Clean hydrogen industry future depends on IRA tax credit

In August, the White House passed a historic piece of legislation with $369 billion in spending to address climate change. One of the most significant tax credits in that historic law was a tax credit to make hydrogen in climate-conscious ways.

Hydrogen is currently used for many purposes, including making ammonia-based fertilizer, which the world depends on for growing crops, and for refining crude oil into useful petroleum products. But it’s also likened to a “Swiss Army Knife of decarbonization” because it could be used as a power source in industries that are particularly hard to wean off fossil fuels, like airplanes and heavy shipping.

The impact of the tax credit on emissions reductions depends on how federal agencies implement it. As with most things in accounting, the devil lies in the details.

On one side of the debate, some energy providers say that making the rules too strict could kill the clean hydrogen industry before it ever gets off the ground.

“Our view is that if you put too onerous of regulations in place…the price to produce green hydrogen will be uneconomic and the industry won’t scale, effectively making it dead on arrival,” says a spokesperson for NextEra Energy, which produces clean energy from wind, solar and nuclear sources and owns a major utility in Florida.

On the other side, environmental policy groups argue that the rules could end up being so lax that the new “clean” hydrogen industry could actually end up increasing, rather than decreasing, carbon emissions.

“Weak guidance could…force Treasury to spend more than $100 billion in subsidies for hydrogen projects that result in increased net emissions, in direct conflict with statutory requirements and tarnishing the reputation of the nascent ‘clean’ hydrogen industry,” according to an open letter 18 organizations sent to federal agencies.

“With loose rules and weak lifecycle greenhouse gas emissions analyses for hydrogen production, the hydrogen tax credit could end up going to producers whose hydrogen is not actually lower-emissions than the alternatives, and could even end up having the indirect effect of increasing emissions from the electricity grid,” explained Emily Kent, who covers fuel sources for the Clean Air Task Force, a climate policy shop that signed on to the letter.

The debate has put Electric Hydrogen CEO Raffi Garabedian into an awkward situation.

Garabedian’s startup is working to produce a type of electrolyzer to split water into hydrogen and oxygen, and has received funding from Bill Gates‘ climate investment firm, Breakthrough Energy Ventures, among others. With a loose interpretation of the tax credit rules, demand would jump for electrolyzers as companies raced to cash in on the new credit.

But in the long run, if the industry actually increases rather than reduces carbon emissions, the public would eventually demand an end to the subsidies, potentially tarnishing the entire idea of “clean” hydrogen.

“I’d love to sell electrolyzers to everybody, but not for the wrong reason. Not if it’s going to be installed and run in a way that’s more carbon-intensive than the alternatives,” Garabedian said.

The U.S. Treasury and the Internal Revenue Service are hashing out how the tax credit will be executed, and their request for public comment drew input from from energy giants like BP and Shell, industry associations like the Renewable Fuels Association and the American Gas Association, and scores of others.

The amount of the tax credit will depend on how much CO2 is emitted when a particular producer makes hydrogen. The debate is over how to account for that CO2.

On the energy grid, electricity generated in any number of ways — by burning coal or natural gas, or capturing wind or solar energy — gets sloshed together. A renewable energy certificate, or REC, is a legal certificate that proves a particular energy producer created a certain amount of renewable energy.

Not all RECs are the same, however. Some are measured annually, while others are measured in much smaller increments.

The divide over the hydrogen tax credit comes down to which kind of RECs should be permitted.

BP America, for example, wants annual RECs to be allowed, according to its public comment to the IRS. The annual RECs are a more flexible way of implementing the tax law, which would help spur investment necessary to get the industry off the ground. That’s important for BP, which plans to spend between $27.5 and $32.5 billion on a combination of what the energy company deems its transition growth engines, including hydrogen production and renewables, between 2023 and 2030.

“The rule should allow for flexibility to help jump start this nascent industry. The ability to match renewable energy production to the hydrogen production demand over an annual basis would provide the most flexibility,” BP said in its statement to the IRS.

NextEra argues that requiring more granular accounting — like hourly — would make it impossible to create green hydrogen economically, and would instead favor so-called “blue” hydrogen, which is generated from burning natural gas or other fossil fuels.

