IRA Hydrogen Incentives: Climate Hit or Miss? TBD.

The Inflation Reduction Act of 2022 (IRA) includes the largest hydrogen subsidies in the world. It undoubtedly marks an inflection point in the arc of the technology’s development and may provide a sea change in the hydrogen market. In some places in the U.S., green hydrogen receiving the IRA hydrogen tax incentives can already start competing with today’s incumbent grey hydrogen. This pushes forward the previous projected timeline for this cross-over by more than a decade. Many experts now also project that low-carbon hydrogen can start competing with fossil fuels in applications such as steelmaking and trucks, a dynamic previously projected to occur no sooner than 2030 onwards.

But there are thick strings attached to this promising picture: the climate benefit of the IRA hydrogen tax incentives is not guaranteed. Instead, it will largely hinge on two key elements: 1) the rigor of emissions accounting systems implemented to ensure that the hydrogen source claiming the subsidy is indeed low-emitting; and 2) the applications where this now low-cost hydrogen is being used. If the subsidized hydrogen is indeed low-carbon and targeted at the hardest to electrify applications in the economy, the tax incentives would be a climate boon. If the hydrogen source is greenwashed and used in applications that have more cost-effective climate solutions, the tax incentives risk stalling climate progress and increasing the costs of the transition to a clean economy.  

Throughout this blog, we use the hydrogen color-coded short hands as follows:

1. Grey hydrogen = today’s incumbent and unabated gas-based hydrogen;
2. Blue hydrogen = produced in a similar manner to grey hydrogen, but the process is equipped with carbon capture to reduce the carbon intensity
3. Green hydrogen = hydrogen produced via the electrolysis of water powered by 100% (or nearly 100%) renewable electricity

Recap: What passed in the IRA?

While IRA includes a range of hydrogen support mechanisms, the hydrogen production tax credit (PTC) is the headliner. The PTC is eligible for “clean” hydrogen, defined as a hydrogen source that delivers at a minimum an approximate 60% greenhouse gas (GHG) reduction relative to today’s incumbent and unabated fossil hydrogen, or “grey” hydrogen. The credit then follows a sliding scale, whereby the higher the GHG reductions, the higher the credit. With the PTC, we estimate that green hydrogen—produced from nearly 100% renewable electricity-- can start competing with grey hydrogen in some places in the U.S. today, and in most places by end of decade. 

Production tax credit in $ per kilogram of hydrogen produced ($/kg) relative to the carbon intensity of the produced hydrogen in kilograms of carbon dioxide equivalent per kilogram of hydrogen (kgCO2e/kgH2). The PTC in this graph assumes prevailing wage requirements are satisfied. Percentages reflect approximate GHG reductions relative to today’s grey hydrogen.

We offer our commentary on the following key elements in the PTC:

1. The much higher incentives for green hydrogen strengthen the credit: based on current and projected technology, only green hydrogen can qualify for the top $3/kg credit tranche. This offsetting appropriately reflects the dynamics in the hydrogen landscape: 1) green hydrogen is the resource most strictly aligned with U.S. climate goals and should therefore be prioritized; and 2) while it is today more expensive than both blue and grey hydrogen, it is poised to experience the steepest cost reductions and become the cheapest form of low-carbon hydrogen in many places in the U.S. by 2035 or earlier. The much higher subsidy for green hydrogen therefore helps the PTC deliver on the intent of well-designed tax credits: to incentivize deployment of technologies most poised for medium- and long-term cost reductions and that are strongly aligned with climate goals.

2. The 60% GHG reductions threshold is an OK starting point: previous versions of the bill had defined that cutoff point at a meager 40% GHG reductions relative to grey hydrogen.  This would have subsidized highly emitting forms of hydrogen and markedly trailed existing and proposed global standards. The new 60% threshold is an OK starting point, and a marked improvement, but policymakers and the private sector should strongly prioritize investments in cleaner hydrogen sources that achieve 75% emissions reductions and more. Those hydrogen sources are far more aligned with U.S. climate goals and the goals of protecting the health of communities. And the good news is that those sources can now benefit from a generous PTC.

The table below gives a sense of where the IRA standard ranks in the landscape and illustrates the room for improvement:

3. The prohibition of credit stacking for blue hydrogen prevents market distortions: the bill expressly prohibits blue hydrogen projects from double dipping and receiving both the 45Q tax credits for carbon capture and the hydrogen PTC; it’s either/or. Based on NRDC estimates, the stacking would have driven blue hydrogen costs to markedly below the costs of grey hydrogen. This would have constituted a dangerous market distortion and a wasteful use of public funds on a resource that is unlikely to experience any meaningful cost reductions.

