assess the carbon emissions of the grid power they’re using, the quantity of dirty grid power actually feeding their electrolyzers will almost certainly be well above the intended threshold for even the lowest level of tax credit. No part of the U.S. grid has a 24/7/365 supply of clean power. Even regions with significant supplies of carbon-free nuclear power and hydropower still get much of their supply from fossil fuels.
“There are many possible ways the [hydrogen production tax credit] could be implemented that could allow the producers to claim they’re using 100 percent clean energy from the grid” even while having “zero impact” in reducing carbon emissions, said Wilson Ricks of Princeton, a co-author of the paper on the Zero Lab’s model.
The flaws in existing annual REC accounting
What’s more, Ricks said, unbundled RECs “essentially do nothing to change the underlying grid mix.” Growth in clean energy is outpacing the scope of the market structures that exist for buying and selling the RECs that energy buyers use today to claim they’re “carbon-neutral” on an annual basis. That means hydrogen producers would likely be able to purchase those credits at a very low cost while doing nothing to increase the share of clean power on the grid, let alone supply themselves with zero-carbon power.
That could allow hydrogen projects to add more demand to the grid more quickly than clean energy is being built to supply it, increasing demand for fossil-fueled power during the hours when there isn’t enough solar and wind power.
That’s why developers like Intersect Power are intent on building new clean-energy resources to power their hydrogen production as well as matching that production to the hours that clean energy is being produced, said Garabedian of Electric Hydrogen. “What we’re actually trying to do is to avoid the signal to a fossil generator to ramp up.” If hydrogen production leads to gas-fired peaker power plants being activated more often, that hydrogen is hardly “clean,” as illustrated by this graphic from the Zero Lab.
The new electricity demand from hydrogen electrolysis could quickly add up to significant increases in carbon emissions, according to a March report from Rhodium Group. The research firm projected the potential emissions impact of electrolytic hydrogen production if it were to grow to 21 gigawatts a year in the U.S. by 2030, representing about a 4 percent increase in the country’s total electricity use that year.
If that power were renewable energy obtained via annually averaged RECs, it could increase total greenhouse gas emissions by 34 to 58 million metric tons (MMT) by 2030 — a rise of a third to more than half on top of the roughly 100 MMT of emissions from today’s U.S. gray hydrogen production.
Those emissions estimates increase by another 73 MMT in 2030 in scenarios with no requirement for new hydrogen production projects to build new clean energy resources to supply them. And they increase by 63 to 100 MMT if that hydrogen is only produced in parts of the country with the highest-emitting power grids, Rhodium found.
The threat of using clean hydrogen tax credits the wrong way
Another big issue for clean hydrogen production is how the hydrogen will ultimately be put to use. Hydrogen could be a vital and near-irreplaceable feedstock for decarbonizing certain sectors of the economy — primarily liquid fuels and high industrial-process heat — that are quite challenging to power with electricity. But it could also be used in inefficient ways that undermine effective decarbonization — particularly if the Inflation Reduction Act’s tax credit and incentive regimes aren’t put into practice in ways to guard against that possibility.
NextEra — the parent company of utility Florida Power & Light, the state’s largest utility, and NextEra Energy Resources, one of the country’s largest clean-energy developers — has been one of the more vocal advocates for annual clean-energy accounting for hydrogen production tax credits.
NextEra plans to rely on hydrogen to meet its goal of zero carbon emissions by 2045. Its first foray is a 25-megawatt pilot electrolysis plant in Florida that will use surplus solar power to produce hydrogen that it intends to burn in a refurbished fossil-gas power plant. At small scale, this kind of pilot project may make sense, since markets for clean hydrogen have yet to emerge.
But a clean hydrogen plan that relies on using annually matched clean-power purchases to produce hydrogen to replace fossil gas in power plants is not just highly carbon-intensive. It’s also highly energy-inefficient, losing more than half to more than four-fifths of the energy in the electricity put into it, depending on how the processes are managed.
Such severe “round-trip” energy losses may be acceptable for hydrogen made to serve electric-grid needs that are even more costly to meet using other technologies. That’s the idea behind using zero-carbon hydrogen for “seasonal” energy storage, for example, which can fill days- or weeks-long lulls in renewable power production on a grid that’s approaching 100 percent clean energy.
But in a worst-case scenario, such “power-to-hydrogen-to-power” processes could allow what policy firm Energy Innovation described in its IRS comments as “hydrogen-washing.”
The Inflation Reduction Act provides tax credits for making hydrogen and also for burning hydrogen for power. This could encourage a company that owns both electrolysis facilities and power plants to make and burn hydrogen primarily for the tax-credit revenue — a wasteful and environmentally harmful practice that Zero Lab’s Ricks described as a “way to turn a lot of electricity into less electricity and get paid to do it.”
