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Hydrogen can play a role in decarbonization, but Treasury needs to get 45V right

April 5, 2024 Work Area: Zero-Carbon Fuels

Ever the social butterfly, the hydrogen molecule is rarely found alone on earth. Instead, hydrogen atoms often bond with carbon (forming hydrocarbons like methane) and oxygen (forming water). However, hydrogen itself may be critical to our ability to reach net-zero because of its potential to decarbonize hard-to-abate sectors and its role as a feedstock for industrial and agricultural processes that are integral to our modern economy. But to achieve any of these decarbonization goals with hydrogen, the molecule must be produced cleanly – i.e., through a process resulting in low greenhouse gas (GHG) emissions. Today, most hydrogen is produced through steam methane reforming without carbon capture, a carbon intensive process that results in lifecycle GHG emissions between 10–11 kilograms (kg) of carbon dioxide-equivalent (CO2e) per kg of hydrogen (H2). 

Producing hydrogen through cleaner methods costs more, in part due to the additional processes required to capture, transport, and sequester carbon; the cost of clean electricity; and the relative nascence of large-scale electrolyzers. Recognizing this, Congress passed the Section 45V Clean Hydrogen Production Tax Credit as part of the Inflation Reduction Act (IRA) to advance clean hydrogen technologies along the cost curve and promote the growth of a truly clean hydrogen market in the U.S. Section 45V appropriately assigns tax credit amounts based on the GHG intensity of hydrogen, starting at $0.60/kg H2 produced at or below a GHG intensity of 4 kg CO2e/kg H2 and increasing up to $3.00/kg H2 produced below 0.45kg CO2e/kg H2

But before it can be fully implemented, the passage of IRA in 2022 kicked off a process that takes place at the U.S. Department of the Treasury (Treasury). At the end of 2023, the agency published proposed guidance for implementing the 45V credit along with a request for comment from the public. While the release of the proposal included many important guardrails that CATF has advocated for to ensure the tax credit bolsters a truly clean hydrogen market, adjustments are necessary for the credit to be successful at supporting a path towards economy-wide decarbonization.  

CATF submitted comments to Treasury with recommendations to both strengthen guardrails around hydrogen lifecycle analyses to avoid increased emissions from hydrogen – which would negate the purpose of the credit – while also emphasizing flexibility and the need to create certainty for hydrogen producers. Both principles are critical to getting this lucrative credit right and ultimately promoting a clean hydrogen market to protect our climate. Key highlights from those comments are below.  

1. Hydrogen producers who use natural gas feedstocks must be required to use verifiable, project-specific upstream emissions data to incentivize natural gas producers to clean up production

Under the current version of 45VH2-GREET – the tool used to calculate lifecycle GHG emissions for the 45V credit – the upstream methane leak rate for the natural gas supply chain is fixed at a nationwide average of 0.9%, and the upstream CO2 emissions from procuring, extracting, and transporting the natural gas are similarly fixed. Treasury’s proposed fixed methane leak rate and upstream CO2 emissions are both over- and under-inclusive of the reality on the ground. They prevent operators with cleaner supply chains from proving so and achieving a higher 45V credit, a situation that can harm the economic viability of low-emissions projects. And this also allows operators with dirtier supply chains to claim an artificially lower GHG intensity without incentive to improve their lifecycle emissions.  

To make sure that cleaner projects are properly rewarded for that characteristic, CATF has advocated that Treasury should require hydrogen producers to provide verifiable, project-specific data to establish their methane leak rates using the data that natural gas producers submit as part of Subpart W of the EPA-administered Greenhouse Gas Reporting Program (GHGRP). CATF also urged Treasury to finalize similar requirements for upstream CO2 emissions using GHGRP Subparts C and W. This data is already submitted by most natural gas operators, is familiar to the EPA, and is verified by built-in submission processes. 

2. Negative emissions values should not be allowed as inputs for 45V lifecycle analyses

In our comments, CATF also urged Treasury to adopt strict guardrails around hydrogen production methods that use biomethane (methane from landfills and digesters) and fugitive methane (methane that would have otherwise been leaked or flared). Without these guardrails, hydrogen producers could offset direct hydrogen facility emissions using “negative” emission rates from biomethane. Allowing such a practice would undercut the truly clean hydrogen production methods that the tax credit is meant to promote.  