4. The credit duration is too long; a future step-down should be considered: The bill offers the PTC to clean hydrogen projects that begin construction by as late as 2033, with no credit step-down. As currently designed, the PTC risks surpassing its intent as we expect that with the current U.S. and global policy support landscape, green hydrogen may start experiencing significant cost reductions well before 2030. For example, BNEF projects that green hydrogen costs in some places can dip into the negative by end of decade—i.e., the PTC would be so generous that to receive the credit, producers would pay consumers to buy their product. It would be advisable, in potential future iterations of the credit, for policymakers to assess the state of the market and implement a credit step-down if warranted.

Rigorous emissions accounting will be fundamental to deliver climate benefits

Ensuring that the GHG emissions of hydrogen sources are rigorously and accurately determined is a key issue. Without accurate accounting we run the risk of rewarding dirty hydrogen and locking in these assets for decades to come. The bill:

1. Requires the use of models developed by the Department of Energy (GREET or a successor model as determined by the agency) to determine lifecycle emissions of hydrogen sources; and
2. Further directs federal agencies to publish regulations or other guidance within 1 year of passage of the bill for determining lifecycle GHG emissions. It is unclear whether this is within the purview of the IRS only, or whether the Department of Energy can also play a part.

This is immensely important, as the climate benefit of the PTC will only be as strong as the rigor of the model used and the guidance. Hydrogen production typically involves two major categories of GHG emissions: those arising at the site of production (think emissions linked to using and burning gas to produce grey or blue hydrogen), and those arising upstream of the site of production (think methane leakage linked to the transport of gas to a grey or blue hydrogen facility, or emissions linked to the generation of electricity that then powers the electrolysis process). Upstream emissions can be very large and dictate the overall emissions footprint of the hydrogen source. For example, while electrolysis produces virtually no emissions at the site of production, an electrolytic hydrogen source can have twice the GHG emissions relative to today’s grey hydrogen if powered by today’s average, still fossil-dominant U.S. grid.

The challenge resides in the fact that we still don’t have mechanisms to rigorously measure and report those upstream emissions. As it relates to blue hydrogen, accurate measurements and reporting of methane leakage have long been beset by technological challenges and intentional malpractice; and due to the nascency of electrolytic hydrogen, we still don’t have a mature system to ascertain that electrolysis is powered by renewable electricity and/or doesn’t lead to increased emissions on the grid (the European Union is actively grappling with this latter issue). The figures below illustrate how a weak emissions accounting and verification system can lead to the subsidization and greenwashing of highly emitting hydrogen sources.

Effects of the greenwashing of an electrolytic hydrogen source that claims 100% renewable electricity sourcing but is in reality powered by 50% renewable electricity and 50% grid power (assuming today’s average U.S. grid).

Effects of the greenwashing of a blue hydrogen source that claims low methane leakage of 1%, but in reality records a leakage rate on the order of 3%.

Emissions accounting protocols will therefore heavily bear on the climate value of the hydrogen PTC—or lack thereof-- and NRDC will be actively working on recommendations for a rigorous accounting protocol.

Targeting clean hydrogen in its highest value applications is more important than ever

The PTC can end up providing a huge supply push for clean hydrogen. It is therefore more vital than ever to focus on the demand side, or where the hydrogen is being deployed.

As we have extensively written and testified, hydrogen can help support achievement of climate goals IF it is targeted at applications that may not have other clean energy alternatives. Those are generally applications that are hardest to electrify, such as steelmaking and maritime shipping. That is because hydrogen is an energy intensive resource, as its production and use incur a chain of energy conversions and losses. These losses make hydrogen a relatively costly option for many applications that can be feasibly served by more efficient solutions, like direct electrification. Buildings, 24/7 power generation and (most) passenger cars are particularly poor applications for hydrogen.

Therefore, widespread deployment of hydrogen in applications that can be more efficiently decarbonized with alternatives risks putting significant pressure on the energy system, unnecessarily increasing the costs of the transition to a clean economy, and complicating climate progress. A forthcoming NRDC blog further delves into those dynamics and a forthcoming global report on hydrogen (which I co-authored and will be blogging about) emphasizes the importance of such targeted deployment.

With climate alarm bells tolling, there is no room to swing and miss

Congress swung and it is now time for federal agencies, states, and the private sector to deliver a strong run. In particular:

1. Federal and state agencies should design and implement a rigorous emissions accounting system to ensure that truly low-emitting hydrogen sources are subsidized. We cannot afford investing and subsidizing dirty and long-lived hydrogen assets that would lock us into a high emissions future.
2. Stakeholders must prioritize the cleanest hydrogen sources most aligned with climate and public health goals. Green electrolytic hydrogen has clear primacy over others in this domain, and fortunately, can tap into the largest PTC. Otherwise, stakeholders should minimize investments in resources that achieve less than 75% emissions reduction relative to today’s grey hydrogen.
3. Stakeholders must target hydrogen deployment into its highest value applications where it has a clear climate and technoeconomic case relative to alternative clean solutions. Those will largely be applications that are hardest to electrify.

The PTC will either bolster climate progress or throw a wrench in our bid to achieve a clean economy. It will all depend on implementation. Let’s do this right.