Here’s how U.S. clean hydrogen tax rules could shake out

The U.S. Treasury Department will need to determine how to account for the emissions from electricity used to make electrolytic hydrogen.

Clean hydrogen is seen as essential for decarbonizing difficult-to-abate sectors of the U.S. economy, such as heavy manufacturing, chemical production and transportation. In the power sector, hydrogen can be combusted in natural gas-fired engines or turbines.

Signed into law last year, the Inflation Reduction Act (IRA) includes a suite of tax incentives for project developers and is aimed at jumpstarting the U.S. clean hydrogen industry.

A Production Tax Credit (PTC) included in Section 45V of the Inflation Reduction Act (IRA) offers a tiered approach. It awards up to $3 per kg of hydrogen produced to projects that have a lifecycle greenhouse gas emissions intensity of less than 0.45 kilograms per kilogram of hydrogen (kg CO2e/kg H2). The smallest qualified tax credit, $0.60 per kg of hydrogen produced, would be available to projects with an intensity of less than 4 kg CO2e/kg H2.

The U.S. Treasury Department is expected to determine by August a set of rules for the tax credit. Notably, Treasury will need to determine how to account for the emissions from the electricity used to make electrolytic hydrogen.

How Treasury determines it will account for these emissions could affect which types of generation would ramp up to meet demand. Projects with grid-connected electrolyzers will need to verify they are effectively obtaining clean power — rather than grid power, still strongly supported by fossil fuels. To that end, Treasury’s rules are likely to ensure low emissions using geography and time standards.

Electrolysis, or producing hydrogen by splitting water into hydrogen and oxygen, is also a very electricity-intensive process. It takes a lot of electricity to produce a little bit of hydrogen. That’s why Treasury and other interested parties are concerned about ensuring the source of electricity to produce hydrogen doesn’t result in major emission increases on the grid.

“It doesn’t take very much fossil generation in your mix to ultimately result in production emissions of electrolytic hydrogen that [are] actually dirtier than the current steam methane reform-produced hydrogen,” said Ben King, associate director with Rhodium Group’s Energy & Climate practice.

Stakeholders and industry groups have proposed several different approaches for calculating emission levels that determine tax credit eligibility. Under the strictest emissions accounting approach, for electricity to qualify as zero-emitting, every kilowatt-hour of electricity going into an electrolyzer must be matched with a kilowatt-hour of electricity generated from a new, zero-emitting generator (referred to as additionality) and sited in the same region (called deliverability) as the electrolyzer on an hourly basis (time-matching).

Comments submitted to the Biden administration on how to set the Treasury rules are mostly divided on whether to match kilowatt-hours on an hourly basis and when that matching should take effect.

“I think the real question is going to be where Treasury winds up on the question of temporal matching,” said King in an interview with Power Engineering.

Under hourly matching emissions accounting, developers would have to match their hourly consumption of grid power used for electrolysis with the hourly power generation from a new renewable facility.

Hourly-matching emissions accounting is supported by environmental groups like the Clean Air Task Force, Natural Resources Defense Council and Environmental Defense Fund. They argue it provides the highest degree of confidence that the electricity demand from the electrolyzer itself isn’t causing increased emissions in the power sector.

Under a less restrictive annual matching scenario, a hydrogen producer would sum up the amount of electricity to power the electrolyzer over a year-long period and demonstrate that the total was offset with an equivalent amount of clean generation going to the grid.

The American Council on Renewable Energy has advised Treasury to use annual matching to “support rather than impede the growth of electrolytic hydrogen.”

In June the American Clean Power Association released a green hydrogen policy recommendation that advocated for the gradual phase-in of hourly matching. The trade group’s framework is intended to help investors start the project development process under annual time-matching, so long as projects begin construction before Jan. 1, 2029. The proposal transitions to hourly matching for projects beginning construction after Dec. 31, 2028.

ACP said its phase-in approach allows the cost curve to decline for green hydrogen due to greater scale and maturity and offers “a compromise between supporting early-market development of green hydrogen while ensuring its production does not exacerbate the current climate crisis.”

NextEra Energy, the largest clean power producer in the U.S., has also pushed for a slower phase-in to hourly matching.

“Starting off with annual matching will jumpstart green hydrogen, leading to more investment and greater overall decarbonization potential over the next five years,” the energy company said.

Jesse Jenkins, an assistant professor and ZERO Lab lead at Princeton University, said a slower phase-in could result in projects coming online as late as 2032 receiving tax credits through 2041. Based on analysis by ZERO Lab cited by Jenkins, ACP’s recommendation could lead to significant system-level emissions increases.

Jenkins discussed his findings on the Factor This! podcast from Renewable Energy World, and acknowledges that some kind of phase-in to hourly matching requirements could be necessary to get the U.S. green hydrogen industry off the ground. But he said grandfathering projects through 2028 “would be a devastating outcome that directly contradicts the statutory intent of the Section 45V clean hydrogen tax credit and imperils U.S. climate goals.”

In June a group of 11 leading hydrogen and renewable energy companies wrote a letter calling on the Biden administration to adopt hourly time-matching standards. The group, which included Electric Hydrogen, Avantus and First Solar, called for a brief transition from annual to hourly accounting.

“A slower transition with grandfathering will saddle the U.S. with inflexible infrastructure that will increase emissions and exacerbate grid congestion,” the group wrote.

Other research suggests the emissions divide between hourly and annual matching could be negligible while leading to significantly higher production costs.The consultancy E3, on behalf of the American Council on Renewable Energy found that under 34 of 40 scenarios in ERCOT, MISO, PJM, and SPP, annual matching would induce CO2 emissions of less than 0.45 kg CO2 e/kg H2.

In 25 scenarios, emissions were lower under the annual matching approach than under the hourly matching approach (the matched clean energy production saves more emissions than the hydrogen load causes).

For all scenarios, across all markets, years, and renewable portfolio assumptions, hydrogen production costs were found to be higher under an hourly matching requirement than under an annual matching requirement. Hydrogen production costs under an hourly approach were modeled to be 14% to 108% higher than under an annual approach with the same renewable generation portfolio, E3 found.

King said two issues come up around hourly matching. First, the cost of the electricity can be higher, but King said that can be mitigated with a number of different techniques, including overbuilding wind and solar and selling excess electricity back to the grid.

“That works in some regions, less well in other regions,” he noted.

Second, the viability of hourly matching needs to be demonstrated. Right now, King said hourly renewable energy certificates (RECs) are only available in some markets.PJM, for example, began offering hourly matching in March.

King said a voluntary tracking system called M-RETS has been tracking hourly RECs since 2019 and has over 120 million hourly RECs in its system.

In its letter to federal officials, the group of 11 hydrogen and renewable energy companies said hourly matching is no more complex to implement than annual matching.

“Realistically, it should not take longer than 18-36 months to accomplish broader registry adoption,” the group said. “A short transition period to allow time for implementation of hourly tracking would not meaningfully increase system level emissions or grid congestion problems.”

King said the M-RETS system is available almost nationwide but hasn’t been used in regulatory settings.

“It’s not that complicated to timestamp your generation,” he said. “It’s really just the question of turning that switch on and giving investors and regulators some degree of confidence in that system.”