“Requiring time matching that is too granular (such as hourly) would devastate the economics of green hydrogen by providing a significant advantage to blue hydrogen and reliance on fossil fuels, and does not align with legislative intent to accelerate progress towards a clean hydrogen economy,” David P. Reuter, chief communications officer at NextEra, told CNBC.

Reuter pointed to an analysis from the global consultancy company Wood Mackenzie showing that annual credits would allow the electrolyzers that produce hydrogen to run all the time, and that hourly matching would make the cost of hydrogen production more expensive.

“An hourly approach would be constrictive and ensure that a nascent industry is strangled before it gets started,” Reuter said.

The environmental groups say that using fossil fuels to power an electrolyzer to make hydrogen is actually much worse for the climate than today’s method of using natural gas in a steam methane reformer process.

These climate-focused groups are advocating hourly REC standards, and what’s called “additionality and deliverability,” which would serve to ensure that the energy used to power an electrolyzer to generate hydrogen is in fact clean energy.

First and foremost, hourly accounting would allow hydrogen producers to claim renewable energy credits only if clean energy is being generated at the same hour when they are consuming it — when the wind is blowing, the sun is shining, or a nuclear power plant is generating energy on the relevant transmission system.

This hourly approach to energy accounting has been adopted by Google, which has been a forerunner in adopting clean energy, for example.

Today, hourly RECs are available only in some markets. But Beth Deane, the chief legal officer at Electric Hydrogen, told CNBC she expects other registries to provide their own hourly RECs as soon as demand for the more rigorous accounting standards are demanded outside of the hydrogen tax credit debate. It takes between 12 and 18 months to stand up an hourly matching accounting system, but at least 24 months for large scale hydrogen production to be started, according to the open letter from the climate groups. In the meantime, M-RETS, a non-profit and the largest North American credit tracking system, can provide hourly REC tracking across North America as a service.

“Additionality” means that credits could not be counted for clean energy that would have been generated anyways.

“Deliverability” means that credits could only be counted for clean energy that’s actually being generated in a location that is connected via a transmission line that is not already congested, to where the hydrogen producer is using the electrolyzer to produce hydrogen.

Forcing hydrogen producers to match their energy consumption hourly and on a location specific basis will is “a better approximation of reality,” said Deane.

“When it’s on the grid, an electron is electron, it doesn’t have a color, but it does have a history, and you’re trying to make the history match up so that you have some validity to your to your claim that it is clean, and therefore should be eligible for a tax benefit.”

Jesse Jenkins, a Princeton professor who studies macro-energy grids, agrees that the more rigorous accounting is necessary.

“Our peer reviewed research is pretty definitive on this front: hourly matching, additionality, and physical deliverability are all required to ensure grid connected electrolysis can meet the stringent requirements set by the IRA statute. Our research demonstrates that removing any one of those criteria results in significant emissions,”

Without this trifecta of accounting standards, hydrogen producers could run their electrolyzers 24-7, drawing from fossil fuel sources at night or when there is no wind energy, then claim to offset it by getting credits from wind farms or solar farms that would’ve produced that energy anyway, explains Wilson Ricks, who works in Jenkins’ research lab.

An imbalance in supply and demand for RECs is also a factor. Right now, there are more RECs being produced than the market wants, which means hydrogen producers could simply grab existing RECs without incentivizing any new clean energy creation.

“There’s a massive national gap between the total number of clean certificates generated and the total demand for these certificates,” said Ricks. “I’m even surprised how large it is. If this is any indicator, there will be plenty of headroom for hydrogen producers to buy up annual RECs without needing to bring any new zero-carbon generation online.”

So far, federal agencies aren’t taking a clear side. The Treasury and IRS will implement the tax benefit such that it “advances the goals of increasing energy security and combatting climate change,” a spokesperson for the Treasury told CNBC.

In the long run, Garabedian says, his stance is about protecting his company, the industry’s reputation, and the tax credit.

“We have to do it right. Otherwise, this entire proposition of green hydrogen is gonna get a black eye. We have to do the right thing for the long term if we’re going to be true to our intention here, which is decarbonization,” Garabedian told CNBC. “If we emit more carbon as a result of this than we were before, that’s a travesty. And the result of that travesty is people will wake up to it, NGOs will wake up to it, environmentalists will wake up to it, and the subsidy will get shut down. So there’s a practical reason to hold the high ground. There’s also an ethical reason.”