The Inflation Reduction Act contains incentives that can spur the use—and new use—of hydrogen fuels in industrial processes. We’ve yet to see the net effect of all these incentives. But whereas other bills left hydrogen with an uncertain future, the new law puts hydrogen hubs on a wider path to success.
Clean hydrogen, that is, hydrogen production with little to no greenhouse gas emissions, can be a key component of decarbonizing the industrial sector. Clean hydrogen has industrial applications in iron and steel manufacturing, refining, chemical production, and providing a low-carbon source of heat for industrial processes. (Not to mention that clean hydrogen fuels also have potential applications in the electric power and transportation sectors.) However, current hydrogen production technologies release significant carbon emissions, and little economic incentive has existed to date to encourage the use of hydrogen in novel applications.
To help jump-start the production and use of clean hydrogen, the Infrastructure Investment and Jobs Act appropriated $8 billion for the US Department of Energy to fund a set of “hydrogen hubs,” (called “H2Hubs” in the agency’s terminology) where an H2Hub is defined to be “a network of clean hydrogen producers, potential clean hydrogen consumers, and connective infrastructure located in close proximity.” The Department of Energy recently released a request for information on how to fund the H2Hubs, which we have discussed in a recent blog post. As we’ve noted, for the H2Hubs to be a success, a policy or policies must bridge the gap between the price of carbon-intensive hydrogen and the presumably higher price of low-carbon hydrogen.
The Inflation Reduction Act (IRA), which President Joe Biden recently signed into law, may be the missing ingredient that the H2Hubs need. The IRA creates a tax credit for hydrogen production (which is very similar to a provision in the House-passed Build Back Better Act) and a provision that increases the value of the tax credit for carbon capture and sequestration (CCS). In this blog post, we discuss the new hydrogen tax credit in the IRA, the changes to the CCS tax credit in the IRA, the impact of both of these changes on hydrogen producers, and the implications for H2Hubs.
Tax Credits for Hydrogen and for Carbon Capture and Sequestration
The IRA creates a new tax credit through Section 13204 of the law (which we will reference here as “45V” per the name of its section in the Internal Revenue Code) that subsidizes the production of clean hydrogen. Hydrogen producers have the option of receiving either a credit equal to a specified fraction of their capital expenses (an investment tax credit) or a tax credit equal to a specified dollar value per kilogram of hydrogen produced (a production tax credit) (Table 1). If a producer is not in compliance with these requirements, then the credit is reduced by a factor of five. In the case of the production tax credit, hydrogen producers will receive the tax credit for 10 years after the production facility is placed into service. No facility that begins construction after 2032 qualifies.
Table 1. “45V” Tax Credits Available for Hydrogen Producers through the Inflation Reduction Act of 2022
For CCS, the IRA increases the existing tax credit (known as “45Q” in the Internal Revenue Code) through Section 13104 in the law for projects that capture carbon dioxide (or other carbon oxides) from fossil fuel burning or production processes and either storing or utilizing it. The IRA increases the highest rate of the tax credit to $85 per metric tonne of carbon dioxide captured and geologically sequestered. The law likewise increases the credit for utilized carbon, such as for enhanced oil recovery, to $60 per tonne.
While not relevant for hydrogen, the IRA also increases the credit for capturing CO2 out of the air to $180 or $130 per tonne, respectively, again depending on whether the carbon is geologically sequestered or utilized.
As with 45V and many other tax credits in the IRA, the 45Q credits are divided by five if prevailing wages and apprenticeship requirements are not met. The IRA also changes the thresholds of carbon capture that are required to receive the credit. These new requirements are more stringent for electric generators. For industrial carbon capture, such as with hydrogen production, at least 12,500 tonnes must be captured annually. Importantly, project developers cannot take both 45V and 45Q credits.
The IRA contains important provisions to allow taxpayers to monetize both of these tax credits, which reduces transaction costs. Unlike many other tax credits in the law, the 45V and 45Q provisions of the IRA do not allow bonuses for domestically manufactured products nor development in “energy communities” (as defined in the IRA). We will discuss more details on these policies, their interactions, and their implications in a forthcoming issue brief.
