Originally published for customers January 26, 2024
What’s the issue?
In December, the Internal Revenue Service issued long overdue proposed regulations that will govern what hydrogen production will be entitled to a new tax credit that was enacted as part of the Inflation Reduction Act of 2022.
Why does it matter?
The credit can range from zero to a high of $3 per kilogram of hydrogen produced during the first ten years a new hydrogen facility operates. The credit varies based on the level of emissions that are created to produce the hydrogen.
What’s our view?
The proposed regulations adopted a strict standard for the production of “green” hydrogen that will make it more difficult for hydrogen produced using grid-connected wind and solar resources to qualify for the highest credit. This strict standard may be to the benefit of facilities that intend to use natural gas combined with carbon capture and storage to create “blue” hydrogen. However, the new rules will also not satisfy those promoting the use of renewable natural gas or certified natural gas. Comments can still be filed on the proposed rule until February 26.
In December, the Internal Revenue Service (IRS) issued long overdue proposed regulations that will govern what hydrogen production will be entitled to a new tax credit that was enacted as part of the Inflation Reduction Act of 2022. The credit can range from zero to a high of $3 per kilogram of hydrogen produced during the first ten years a new hydrogen facility operates. The credit varies based on the level of emissions that are created to produce the hydrogen.
The proposed regulations adopted a strict standard for the production of “green” hydrogen that will make it more difficult for hydrogen produced using grid-connected wind and solar resources to qualify for the highest credit. This strict standard may be to the benefit of facilities that intend to use natural gas combined with carbon capture and storage to create “blue” hydrogen. However, the new rules will also not satisfy those promoting the use of renewable natural gas or certified natural gas. Comments can still be filed on the proposed rule until February 26.
For a refresher on hydrogen as fuel, check out Arbo’s report Opportunities and Obstacles for Hydrogen as a Net-zero Fuel and webcast (at the bottom of the page) of a related presentation at the First Element Conference.
Hydrogen Production Credit
We first wrote about the hydrogen production credit in IRS Seeks to Define Clean Hydrogen –There Will Be Winners and Losers in May of last year. In that article we noted that the IRS appeared poised to choose a path that would benefit steam methane reforming, which uses natural gas, with a better tax credit than most electric driven processes, even though electrolytic hydrogen is typically considered the greenest way to produce hydrogen.
That certainly appears to be what the IRS has, in fact, done in proposed regulations it issued in December of last year. To understand how that is possible it is necessary to understand how the credit works and the limits placed on the use of grid-connected electricity to produce hydrogen.
The credit increases as the level of greenhouse gas emissions decrease per kilogram of hydrogen produced. The proposed credit relies on the model created by Argonne National Laboratory called the Greenhouse gases, Regulated Emissions, and Energy use in Technologies model, or ‘‘GREET” model. The GREET model calculates the carbon intensity for different pathways for producing hydrogen. A 2022 article identified ten different pathways for producing hydrogen.
As seen above, each of these pathways has a different “well to gate” emission intensity. Also as shown above, those intensities would be entitled to a varying level of tax credit under the statute and the proposed regulations. In the above chart, the use of an electrolytic membrane powered by renewable sources like wind and solar would appear to be the clear winner, producing zero emissions. However, the devil is in the details and the IRS proposed regulations appear designed to bedevil the wind and solar producers of hydrogen.
Wind and Solar - Not So Fast
As we noted back in May 2023, most comments filed with the IRS when it was formulating the proposed regulations would agree with the zero emissions measure if, and this was a big if, the hydrogen facility was directly tied to the source of the electricity and the source was newly built to provide power exclusively to the hydrogen facility. But, as we noted then, that is not how most plants that are being planned intend to get their power. Instead they intend to connect to the grid, purchase power and may even use current power plants as their source. The key question that needed to be answered in the regulations was what would such a hydrogen facility have to show about its power source with respect to three key variables, incrementality, temporality and deliverability. The tighter each of these standards were, the less likely a grid-connected facility would be able to qualify for the highest level of credit.
Sadly for wind and solar powered hydrogen facilities, the IRS sided almost entirely with the environmental purists making it nearly impossible for a grid-connected facility to claim its hydrogen is produced using wind and solar power only. If it fails to satisfy all three tests, the facility would have to use the general emissions profile for the grid to which it is connected. For a grid-connected facility to claim the characteristics of a particular source for its electricity it will need to procure a qualified energy attribute certificate (EAC). Each EAC will need to meet the following three criteria.
Incrementality
The first criteria the IRS proposes is that the electricity source of a hydrogen facility must have gone into service not more than 36 months before the hydrogen facility does. This will likely mean no existing wind and solar facilities will qualify for the source of a hydrogen facility. While the IRS is asking for comments on whether this requirement should apply to certain facilities like nuclear facilities that would have to close without the demand from the hydrogen facility, it is not asking for any comments about further loosening this standard for wind and solar facilities.
Temporality
The IRS’s second criteria for an EAC may have even more impact on the viability of green hydrogen when it goes into full effect on January 1, 2028. For each hour a hydrogen facility operates it must produce an EAC for the same hour from the electric source. This would make the operation of a hydrogen facility as intermittent as its power source. For example, a hydrogen facility relying on solar power only could not run at night.
Deliverability
The final criteria for an EAC is that it must be from a power source within the same region of the country as the hydrogen facility. The map below shows these regions within the lower 48.
As we have discussed before, sources for wind and solar power are often not near the demand centers on the coasts. This deliverability requirement, therefore, could severely limit the location of green hydrogen facilities to those areas of the country where wind and solar are plentiful.
Blue Hydrogen
The proposed regulations do not really address the use of natural gas to produce hydrogen other than requiring the calculation of the emissions through use of the GREET model. Because steam methane reforming, the typical path for use of natural gas, is so much less expensive than the use of electrolyzers, natural gas production facilities that can develop a carbon capture and sequestration facility may be able to operate more economically than a green hydrogen facility.
The key issue left unaddressed by the regulations, however, is how to credit the use of natural gas that is produced from either renewable natural gas sources or landfill gas. As of now, a facility using such gas as a feedstock can only claim the lower emissions of such sources if they are directly connected to the facility. The discussion that accompanied the proposed regulations indicates that indirectly connected sources will need to meet standards similar to those being imposed on indirect electricity sources with respect to incrementality, temporality and deliverability. The GREET model makes some base assumptions about natural gas, such as the methane leakage rate and the proposed regulations do not deal with how a gas source with a lower emissions profile could be used to fuel a hydrogen facility and get credit for that lower emissions profile. Thus, producers of renewable natural gas and certified natural gas still have work to do to get their gas recognized as a lower emission alternative to pipeline quality geologic gas.
The Path Forward
The proposed regulations can be relied upon following their issuance but are still open for further comment. Comments are due by February 26, 2024, and a public hearing has been scheduled for March 25, 2024. Presumably following that period the IRS will issue the final regulations.