United States: Treasury And IRS Propose Long-awaited Regulations For The Inflation Reduction Act's Hydrogen Production Tax Credit (Section 45V)

Key Takeaways:

• The proposed Hydrogen Production Tax Credit ("PTC") (Section 45V) regulations offer the first significant guidance regarding how this major public investment in domestic clean hydrogen production will be administered. The proposed regulations will likely not be finalized for several months, and comments are due by February 26, 2024. Stakeholder comments will be critical to developing effective and durable regulations that support the growth of the domestic clean hydrogen industry.
• The Hydrogen PTC sets four thresholds of lifecycle greenhouse gas emissions that clean hydrogen must achieve to qualify for credit amounts between $0.60 per kilogram of hydrogen to $3.00 per kilogram. The proposed regulations introduce a version of the GREET model, 45VH2-GREET, that will be used to determine emissions associated with eight specific hydrogen feedstock and production process combinations, including steam and autothermal methane reforming with carbon capture, coal and certain biomass gasification with carbon capture, and electrolysis of water. Other processes that do not fit within those pathways must apply for an "emissions value" with Department of Energy and a "provisional emission rate" with Treasury/IRS.
• For electrolytic hydrogen using grid electricity, the proposed regulations require acquiring and retiring so-called "energy attribute certificates" or EACs and adopt a version of the so-called "three pillars" requirements for those EACs, which the proposed regulations refer to as (1) incrementality, (2) temporal matching, and (3) deliverability. These requirements have been subject to intense debate among stakeholders for months in the runup to the proposed regulations.
• The proposed regulations do not address hydrogen derived from renewable natural gas or fugitive methane and solicit comments on several different topics that will inform the development of forthcoming, additional proposed regulations.
• The proposed regulations address several other topics, including modified or retrofitted hydrogen production facilities, the interplay between the Hydrogen PTC and other tax credits for producing electricity, the election between the Hydrogen PTC and the Section 48 Investment Tax credit, an "anti-abuse" rule, and rules around verification of qualified clean hydrogen production, among others.

On December 22, 2023, the Department of Treasury and Internal Revenue Service (collectively, "IRS") proposed new regulations for the Inflation Reduction Act's ("IRA") Hydrogen Production Tax Credit ("PTC"), otherwise known as Section 45V. The Hydrogen PTC represents one of the most significant public investments in low-carbon hydrogen anywhere in the world. It was meant, along with the Hydrogen Hub grants recently awarded by Department of Energy ("DOE"), to jumpstart an emerging domestic clean hydrogen industry to displace fossil fuels in many difficult-to-decarbonize industries. The White House has estimated that hydrogen could end up supplying energy to up to one fifth of the U.S. economy.

While the proposed regulations offer the first significant glimpse into the government's plans for implementing the Hydrogen PTC, there is still time before these regulations are finalized. December 26, 2023 marked the beginning of a 60-day comment period on the proposed regulations. Comments are due by February 26, 2024. A public hearing will then be held on March 25, 2024, with requests to speak and topic outlines due to the agency by March 4, 2024. Given the hydrogen industry's many complexities, it will be incumbent on commenters to explain what works and what doesn't in the proposed regulations and, in particular, to identify where IRS misunderstood or failed to address critical issues affecting this emerging industry.

Background

The Hydrogen PTC creates a 10-year credit for domestically produced clean hydrogen. Assuming those clean hydrogen projects meet certain requirements, including prevailing wage and apprenticeship requirements, clean hydrogen that achieves the carbon intensity thresholds below is eligible for credits as follows:

Importantly, the Hydrogen PTC does not prescribe any specific method for producing hydrogen—e.g., electrolysis of water or steam methane reforming with carbon capture. If hydrogen meets Section 45V's requirements, including the carbon intensity thresholds, it qualifies for credits regardless of how it was produced.

Ever since the Hydrogen PTC was enacted, questions have arisen regarding how it would apply. Guidance was promised by mid-2023 but delayed until now. Concerns focused on many aspects, but most centered on producing electrolytic hydrogen (electrolysis of water) in ways that avoided increasing greenhouse gas ("GHG") emissions associated with the significant electric power generation needed to separate hydrogen from oxygen, and whether and how to credit hydrogen derived from fossil natural gas (so-called "blue" hydrogen), other fossil sources, or biogas in processes that include carbon capture and sequestration ("CCS").