How the Tax Credits Will Affect the Cost of Hydrogen
Most hydrogen is produced in one of two ways: either directly from fossil fuels, producing carbon dioxide (or carbon monoxide) as a byproduct, or from water, producing no greenhouse gases directly. To be “clean,” hydrogen production from fossil fuels requires CCS to reduce its otherwise high emissions rate. We will discuss these hydrogen production technologies and examine their associated costs in more detail in our forthcoming issue brief. But for now, we will explore the impacts of the tax credits as outlined in the IRA.
In the short run, neither form of hydrogen production, even with CCS, is likely to reach the higher levels of the 45V tax credit. This is because the level of the credit depends on the full life-cycle emissions and not just the direct emissions, and current methane leakage rates and the carbon intensity of electricity production are too high. However, hydrogen production that uses CCS also is eligible for the 45Q tax credit in lieu of the 45V credit. In fact, our analysis shows that, when applicable, the 45Q tax credit often is of greater value than the 45V tax credit. Moreover, in many scenarios, the 45Q tax credit is sufficient to make hydrogen production from natural gas with CCS price-competitive with current hydrogen production without CCS. When upstream emissions are sufficiently low, the 45V tax credit can confer a larger subsidy.
Electrolysis—the production of hydrogen by using electricity to separate the hydrogen atoms from water molecules—produces zero greenhouse gas emissions directly. However, the life-cycle emissions of electrolysis nonetheless can be quite high due to the electricity consumed in the process. Hydrogen production through electrolysis can qualify for the higher tiers of the 45V tax credit only if the emissions associated with electricity inputs are very low. But even with the 45V credit, electrolysis remains significantly more expensive than current hydrogen production that uses natural gas, even when the latter production process carries the additional cost of CCS. In the long run, these costs likely will change with future reductions in capital costs and the potential for cheaper electricity. Some analysts project that electrolysis will be competitive with fossil fuel–based hydrogen by 2030.
Implications for Hydrogen Hubs
Our analysis suggests that the tax credits in the IRA already are sufficient to make hydrogen production from natural gas with CCS competitive with current hydrogen production without CCS. Interestingly, the increase in the value of the 45Q tax credit has the largest impact in the short run. By increasing the 45Q tax credit, the IRA provides a path to sustainability for H2Hubs with traditional hydrogen end uses, such as refining and chemical production, especially because the H2Hubs potentially can share 50 percent of the costs with the Department of Energy for certain expenses, under the Infrastructure Investment and Jobs Act.
Mere competitiveness with existing hydrogen production processes may not be sufficient to fulfill the promise of the H2Hubs, however. New uses for hydrogen likely will carry a cost premium relative to the technologies that hydrogen use will replace, such as fossil fuel–based heat for industrial processes. As such, absent other policies, the socially optimal price of hydrogen may be lower than current prices. In the longer term, a cleaner grid will open the door to the substantial subsidies offered in the higher tiers of the 45V tax credit in the IRA. The prospect of a cleaner grid, combined with the expected decline in costs for electrolysis, has the potential to achieve the goal of bringing new uses of hydrogen into the industrial sector.
Notably, the IRA contains additional incentives for manufacturing. These incentives include the reinstatement of the 48C Advanced Energy Project Tax Credit; additional funding for the Department of Energy’s Loan Guarantee Program; grants for the domestic production of hybrid, electric, and fuel cell vehicles; $5.8 billion for the Department of Energy’s Office of Clean Energy Demonstrations for “advanced industrial technology”; $27 billion to the Environmental Protection Agency for potentially establishing a green bank; and funds for “clean” road, bridge, and building projects procured through the federal Highway Trust Fund and by the US General Services Administration; among other provisions.
How all these incentives will work together, and to what extent their net impact will reduce the price difference between low-carbon and high-carbon manufacturing, remains highly unclear. But, while the Infrastructure Investment and Jobs Act alone had potential to leave the H2Hubs stranded without a path to sustainability, the incentives provided in the IRA can put the H2Hubs on a wider path to success.