Success of IRA Hydrogen Tax Credit Hinges on IRS and DOE

I recently returned from Egypt where I attended COP27. It was hard to miss the hubbub produced by the clean hydrogen production tax credits (PTC) in the Inflation Reduction Act (IRA). Industry, governments, civil society, and businesses are all closely tracking developments, conscious of the sea change that the PTC is already producing in the global hydrogen market. It is now widely accepted that the U.S. will quickly become one the most – if not the most—lucrative market for the nascent clean hydrogen industry. And it underscores how vitally important it is for the U.S. to implement the tax credits well, ensuring that clean hydrogen is actually “clean” and steering the market in a direction aligned with climate goals.

This is no easy feat. The tax credits are linked to the emissions intensity of the hydrogen source, but accurately determining this emissions intensity can be complicated. For example, electrolyzers connected to the grid guzzle grid electricity whose carbon intensity varies by the hour as a blend of clean energy and fossil fuels generate power. Therefore, and as we have written before, whether the tax credits will be a climate hit or miss almost entirely hinges on the guidelines that the IRS and Department of Energy (DOE) will enforce on hydrogen producers to account for their emissions.

The stakes and risks are high. A weak emissions accounting system for grid-connected electrolyzers would dole out large subsidies to dirty hydrogen sources and:

• Increase emissions and jeopardize U.S. ability to achieve its 2030 and 2050 climate goals. Our colleagues at RMI estimate that emissions could increase by half a gigaton of carbon over the lifetime of the tax credit; this is equivalent to nearly half the emissions produced by the entire U.S. power sector today; and
• Undermine confidence in clean hydrogen as a climate solution and taint the industry’s potentially positive climate impact, dragging it down on arrival.

The good news is that this can be done well. IRS and DOE can adopt a system that is both rigorous and affordable.   We worked with our colleagues at RMI and other partners to outline the pillars of such a system in recent comments to Treasury. I summarize those below.

Grid-Connected Electrolyzers Can Increase Emissions on the Grid. A Weak System Would Reward Them for It.

The hydrogen PTC is offered to “clean” hydrogen, defined as any hydrogen resource that reduces emissions by at least about 60% relative to today’s incumbent and dirty “grey” hydrogen. The credit then follows a sliding scale, whereby the higher the GHG reductions—i.e., the lower the carbon intensity of the hydrogen resource-- the higher the credit.

The carbon intensity of the hydrogen resource is the fundamental factor that will determine the level of subsidy. Determining this carbon intensity can be relatively straightforward for some hydrogen production pathways, such as an electrolyzer that is not connected to the grid and primarily powered by a solar project. But it can be complicated for other pathways, such as electrolyzers connected to the grid and drawing grid power to produce hydrogen. Electrolyzers use up a lot of electricity and considering that today’s U.S grid is still widely dominated by fossil fuels, electrolyzer emissions can be high. For example, an electrolyzer powered by today’s average U.S. grid could be twice as emitting as “grey” hydrogen.

However, those electrolyzers can still receive the tax credit if they offset their emissions enough to qualify. An electrolyzer can offset its emissions by spurring clean energy elsewhere on the grid, and that would displace fossil electricity equivalent to the grid electricity that the electrolyzer consumes. The electrolyzer would demonstrate that it is driving this clean energy deployment by procuring clean energy attribute certificates (EACs) produced by clean energy projects, such as Renewable Energy Credits. This system is similar to how corporations like Google currently offset their electricity consumption and emissions.

Ensuring that the procured EACs offset emissions in proportion to the emissions driven by electrolyzers is not straightforward and requires strict parameters, because the risks of greenwashing are high. The complexity has long bedeviled such emissions offsetting systems.

But it Can Be Done: Three Pillars of a rigorous Emissions Accounting Framework

Perhaps recognizing the complexity, IRA directs IRS to publish guidance for an emissions accounting framework within a year of enactment. IRS should work closely with DOE to enforce a strong set of rules for grid-connected electrolyzers to buttress against greenwashing.

The pillars below are fundamental to any rigorous framework. And the good news is that with such generous subsidies as the IRA tax credits, such a system would also be affordable and impose modest costs on the hydrogen industry, contrary to the alarmist claims of some in industry (see here and here).

• Additionality, a non-negotiable feature

Additionality is the requirement that an electrolyzer demonstrate that it helped drive the deployment of a new clean energy project that would otherwise not have been built. This is intuitive: if an electrolyzer is creating new demand on a fossil-dominated grid, it should help secure new clean energy supply. For example, electrolyzers could be required to sign a power purchase agreement with a new wind or solar project which would then supply the EACs to the electrolyzer.