For example, consider the possibility of blending feedstocks like fossil natural gas and biomethane. Producing hydrogen from 25% or less biomethane – depending on the magnitude of the negative carbon intensity – blended with fossil natural gas could result in hydrogen producers that qualify for the highest 45V tier while still use polluting production methods with no carbon capture and storage.  

Similarly, Treasury should not allow fugitive methane sources to receive negative emission rates. This would give oil and gas producers a windfall given that several state and federal regulations currently require emissions reductions to fugitive methane.  

3. Treasury should award credits based on carbon intensities of qualified clean hydrogen on a kilogram-by-kilogram basis, rather than an average of all hydrogen produced by a facility in a given year

Treasury’s current proposal would award tax credits based on the annual average GHG intensity of all hydrogen produced by a facility; that is, the producer would be awarded a credit tier based on the average of all hydrogen produced in a tax year. This annual averaging of all hydrogen to measure lifecycle emissions for credit calculation goes against the statute and is unnecessarily restrictive for the nascent clean hydrogen industry. Producers only need to use grid electricity for 1-3% of the year to exceed the threshold for the top tier of 45V.  

Instead, CATF recommended that the tax credit be awarded using a two-step means of determining lifecycle emissions 

  • First, a hydrogen producer must meet an annual average of no more than 4 kg CO2e/kg H2 for all hydrogen produced to be eligible for the 45V credit. This approach aligns with the statute given that hydrogen must be produced at a qualified clean hydrogen production facility to earn the credit, and a qualified clean hydrogen facility must produce hydrogen with a lifecycle emissions rate of less than 4 kg CO2e/kg H2.  
  • Second, once a facility meets that average on an annual basis, section 45V requires a kilogram-by-kilogram approach, where projects receive credit by multiplying the “kilograms of qualified clean hydrogen” by the applicable amount, which is determined by the lifecycle emissions rate. For ease of accounting, this can be accomplished on an hourly basis. 

4. The statute requires a thorough lifecycle analysis for hydrogen production

A core principle guiding CATF’s recommendations is that section 45V requires Treasury to evaluate systemwide emissions impacts when assessing lifecycle greenhouse gas emissions. This is because section 45V explicitly adopts the definition of “lifecycle greenhouse gas emissions” from the Clean Air Act (CAA), which includes both “direct emissions” and “significant indirect emissions” that are related to the entire fuel production lifecycle – including feedstock generation, extraction, production, and distribution. 

In the context of 45V, “indirect emissions” include induced emissions that are the result of shifting clean electricity supply from the grid to hydrogen production. Increased electricity production would be needed to “bridge [at least some of] the gap” and meet the original demand. If the gap-filling electricity draws partially or entirely on unabated fossil fuels, then there will be a net increase in systemwide emissions. Thus, just as the CAA requires that EPA consider the systemwide land use emissions impacts stemming from production of a biofuel feedstock (e.g., corn), the same statutory provision requires that Treasury consider systemwide grid emissions impacts stemming from production of a feedstock used to produce hydrogen (e.g., electricity) to ensure that 45V is incentivizing truly clean hydrogen. As explained further below, applying the “three pillars” is the best methodology to avoid systemwide grid emissions. 

5. Electricity-based hydrogen production pathways must comply with the three pillars to limit systemwide emissions

Electrolytic hydrogen production requires water and electricity as its feedstocks. To be truly clean, the electricity used to produce the hydrogen must be clean – and any significant indirect emissions resulting from the use of that clean electricity must be avoided.  The systemwide emissions of grid-based electrolytic hydrogen can range from ~10-40 kg CO2e/kg H2, which is up to four times higher than conventional fossil-based generation and magnitudes higher than the section 45V tiers.  

To account for these significant indirect emissions – particularly the systemwide induced emissions on the electricity grid described above – the “three pillars” were included in the proposed 45V guidance: incrementality, hourly matching, and deliverability.  

Incrementality Also known as additionality, this pillar requires that projects draw on new clean power that is not already serving the electricity grid’s existing energy demand. Without incrementality, a project may divert clean power from the grid.
Hourly Matching Also known as temporal-matching, this pillar requires that the hours of electricity used for hydrogen production must be matched with the hours of new clean electricity production. Without hourly-matching, dirtier generation sources may supply electricity for hydrogen production when clean energy is not available.
Deliverability Also known as regional matching, this pillar requires that the hydrogen production facility be in the same region as the electricity it is claiming to use; or in other words, it must be physically feasible to deliver power from the electricity generator to the hydrogen producer. Without deliverability, projects may claim clean energy that is locked behind grid constraints like congestion while being supplied by closer, dirtier generators.