The proposed regulations address many of those concerns. They incorporate the so-called "three pillars" for producing electrolytic hydrogen—incrementality, temporal matching, and deliverability—which are intended to tie electrolytic hydrogen produced using grid electricity as closely as possible to renewable or other low- or zero-emission electricity generation. The proposed regulations say relatively little about "blue" hydrogen, though they certainly do not exclude it: the model for calculating hydrogen's lifecycle GHG emissions, the 45VH2-GREET model, accounts for several hydrogen production pathways that rely on fossil sources with a CCS component. The model also includes pathways for coal and biomass gasification but is unclear on so-called "turquoise" hydrogen, which is derived generally from processes that include methane pyrolysis resulting in hydrogen and solid carbon. The proposed regulations do not address hydrogen derived from renewable natural gas ("RNG") and fugitive methane sources and instead signal that additional regulations are forthcoming and request comments on twelve topics to inform the development of those future regulations. The proposed regulations also address many administrative requirements regarding verifying and auditing hydrogen production processes. IRS is seeking comments on nearly every aspect of its proposal.

Analysis of the Proposed Regulations

Lifecycle GHG Emissions of Hydrogen Production Pathways and 45VH2-GREET

One of the most significant questions regarding the Hydrogen PTC is how the IRS would determine whether hydrogen achieved the mandated lifecycle GHG emissions thresholds. Section 45V offers some guideposts. It states, for instance, that lifecycle GHG emissions "shall only include through the point of production (well-to-gate), as determined under the most recent Greenhouse gases, Regulated Emissions, and Energy use in Transportation model (commonly referred to as the 'GREET model') developed by Argonne National Laboratory, or a successor model (as determined by the Secretary)." Yet Section 45V provides little else regarding how this process might function in practice.

The proposed regulations supply additional details. They rely on a White Paper issued by DOE and incorporate a version of the GREET model developed by DOE for determining lifecycle GHG emissions specifically under Section 45V, 45VH2-GREET. The model, however, supports only the following eight pathways for producing qualified clean hydrogen:

1. Steam methane reforming (SMR) of natural gas, with potential carbon capture and sequestration (CCS);
2. Autothermal reforming (ATR) of natural gas, with potential CCS;
3. SMR of landfill gas with potential CCS;
4. ATR of landfill gas with potential CCS;
5. Coal gasification with potential CCS;
6. Biomass gasification with corn stover and logging residue with no significant market value with potential CCS;
7. Low-temperature water electrolysis using electricity; and
8. High-temperature water electrolysis using electricity and potential heat from nuclear power plants.

If taxpayers wish to produce hydrogen using different feedstocks or processes, they must obtain a provisional emissions rate ("PER"). This requires filing a request with DOE to obtain a "lifecycle emissions value." Taxpayers would then submit DOE's value and its supporting analysis, among other things, to IRS when claiming the credit.

The process for obtaining the DOE emissions value remains somewhat unclear. DOE will elaborate further in forthcoming guidance before April 1, 2024, when the emissions value request process is scheduled to open. But the proposed regulations do state that taxpayers will need to complete a front-end engineering and design ("FEED") or similar study for their projects before requesting an emissions value, ostensibly to ensure that those projects are far enough along in development before DOE expends resources in rendering a determination. Few other details are given, and it remains unclear how long DOE's process might take. If that process is similar to the Environmental Protection Agency's lifecycle emissions assessments for new renewable transportation fuel production pathways under the Renewable Fuel Standard program, it could take significant time. It is also unclear how DOE will verify lifecycle emissions values if 45VH2-GREET does not apply, given Section 45V's mandate that GREET or a "successor model" must be used.

