Why the hydrogen tax credit has become a lightning rod for controversy

One of the most generous tax credits in Biden’s landmark climate bill, the Inflation Reduction Act, is the production tax credit for making hydrogen, which is worth as much as $100 billion.

When hydrogen is used in a fuel cell to generate electricity, water is the only by-product. Generating energy from hydrogen this way does not create carbon dioxide, one of the primary greenhouse gases that causes global warming. Also, hydrogen is a vehicle for storing energy over long periods of time.

Hydrogen is already produced at scale for use in making fertilizer and in the petrochemical industry. But more recently, hydrogen is being seen as a way to decarbonize industries like maritime shipping, long-haul trucking, steel-making, industrial heating, and aerospace. Also, its capacity as an effective way of storing energy makes it attractive for renewable energy sources, like wind and solar, which are inherently intermittent — wind turbines make energy when the wind blows, and solar panels make energy when the sun shines.

However, the only way hydrogen can be a viable solution for reducing carbon emissions is if it can be produced without releasing greenhouse gas emissions. By and large, that’s not the case today.

The proposed tax credit, 45V, is meant to turbocharge the production of low-emissions hydrogen. It’s now up to the Treasury to figure out how to implement it — and that’s the tricky part. The debate centers around how best to write rules that make sure that the hydrogen produced is actually clean so that it can be used as a climate-mitigation tool.

“The IRA’s section 45V production tax credit is the most generous clean hydrogen subsidy in the world,” Jesse Jenkins, professor of macro-scale energy systems at Princeton University, told CNBC.

“But without proper implementation, 45V could backfire, wasting a tremendous opportunity for the United States to become a global leader in new clean industries and causing a significant increase in domestic emissions that imperil U.S. climate goals.”

The adjudication of the hydrogen tax credit has become about more than just the hydrogen tax credit, too. It could also set important precedents for how the government decides electricity used from the grid is really “clean.”

“The hydrogen debate is at its surface level about defining clean hydrogen production, but more fundamentally it’s about what an individual actor needs to do to credibly claim that their electricity consumption is clean,” Wilson Ricks, who works in Jenkins’ Zero-carbon Energy systems Research and Optimization research lab at Princeton, told CNBC.

“Hydrogen is the first time the US government has been forced to directly address the question of verifying clean electricity inputs, so whatever framework it endorses here could set a very strong example for other emissions accounting systems going forward,” Ricks said.

There’s a lot of money on the line and while the details of the debate get a bit wonky, the debate itself represents a larger and more ideological fault line about how the United States should built its clean economy: One side says we should focus on emissions reductions from the outset, while the other says the foundation should be built and scaled quickly and perfected later.

“We have now entered a new phase in the clean energy transition, whereby new solutions and operational paradigms are necessary to accommodate an increasingly renewable grid and catalyze decarbonization. The clean hydrogen tax credits are a major opportunity, and juncture, to start shaping that new phase in the right way,” Rachel Fakhry, the policy director for emerging technologies at the Natural Resources Defense Council, told CNBC.

Hydrogen is the simplest element and the most abundant substance in the universe, but hydrogen atoms do not exist on their own on Earth. Hydrogen atoms are generally stuck to other atoms — like for example in water, H2O — and so creating sources of pure hydrogen on Earth requires energy to break those molecular bonds.

In the energy business, people refer to hydrogen by an array of colors to as shorthand for how it was produced. The different methods produce varying amounts of CO2.

The amount of the hydrogen tax credit, which is available for 10 years, depends on the emissions generated in making hydrogen. If hydrogen is produced without releasing any carbon emissions, the tax credit is maxed out at $3 per kilogram of hydrogen. The tax credit scales down proportionally based on the quantity of emissions released.

One way of making hydrogen is with a process called electrolysis, when electricity is passed through a substance to force a chemical change — in this case, splitting H2O into hydrogen and oxygen. To make hydrogen with electrolysis, hydrogen producers may use electricity from the larger energy grid. The electricity on the grid comes from many sources, some clean, like a solar farm, and some dirty, like from a coal-fired plant. On the electric grid, all that electricity gets mixed together.

So the debate over the 45V tax credit has become acutely focused on accounting for how the electricity hydrogen producers use from the grid is accounted for. If the energy used to make hydrogen is not actually clean, then hydrogen is not really a climate solution.

Some hydrogen industry stakeholders want the Treasury to implement strict electricity accounting standards to maximize the likelihood that the tax credits only go to hydrogen that is produced with the least possible amount of emissions.

Others want the Treasury to implement very flexible standards so the hydrogen industry can grow as fast as possible as quickly as possible, then focus on emissions reduction once it’s scaled.

Energy used from the grid to power electrolysis to make clean, “green hydrogen” must meet three accounting standards in order to ensure that it is actually produced in a clean way, according to Jenkins from Princeton. These standards have become known as the “three pillars:”

• Additionality. The electricity has to come from newly-built sources of clean electricity, meaning it is additional clean energy being added to the grid for the purpose of making hydrogen.
• Regional deliverability. The clean electricity added to the grid has to be able to physically travel from the additional clean energy source to the electrolysis facility, meaning it is regionally deliverable electricity.
• Hourly matching. The additional and deliverable clean electricity that powers electrolyzers has to be accounted for on an hourly basis. If the electricity is accounted for on an annual basis, then electrolyzers used to generate hydrogen could be running when additional clean energy is not regionally available — when the wind isn’t blowing and the sun isn’t shining, for example. That means those electrolyzers could be powered by fossil fuels.