A counterpoint on hydrogen emissions
While Zero Lab and Rhodium Group warn about emissions increases from green hydrogen production, other analyses find less reason to worry. NextEra Energy has cited a report from energy consultancy Wood Mackenzie, which it compiled for an undisclosed client, modeling the carbon-intensity of 250 megawatts of hydrogen (a relatively low level compared to what’s needed nationally) made from grid electricity that obtains carbon-free credentials under annual matching scenarios in Arizona and South Texas.
WoodMac states in a March op-ed in Fortune that these scenarios “can result in net-zero” carbon-intensity. That’s primarily due to the fact that the grids in those two states will increasingly be served by renewables. The report’s scenarios have 20 to 35 percent of hydrogen producers’ annual electricity consumption coming from undifferentiated grid power rather than contracted clean power. The increase in renewable energy supply on those grids will allow electrolyzers to run around the clock without an increase in the overall carbon-intensity of the power serving those grids, according to the report’s model.
NextEra Chief Communications Officer David Reuter cited these findings in defense of allowing hydrogen producers to use annual clean-energy matching to claim tax credits. “During periods of high wind and solar resource, the surplus renewables displace fossil-fuel generators, resulting in negative carbon intensity during these periods,” Reuter wrote in an email. “These bring the total carbon intensity of the hydrogen production near zero on an annual basis.”
But the authors of the WoodMac report further qualify those findings by noting that the overall increase in electrolyzer load will drive more “pull” on fossil-fueled generation during hours when renewable energy availability is low. “As a result of this phenomenon, the [carbon-intensity] benefits seen in 2025 are smaller in 2030 and absolute emissions increase marginally in both markets,” the op-ed states.
To mitigate those emissions increases, “a slight overbuilding of renewables, or strategic curtailment of hydrogen production during peak thermal hours” — hours when fossil-fueled power is needed to serve the grid — “could be effective tools to minimize these unintended emissions impacts in the 2020s.”
WoodMac’s op-ed also states that results may differ on other grids with lower renewable potential than Arizona and Texas, two states with ample solar and wind resources.
How generous tax credits make clean hydrogen possible — and make dirty hydrogen all the more tempting
So far, we’ve focused on the argument for strict emissions rules to prevent hydrogen from increasing carbon emissions. Proponents of strict rules stress that they don’t have to come at the expense of cost-effective hydrogen production. That’s because the Inflation Reduction Act’s hydrogen tax credits are so generous — the full credit can make up for the additional costs of running electrolyzers only when clean energy is actually available to power them.
Jesse Jenkins, head of Princeton’s Zero Lab and co-author of the December study, said that its modeling shows the $3-per-kilogram production tax credit for green hydrogen is on its own enough to make electrolysis cost-competitive with gray hydrogen in many regions, even when it’s only running when clean energy is directly available.
The Inflation Reduction Act’s extended tax credits for clean energy and energy storage also boost the economics for building new zero-carbon resources to power that hydrogen production, he said, echoing the point made by James West of Evercore ISI and other analysts.
“That allows you room to achieve hourly matching — which is not as high-cost as you might think,” Jenkins said. This chart from the Zero Lab’s December study shows the modeled economics for a hydrogen electrolysis facility in the Pacific Northwest under a variety of scenarios, including annual, weekly and hourly clean-energy matching.
In these scenarios, the costs of production with hourly matching are roughly 20 to 50 cents per kilogram higher than with other clean-energy accounting methods, which range in cost from about $2.50 to $3.50 per kilogram produced. But that still allows production within economic breakeven points, even for facilities built at the higher range of costs for electrolysis equipment today. For projects that can achieve lower electrolyzer costs, the price of hydrogen produced will fall at or below the $3-per-kilogram tax-credit value.
An additional boost is available for projects with their own electricity sources that can sell renewable energy in excess of what’s needed to make hydrogen. That’s one argument for building hydrogen projects that generate their own clean power but are also connected to the grid, Jenkins noted.
The chart above also highlights the fact that hydrogen produced with grid power matched by annual RECs could cost well under $3 per kilogram while emitting far more carbon.
If hydrogen producers are allowed to use cheap annual RECs to meet the tax-credit requirements, they’ll be incentivized “to run that electrolyzer 24/7,” Ricks said, because they’re “going to be making money anytime the electricity prices are below the opportunity costs of not running it.” The full $3-per-kilogram tax credit would enable cost-effective production with electricity prices as high as $60 per megawatt-hour, he said — “and prices are almost always below that threshold.”
That, in turn, could undermine the cost-competitiveness of projects that are designed and operated in a way that actually reduces emissions, Fakhry said. “If the rules are lax, and hydrogen that is very emissions-intensive counts as clean and green, that will create very wrong market signals.”
“We don’t want a race to the bottom,” she said. “That’s not the way we want to go.”
Source: canarymedia