Energy Attribute Certificates and the "Three Pillars"

The proposed rules will allow electrolytic hydrogen producers to rely on grid electricity to power their operations by obtaining and retiring "Energy Attribute Certificates" for zero-GHG-emission electricity generation. Energy Attribute Certificates or "EACs," are defined as tradeable contractual instruments issued through a qualified EAC registry or accounting system. Renewable Energy Certificates ("RECs") are one example of a potentially qualified EAC, according to the proposed regulations. The proposed regulations also give examples of qualified EAC registries: Electric Reliability Council of Texas ("ERCOT"); Michigan Renewable Energy Certification System ("MIRECS"); Midwest Renewable Energy Tracking System, Inc. ("M–RETS"); North American Registry ("NAR"); New England Power Pool Generation Information System ("NEPOOL–GIS"); New York Generation Attribute Tracking System ("NYGATS"); North Carolina Renewable Energy Tracking System ("NC–RETS"); PJM Generation Attribute Tracking System ("PJM–GATS"); and Western Electric Coordinating Council ("WREGIS").

EACs must meet several requirements, including a version of the so-called "three pillars" of hydrogen production, referred to in the proposed regulations as (1) incrementality, (2) temporal matching, and (3) deliverability. The three pillars have been the subject of intense debate, study, and (particularly for D.C. residents) television and online ad campaigns in the runup to the proposed regulations. Some assert that strict adherence to the three pillars will ensure that electrolytic hydrogen actually reduces GHG emissions. Others contend that, if applied too strictly, the three pillars may hinder investment in clean hydrogen projects and may not lead to meaningfully lower GHG emissions. Still others, such as the American Clean Power Association ("ACP"), have advocated for an ostensible middle ground, providing for, among other things, phase-in periods for certain clean hydrogen requirements. The proposed regulations incorporate the three pillars as follows:

Incrementality. Incrementality refers to the notion that hydrogen producers should rely on renewable electricity only from new or recently built renewable energy generation facilities to avoid diverting preexisting generation capacity from its current uses. Under the proposed regulations, "an EAC meets the incrementality requirement if" the commercial operation date of "the electricity generating facility that produced the unit of electricity to which the EAC relates" is "no more than 36 months before the hydrogen production facility" was placed in service. (Emphasis added.) The proposed regulations will also allow for EACs to meet the incrementality requirement if they represent the additional incremental capacity of existing renewable electricity generating facilities that undergo an "uprate"—increasing the existing facilities' rated nameplate capacity—if the uprate occurred within the 36-month timeframe.

IRS requests comment on several potential alternative approaches that it is considering but currently are not part of the proposed regulations:

• Whether electricity generated by an existing fossil-fuel facility that adds CCS capabilities should be considered incremental if the CCS upgrade occurs no more than 36 months before the hydrogen facility is placed in service.
• Whether to treat avoided retirements of generation facilities as incremental if the avoided retirement relates to producing hydrogen. Here, the proposed regulations note many megawatts of recent and planned retirements, particularly, of nuclear plants.
• Whether "to provide an opportunity to demonstrate zero or minimal induced grid emissions through modeling or other evidence under specific circumstances." IRS notes that "periods of curtailment or zero or negative pricing," such as hydropower plant "spill[s]" as a means of curtailment, could be addressed by such a requirement. IRS also suggests the incrementality requirement could be met in regions where all generation comes from minimal-emitting sources and modeling shows that drawing on those resources for hydrogen production will not increase GHG emissions due to the need for additional power production in those areas.
• Whether to adopt an approach for the previous two options that would "deem five percent of the hourly generation from minimal-emitting electricity generators (for example, wind, solar, nuclear, and hydropower facilities) placed in service before January 1, 2023, as satisfying the incrementality requirement," given the difficulties in determining incremental generation, in particular, during "periods of curtailment or times when generation from minimal-emitting electricity generation is on the margin."

The incrementality proposal incorporates some elements of the ACP framework, which also suggested a 36-month timeframe for newly built renewable generation facilities. Yet they seemingly omit others, such as generation facilities that are upgraded or retrofitted such that they meet the "80/20 rule"—where the fair market value of remaining used property at those facilities amounts to no more than 20 percent of their total value.