“We call these requirements ‘pillars’ because all three are structurally critical: remove any one and the whole ‘clean’ hydrogen house comes tumbling down,” Jenkins told CNBC.

“Peer-reviewed modeling work by our group and follow-up studies by other academics have shown that simply plugging electrolyzers into the grid would produce hydrogen with embodied emissions twice as bad as ‘grey’ hydrogen produced from fossil methane. In fact, even an electrolyzer getting just 2% of its electricity from natural gas plants or less than 1% from coal would violate the strict statutory emissions requirements to claim the $3 per kilogram subsidy,” Jenkins said.

Some companies in the hydrogen industry, including electrolyzer producer Electric Hydrogen, clean energy company Intersect Power, industrial heat and power company Rondo, and grid carbon data provider Singularity have publicly pleaded for the Treasury to adopt these “three pillars” of strict electricity accounting for the 45V hydrogen tax credit.

Air Products, an 80-year old company that sells gases and chemicals for industrial uses, also supports the three pillars of additionality, regional deliverability and hourly matching for the 45V tax credits. Air Products operates in about 50 countries around the globe, has over 200,000 customers, over 110 production facilities around the globe for hydrogen, and already has over 700 miles of dedicated hydrogen pipelines.

“We’ve been producing, distributing, dispensing hydrogen for over 60 years,” Eric Guter, a vice president of hydrogen production at Air Products, told CNBC in a video interview at the end of August.

“If we don’t deliver on the emissions reduction, we will lose the confidence of society in hydrogen and the energy transition. And as a long-term provider of hydrogen, it’s important to us that we get it right and preserve the integrity of the energy transition and the hydrogen industry.”

Air Products already has two projects under construction that will be compliant with the three-pillars approach. Air Products is part owner of the NEOM Green Hydrogen Company, which is currently building a plant at Oxagon, Saudi Arabia, and which will be three pillars complaint. It’s also part owner of a mega-scale renewable-power-to-hydrogen project in Wilbarger County, Texas.

The European Union will need to import hydrogen, and has already decided to institute the “three pillars” in its hydrogen accounting, Guter told CNBC. So Air Products wants hydrogen produced in the United States to meet international standards.

“Otherwise our products won’t qualify or they will be taxed at the EU border for imports,” Guter said. “We’re talking about a global liftoff, not just U.S. liftoff, of the hydrogen market.”

On the other side of the debate, utility company and energy giant NextEra wants the Treasury to accept annual — as opposed to hourly — matching RECs as sufficiently specific.

“Starting with annual matching would boost green hydrogen investment and lead to greater overall decarbonization potential, allowing the industry to develop the first wave of hydrogen projects and build industry knowledge. If an hourly matching is enacted too early, it will limit U.S. green hydrogen investment, production and the country’s ability to lower emissions, and stifle innovation,” Phil Musser, vice president of federal government affairs at NextEra Energy, told CNBC in a written statement from.   

So, too, does the Clean Hydrogen Future Coalition, which is a trade group representing a diversity of stakeholders from BP to Duke Energy, Exxon Mobile, General Electric, Siemens Energy, American Clean Power, Shell and more. The Clean Hydrogen Future Coalition also says that no additionality should be required for companies looking to produce clean hydrogen, meaning companies do not have to be responsible for putting “additional” clean energy on the grid to get access to the tax credit.

“We’re not suggesting that we should do this indefinitely,” Shannon Angielski, president of the Clean Hydrogen Future Coalition, told CNBC in a video interview at the end of August. “Rather, let the industry start to make investments in that full ecosystem, send signals throughout that supply chain to make investments, and enable an industry to get seeded with the tax credits, and then over time, become more restrictive.”

The Clean Hydrogen Future Coalition proposes becoming more restrictive in those electricity accounting standards starting in 2030. The electricity accounting systems for monitoring electricity usage on a more granular level is not robust and standardized enough on a federal level, Angielski said, for hourly matching electricity accounting to be required.

But technology does exist to allow hourly matching, Wenbo Shi, the CEO of Singularity, told CNBC. His company makes that technology.

“Hourly and even sub-hourly clean energy matching is not only technologically feasible, but it is already being implemented and used by many. The barrier to adoption is not technology, but policy,” Shi told CNBC.

There are also barriers to getting additional sources of clean energy on the electric grid, Angielski told CNBC. For example, interconnection queues, which are the lines power generators have to wait on to apply to get new sources of clean energy connected to the grid, are years long and make the additionality requirement a barrier for the hydrogen industry.

“What we don’t want to do is wait to be able to actually start investing in low-carbon hydrogen,” Angielski said.

But Ricks doesn’t think there needs to be such a rush.

“The ‘order of operations’ for the energy transition has always been a subject of debate in the policy world: should we use our resources to push rapid near-term decarbonization, or instead support scale-up of nascent technologies that we think we’ll need in the future? Supporters of lax rules for hydrogen subsidies have sought to frame the debate in this way, but in this case it is a false choice,” Ricks told CNBC. “The hydrogen subsidies are large enough to support scale-up even with strict rules, and the absence of these rules would likely drive significant excess emissions for decades — hardly a near-term impact.”

Fakhry from the NRDC says it’s very possible that the IRA is going to incentivize more hydrogen than needed for the clean energy transition, especially depending on how the Treasury dictates the rules.

“It’s really hard to say if there will be excess or not. What we can say for sure is if the rules are very, very lax and hydrogen production can happen anywhere without any guardrails, then yes, we will have a lot of hydrogen production that will go to fairly bad end uses,” Fakhry told CNBC.