Hydrogen is the most abundant element in the universe and it is critical to global decarbonization efforts. Hydrogen is an essential industrial feedstock in fertilizer production, as well as oil and gas refining. Additionally, hydrogen can serve as an energy-carrier if it is produced with low carbon electricity and burned later.[1] Hydrogen can be blended into existing natural gas fired power plants or converted to longer chain molecules such as ammonia and methanol, all of which can be burned in specialized engines. The world produces 95 million metric tons of hydrogen through an energy and carbon intensive process of cracking natural gas molecules. The IEA estimates that we will need to produce as much as 450 MMT of low carbon hydrogen by 2050 to meet growing energy and industrial demand.[2] All of this will need to be produced cleanly with renewables and nuclear power to avoid increasing already high levels of atmospheric carbon dioxide.

Policy support for hydrogen in the United States has been hot and cold, with an initial wave of enthusiasm, public funding, and support cresting during the George W. Bush administration. Lackluster enthusiasm was due to the absence of financial support to drive down the cost of production, slow improvements in the efficiency of hydrogen production technology, and lack of demand support. However, the historic 2022 Inflation Reduction Act kicked off a new round of excitement for low carbon hydrogen with the inclusion of a robust 45V production tax credit (“PTC”).[3] If a taxpayer produces hydrogen at the cleanest tier and meets the domestic labor requirements, they can earn $3 per kilogram. This will bring down the cost of clean hydrogen from about $8-6/kg, but it is still more expensive than traditionally produced fossil-fuel hydrogen which costs about $1-2/kg.[4]

Taxpayers looking to take advantage of the PTC had to wait more than 15 months between the signing of the bill in August 2022 and the release of draft IRS guidance in December 2023.[5] This delay was likely due to the significant controversy surrounding how the tax credit should be structured, as well as the technical and financial complexity of designing a sliding scale emissions standard for a product that can be produced in a number of different ways and with different fuel sources. DC residents, for example, were subject to significant advertisements from companies and NGOs advocating for either stronger or weaker tax credit guidance.[6]

The draft guidance rests on three key pillars that aim to ensure the environmental integrity of the PTC while spurring development of this nascent commodity. First, to be considered clean hydrogen it must be produced from low carbon electricity generated at a plant that was placed in service no more than 36 months prior to the hydrogen facility.[7] Known as additionality (or incrementality), this pillar aims to ensure that existing low carbon electricity is not being diverted from decarbonizing the rest of the grid to power new hydrogen production. A weak additionality pillar would likely increase overall grid emissions as fossil fuel, mainly natural gas, ramps up to backfill electricity production otherwise used in hydrogen production.[8]

This requirement, largely supported by the environmental community, has been strongly opposed by the nuclear power industry on two grounds. One, they argue that existing nuclear, a zero-emitting resource, should qualify as an eligible fuel source for clean hydrogen and that the text of the IRA makes no distinction between new and existing resources.[9]Second, they argue that the bill allows for stacking the 45V PTC with the revamped existing nuclear power PTC (45U), and therefore the IRS is exceeding their congressional authority and acting in an arbitrary and capricious manner by requiring that hydrogen be produced from new or incremental nuclear power.[10] The Nuclear Energy Institute raised these concerns in their comment letter, noting that the IRS is likely foreclosed in their interpretation by the so-called Major Questions Doctrine because the IRS is attempting to regulate an area that it is not an expert in.[11]

Proponents of a strong additionality requirement argue that the term “life cycle emissions” as used in the statute and defined in the Clean Air Act, mandates consideration of the “induced grid emissions” on a life cycle basis. They also claim that IRS guidance satisfied Congressional intent, which was to bolster the clean hydrogen industry and reduce emissions economy-wide.[12]  While the final regulations have yet to be published, expect this pillar to be a major source of litigation which may delay full implementation of the PTC and undermine investor confidence in this nascent industry.

The second pillar is just as contested. It requires temporal matching between the production of clean electricity and when the hydrogen is produced. This mechanism is designed to avoid claiming hydrogen as clean when in fact it was produced from fossil fuels.[13] The draft regulation calls for annual temporal matching until 2028, requiring that hydrogen producers show that they have acquired enough additional clean energy needed to produce the hydrogen they are claiming the credit for on an annual basis. However, starting in 2028, hydrogen facilities will have to prove hourly matching and there will be no grandfathering of existing systems that are using the annual system. In comments, the American Clean Power Association strongly rejected this as a viable approach to spurring investment in the industry.[14]ACP notes that without grandfathering and a transition period, first-movers will develop projects under the future hourly matching regime, resulting in fewer projects built given cost and technology limitations.[15]  Environmental NGOs, on the other hand, argue that hourly matching is critical to ensuring the environmental integrity of the PTC and that the credit is generous enough to induce additional clean energy demand on the market to alleviate cost concerns.[16] This will also likely be a point of litigation after the final rules are published, with renewable energy developers challenging the IRS’s statutory authority to implement a policy that switches mid-stream from annual to hourly.