For an electrolytic hydrogen producer who claims that their electricity is from a specific generating facility rather than their regional grid, the proposed 45V guidance appropriately requires that they must purchase Energy Attribute Certificates (EACs) that comply with the three pillars. This is the best methodology for ensuring and verifying that the electricity used to produce hydrogen is truly clean. 

6. A 5% exemption to incrementality does not directly address curtailed electricity and avoided retirements and will lead to significant indirect emissions

CATF has previously advocated for incrementality exemptions for surplus electricity that would have otherwise been curtailed and facilities that can avoid retirement through 45V-related revenues. Treasury’s proposal considers incorporating both circumstances through a blanket 5% exemption to incrementality for all existing clean generators, citing that this matches historical curtailments and future projections for nuclear retirements. However, CATF has urged Treasury to avoid a blanket 5% exemption to incrementality that does not target specific circumstances.  

The emissions data backs up this concern: analysis from the Rhodium Group found that a 5% exemption for all existing clean generation could result in 1.5 billion metric tons of increased emissions cumulatively through 2035. And new analysis of existing clean generators in California observes a “consequential emissions intensity of roughly 20 kg CO2e/kg H2 for any hydrogen produced by electrolyzers taking advantage of this [5-10 percent] incrementality exemption”, which far exceeds the statutory thresholds for 45V. 

Instead of a broad 5% exemption, Treasury must adopt more targeted solutions to avoid these significant indirect emissions. For electricity that would have otherwise been curtailed, Treasury could establish price floors for locational marginal electricity prices, below which electricity could be considered curtailed. Treasury could also ask the Department of Energy (DOE) to conduct backwards-looking analyses on curtailment capacities and timeframes in each deliverability region, which could be the basis for a region-specific percentage exemption limited to specific hours of the day. For avoided retirements, a more targeted solution would be to apply a 5% exemption for facilities that prove that they are in financial distress. For nuclear facilities, for example, Treasury could require the same economic test used to determine eligibility for the section 45U nuclear production tax credit or the Civil Nuclear Credit Program to establish whether the nuclear facility is at risk of shutting down without additional funding.  

7. Exemptions to incrementality based on clean energy standards or renewable portfolio standards require further examination

Some 45V stakeholders have advocated that certain regions of the U.S. should be exempted from incrementality if there are complimentary state policies that are already cleaning up the grid and limiting systemwide emissions. CATF recommends that Treasury work with DOE to evaluate the following considerations when developing an exemption from incrementality based on state policies: 

  • Regions should have a cap-and-trade system; exemption to incrementality should not be based solely on the current emissions intensity or the percentage of minimal-emitting generation within the region.  
  • Cap-and-trade systems should account for import and export power flows to minimize emissions leakage to other regions. 
  • Penalties for exceeding emissions caps should be sufficient to outweigh the value of 45V to prevent gaming. 
  • States should be required to submit modeling to demonstrate that the incrementality exemption does not result in increased consequential emissions. 

8. Hourly matching by 2028 is both necessary and feasible

CATF supports Treasury’s proposed 2028 phase-in for hourly matching as an important measure to limit significant indirect emissions. As discussed in our previous blog, without hourly-matching, dirtier generation sources may supply electricity for hydrogen production during hours when clean generation is not available. A 2028 phase-in date is ample time for registries to implement systems to issue hourly EACs: a recent study by the Center for Resource Solutions projects that nearly all U.S. registries could transition from issuing annual to hourly certificates within two years. And once one registry is ready to issue hourly EAC’s, the same registry can cover regions that do not have the capability. If certain registries decide not to issue hourly EACs, facilities can also use hourly metering data along with retiring annual or monthly EACs to prevent double counting. This method of hourly tracking and verification is already available and in use in the U.S. and around the world.  

Overall, Treasury’s 45V proposal is an excellent first step toward fostering growth of the truly clean hydrogen market that is needed to reach full economy-wide decarbonization. We look forward to continued engagement with clean hydrogen stakeholders as this market is thoughtfully developed. 

CATF’s full comments can be found here

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