Zero-Carbon Hydrogen Tax Rules Spark Divide Over Grid Emissions

Proposed rules governing a new production tax credit for clean hydrogen have raised fresh skepticism from industry about whether the Biden administration can meet its decarbonization goals.

The Treasury Department’s much-anticipated proposal in December would require hydrogen producers to prove they’re sourcing electricity from new sources of power and, by 2028, to match their production to clean power generation on an hourly basis. Producers would also need to show they are sourcing power from a plant in the same region of the country.

The guidance effectively excludes nuclear and hydropower—energy sources that are difficult or expensive to build quickly—while intermittent wind and solar energy can’t produce 24 hours a day.

The Treasury’s so-called three pillars approach largely sided with environmental groups and frustrated hydrogen advocates who want the ability to plug into the grid today and match emissions on an annual basis.

“The guidance, as proposed, is overly restrictive to the point that I do think it will stifle innovation in this space,” said Traci Kraus, director of government relations for Cummins Inc.

The Indiana-based company’s zero-emissions business, Accelera by Cummins, has moved aggressively into low-carbon fuels like hydrogen, opening an electrolyzer assembly line in Minnesota that both President Joe Biden and Energy Secretary Jennifer Granholm visited last year. But whether the company can expand the facility to produce more electrolyzers, which use electricity to split water into hydrogen and oxygen, depends on opening up the tax credit to more projects, Kraus said.

“Customers are still waiting—they are not ready to invest significantly beyond what they have already said,” Kraus said. “We aren’t seeing the demand we think we would have,” if the guidance had been more flexible.

Emissions Now or Later

The 45V hydrogen production tax credit, established by the Inflation Reduction Act of 2022, promises as much as $3 per kilogram for hydrogen that meets certain emissions standards. Hydrogen is seen as a fuel that can replace fossil fuels in carbon-intensive industries such as ammonia, steel, maritime shipping, and heavy-duty trucking.

The tax credit debate boils down to what is legally durable and economically feasible. The Treasury Department ultimately decided the short-term emissions increases from drawing electricity from a power grid still run by fossil fuels would fail to meet the climate law’s standards of emissions reductions.

Without the three pillars, “emissions would increase on the grid, in violation of the IRA,” said Rachel Fakhry, a policy director in the climate and clean energy program at the Natural Resources Defense Council. “Legally speaking, they were driven in that direction. The case they made is very strong.”

Economics are another matter, industry advocates say.

Hydrogen experts at the department were “fully aligned” that some hydrogen capacity should be allowed to operate beyond 2028 without adhering to the three pillars of power sourcing, said Jason Munster, a former Energy Department employee who conducted commercial analysis for hydrogen and is now a hydrogen industry consultant.

If 10 gigawatts of power could be grandfathered into the 2028 requirements, Munster found, hydrogen projects could economically source from zero-carbon power sources. Without it, hydrogen sourced from electricity is likely kneecapped, he said.

“The goal was to ensure that the US electrolyzer market was kicked off aggressively,” Munster said. Instead, Treasury officials “insisted that the initial emissions bump is going to be a much bigger problem than anything else,” Munster said.

The Energy Department and Treasury Department declined to comment on Munster’s characterizations.

Innovation Sapped?

Some hydrogen companies pressed for the stricter guardrails. Just before the guidance was published last month, seven companies—a mix of established players, startups, and renewable companies—signed a letter to Biden administration officials backing the three pillars.

“Our companies are already developing and executing large-scale hydrogen projects that comply with the three pillars,” the letter stated. “We urge you to be skeptical of claims that proposed strong guidance will kill the industry. This is demonstrably false.”

Such views are the minority of the hydrogen industry, said Frank Wolak, president and CEO of the Fuel Cell and Hydrogen Energy Association, a trade association that includes three companies behind the letter: Air Products, Hy Stor Energy, and Electric Hydrogen. Those companies “are the outliers among our members” that total nearly 100 companies, Wolak said.

The tax guidance saps much of the innovation from the industry if they’re not allowed to use grid power in the early years, Wolak said. Projects will either be a few massive collocated electrolyzers connected to a solar or wind facility or will look to rely on natural gas-sourced hydrogen.

“That ecosystem for building demand and instilling innovation and getting early-stage decarbonization getting close to where it’s needed is missed entirely,” Wolak said. “This guidance woefully falls short of what is needed to stimulate our hydrogen industry in the United States, achieve the goals of the IRA, and actually build the momentum that’s going to be needed to use hydrogen to drive decarbonization.”

Others have raised the prospect of strict green hydrogen rules pushing investment into projects that instead source hydrogen from natural gas paired with carbon capture equipment. The 45Q carbon capture tax credit was increased by the IRA and could be attractive for producers, said Kyle J. Hayes, a partner at Foley & Lardner LLP.

Would-be operators of hydrogen facilities are currently “taking a closer look at how 45Q might pencil out instead,” Hayes said.

“I don’t want to definitively say the whole industry is turning their heads in the direction of blue hydrogen, but I do think that certainly some of the strategics who were already thinking about 45Q as a path forward are definitely looking at it more.”

Flexibility Possible

Treasury is seeking comment on possible pathways for grid power sources to qualify. Facilities that would otherwise close—such as an economically struggling nuclear reactor or hydroelectric dam slated to retire instead of relicensing—could potentially be considered a new source of power, officials said.

The department is also considering allowing 5% to 10% of all existing clean power to count toward 45V compliance, reasoning that percentage could be a proxy for the amount of zero-emissions power curtailed or at risk of closure today. Fakhry, of the NRDC, said that would be “dashing the whole purpose” of the three pillars.

Public comments on the proposed rule are due Feb. 26.

Hydrogen companies will continue to press their case that the guidance is inconsistent with other Biden administration policies, said Kraus of Cummins.

The Biden-backed bipartisan infrastructure law of 2021 allocated $9.5 billion to the Energy Department to fund hydrogen initiatives, including seven regional hydrogen hubs. Several of those hubs rely on nuclear and hydropower to run electrolyzers, and Biden invoked the Defense Production Act in 2022 to boost US manufacturing of electrolyzers.

The Environmental Protection Agency is also leaning on hydrogen scale-up as a potential pathway for plants to comply with its proposed power plant rule.

“I definitely see some inconsistencies and incongruities there” that the Biden administration will have to address, Kraus said.