Finally, geographic matching requires that clean energy be generated within a particular geographic area to qualify. IRS uses the DOE’s National Transmission Needs Study, which broadly clumps states into multi-state regions, except for California, New York, and Texas. Geographic matching is essential to prevent producers from claiming credit for clean hydrogen when the electricity used to generate it was not actually produced in the region in which the hydrogen facility is located. This pillar has garnered less opposition from industry proponents but has raised concerns from states with ambitious climate decarbonization targets, such as Massachusetts.[17] The Bay State is concerned that a strict geographic requirement will harm states and regions that have already implemented robust carbon emissions compliance and reduction requirements. These state policies result in more expensive electricity, disincentivizing hydrogen producers from locating in their state if subjected to the matching requirement. One suggested solution is to allow for greater geographic flexibility and retirement of credits produced in one region but used in another, so long as the grids are interconnected and capable of sharing electrons across regions.[18]

The comment period closed on February 26 and IRS received close to 30,000 comments on the draft guidance. The agency will now review and incorporate feedback into a final rule, but taxpayers can’t rely on the draft regulations until the final regulations are published. This guidance is likely one of the most controversial IRS guidelines to come out of the IRA. Both of West Virginia’s Senators, Joe Manchin and Shelley Moore Capito, have expressed concerns about the stringency of the regulations and their potential effect on this nascent industry.[19] Environmental groups maintain that only strict guardrails on the PTC will ensure that hydrogen is in fact clean and does not increase economy-wide emissions. Ultimately, final guidelines will be challenged in the courts and, given the complexity of the technical issues and the emergence of novel legal theories to challenge agency action, there is no predicting how this will ultimately resolve itself. Meanwhile, clean hydrogen investors, developers, and consumers wait on the sidelines.

 

[1] Galen Bower et. al., Clean Hydrogen: A Versatile Tool for Decarbonization, Rhodium Group (Sept. 9, 2021).

[2] Internation Energy Agency, Global Hydrogen Review 2023.

[3] Inflation Reduction Act of 2022, Pub. L. No. 117-169, 136 Stat. 1946.

[4] Kamala Schelling, Green Hydrogen to undercut Gray Sibling by End of Decade, Bloomberg New Energy Finance (Aug. 9, 2023).

[5] Prop. Treas. Reg. §1.45V-1(a)(2), 88 Fed. Reg. 89220, 89244 (Dec. 26, 2023).

[6] Maxine Joselow, The advertising blitz behind Biden’s hydrogen tax credits, Wash. Post (July 21, 2023).

[7] Supra note 4 at 89229.

[8] Angelina Bellino, Harrison Branner, Cameron Movahhedian, Lauren Slawsky, Mackay Miller, ”Assessment of Grid Connected Hydrogen Procution Impacts”, at 3, ERM (Feb. 2024), https://www.erm.com/globalassets/documents/publications/assessment-ofgrid/assessment-of-grid-connected-h2-electrolysis-impact_part-i_lit-review_final.pdf.

[9] Nuclear Energy Institute, NEI’s Comments on Proposed Section 45V Clean Hydrogen Regulations (Reg-117631-23), at 2 (Feb. 26, 2024).

[10] Id. at 3.

[11]Id. at 2.

[12] Natural Resources Dense Council, Re: The Notice of Proposed Rulemaking for Section 45V Credit for Production of Clean Hydrogen, published in the Federal Register on 12/26/2023. Comments focused on the electrolytic hydrogen production pathway, at 18-19, Feb. 26, 2024.

[13] Supra note 4 at 89232-33.

[14] American Clean Power Association, Re: Section 45V Credit for Production of Clean Hydrogen; Section 48(a)(15) Election to Treat Clean Hydrogen Production Facilities as Energy Property, at 17, Feb. 26, 2024.

[15] Id. at 17-18.

[16] Supra note 4 at 36-37.

[17] Commonwealth of Massachusetts Department of Energy Resources, IRS Docket No. REG-117631023 – Comments in Response to Section 45V Credit for Production of Clean Hydrogen, Section 48(a)(15) Election to Treat Clean Hydrogen Production Facilities as Energy Property, Feb. 26, 2024.

[18] Id. at 2-4.

[19] See Steven Allend Adams, Manchin and Capito: W.Va hydrogen projects at risk due to tax credit restrictions, The Parkersburg News and Sentinel (Dec. 27, 2023).