There is a pile of evidence that a framework that excludes additionality will be dubious and should be rejected. This is because if electrolyzers cannibalize existing clean energy on the grid, fossil electricity would likely ramp up to fill at least a portion of the gap. A recent study by Princeton University finds that absent additionality, electrolyzers could have an emissions intensity up to 5 times the minimum threshold for qualifying for the tax credits, due to the high emissions it drives on the grid. The fundamental importance of additionality is also widely accepted globally (see here and here) and even making its way to Africa, with Egypt espousing it in its Green Hydrogen Strategy released at COP.

• Deliverability of the clean energy, ensuring an apples-to-apples comparison

It stands to reason that for an electrolyzer to claim that a clean energy project is offsetting its grid electricity consumption by displacing fossil fuels, the clean energy project needs to be delivering power into the same grid where the electrolyzer is located and displacing fossil electricity in proportion to the fossil electricity drawn by the electrolyzer. Consider this example: an electrolyzer located in Wyoming and drawing coal power—and therefore producing very high emissions-- should not be able to rely on a solar project in California that is mainly displacing other solar projects and some gas power—i.e. displacing much lower emissions than those produced by the electrolyzer in Wyoming. Such an electrolyzer would on the net, produce high emissions and should not be subsidized.

But ensuring this deliverability of clean power is not clear-cut. The U.S. is not one sprawling, well-connected grid; transmission constraints are widespread. Therefore, any emissions accounting system should impose a rigorous geographic boundary around where the electrolyzer and clean energy project should be located to ensure that clean electricity is delivered into the same grid where the electrolyzer is situated.

• Granular temporal matching, because annual matching is way too loose

Emissions on the grid vary widely depending on the time of day: when the sun is shining during the day or wind is copious at night, emissions are lower as wind and solar projects – where those are present—generate electricity. In contrast, when wind and solar generation is paltry and electricity demand is high, emissions can be very high due to the utilization of coal and gas plants. An electrolyzer drawing grid power should only be allowed to claim that its consumption is offset by clean energy during times when this clean energy is actually generating. Therefore, there needs to be some strong correlation, or “temporal matching”, between times of electrolyzer operations and times of clean energy generation.

Some argue that annual matching is sufficient—i.e., as long as the clean energy project operates within the same year as the electrolyzer, the latter should be able to claim that its grid consumption is adequately offset. Evidence points to the contrary. Consider this example: an electrolyzer consuming fossil electricity during evening hours—and producing significant emissions-- but purchasing EACs from a solar project generating during day hours and mainly displacing other solar projects. On the net, electrolyzer emissions would be very high. The Princeton study finds that annual matching is widely ineffective at truly reducing electrolyzer emissions, even when additionality and deliverability conditions are met, and would subsidize hydrogen resources with emissions up to 5 times the minimum threshold to qualify for the tax credits. A recent European study reaches a similar conclusion.  

Requiring hourly matching between the electrolyzer and clean energy projects – i.e., that the electrolyzer operates within the same hours as the clean energy projects it claims are offsetting its emissions -- offers sufficient rigor. And the good news is that market and policy forces are already moving in this direction. Corporate giants like Google and Microsoft are committed to hourly match their grid electricity use with clean electricity and successfully piloting it; leading organizations like EnergyTag and M-RETS are successfully developing the hourly tools and systems needed and are confident that those could be widespread in time for clean hydrogen development; and President Biden’s Executive Order 14057 sets out the goal of powering federal facilities with 100% carbon-free electricity by 2030, including 50% on an hourly basis. IRA tax credits and those parallel forces could therefore be mutually reinforcing.

The Cost of a Flop is Too High; IRS and DOE Should Get This Right

It is critical that IRS and DOE get the system right if hydrogen is to fulfil its potential as a climate solution. Whatever system the U.S. adopts will also have global ripple effects, as countries are attempting to mirror it. The European Parliament recently scrapped fairly solid rules for hydrogen producers in response to threats by industry players that they would migrate to the U.S. with its generous tax credits (we are closely monitoring the new rules set to be released by December 15). This is the wrong signal. The U.S. should set world leading standards to meet the IRA’s intent, scale up truly “clean” hydrogen sources, and lift global boats.

Never has something so wonky as emissions accounting frameworks been so eminently important. IRS and DOE can and should get this right.