Time Matching. Time matching requires hydrogen producers who draw power from the grid to match their electricity use to specific times when renewable electricity generators are producing power. The proposed rules would allow for annual matching (matching electricity use to power production on a yearly basis) until January 1, 2028. Thereafter, they would require hourly matching (matching electricity use to power production on an hour-per-hour basis). Annual matching is arguably simpler to satisfy. Hourly matching more closely ties hydrogen production to simultaneous renewable electricity generation but may initially limit hydrogen production on a 24/7 basis if renewable electricity is not available at certain hours of the day. The proposed regulations observe that hourly tracking systems are not yet widely available and will take time to develop. IRS believes that the January 1, 2028 deadline will give those systems enough time to adapt.

This phased-in approach to hourly matching was a key element of the ACP framework, though the proposed regulations differ substantially from ACP's proposal. The ACP framework would have allowed projects beginning construction before the end of 2028 to be grandfathered into an annual matching requirement. Hourly matching would apply only to projects beginning construction in 2029 and after. The proposed regulations, by contrast, would seemingly require hourly matching for all projects after January 1, 2028, regardless of when they began construction.

Energy storage projects could address industry concerns with hourly matching. Citing the DOE White Paper, the proposed regulations would rely on EAC registries to determine how hourly matching might account for energy storage. If energy storage projects are widely implemented before the shift to hourly matching, they could more easily allow for creditable hydrogen production to occur during hours when renewable electricity isn't being generated.

Deliverability. Also referred to as regionality, deliverability would require that electricity be generated in the same region as the hydrogen production facility. The proposed regulations would define "region" as provided in DOE's October 2023 National Transmission Needs Study (see, e.g., Page iii, Figure ES-1). This is similar to ACP's proposal of relying on the 66 "balancing authorities" across the country, which include individual utilities as well as the seven RTOs and ISOs.

Electing the Section 48 Investment Tax Credit

The proposed regulations address the taxpayers' choice between the Hydrogen PTC or the Section 48 Investment Tax Credit ("ITC"). Section 48 allows taxpayers to irrevocably elect to claim the ITC instead of the Hydrogen PTC for a clean hydrogen production facility property placed in service beginning in 2023. The proposed regulations address the energy percentage used by the taxpayer to calculate the Section 48 credit, verification requirements for Section 48 as it applies to hydrogen production facilities, as well as credit recapture.

Claiming 45V and 45 or 45U Credits

Sections 45 and 45U refer to separate production tax credits for renewable electricity and electricity from qualified nuclear power facilities. The proposed regulations address the interplay between those credits and the Hydrogen PTC. Taxpayers may claim credits under both Section 45/45U and the Hydrogen PTC when they produce creditable electricity that is then used to produce qualified clean hydrogen, provided they submit a verification report with attestations from a qualified third-party verifier that "(i) the electricity used to produce hydrogen was produced at the relevant facility for which either the section 45 credit or section 45U credit was claimed; (ii) the given amount of such electricity (in kilowatt hours) used to produce hydrogen at the relevant qualified clean hydrogen production facility is reasonably assured of being accurate; and (iii) the electricity for which a section 45 or section 45U credit was claimed is represented by EACs that are retired in connection with the production of such hydrogen."

Placed in Service Date for Existing Facilities that are Modified or Retrofitted

The proposed regulations also address the placed-in-service date for modified and retrofitted clean hydrogen production facilities. For modified facilities, the placed-in-service date is when the modification is complete. The proposed regulations also require that "the modification is made for the purpose of enabling the facility to produce qualified clean hydrogen" and that "the taxpayer pays or incurs an amount with respect to such modification that is properly chargeable to the taxpayer's capital account for the facility." The proposed regulations clarify that changing fuel inputs in the hydrogen production process, e.g., from conventional natural gas to RNG, do not qualify as a modification. For retrofitted facilities, the proposed regulations incorporate the "80/20 rule," as described above.

Additional Administrative Requirements and the Anti-Abuse Rule

The proposed regulations set forth requirements for the verification of clean hydrogen production processes by an "unrelated party," as is required in Section 45V. These include requirements for "verification reports," which must be submitted to IRS when claiming the Hydrogen PTC, as well as production attestation, sale and use attestation, and conflict attestation requirements. They also include proposed rules for determining who may act as a qualified verifier.

Additionally, the proposed regulations create an "anti-abuse rule" that "would make the [S]ection 45V credit unavailable in extraordinary circumstances in which, based on a consideration of all the relevant facts and circumstances, the primary purpose of the production and sale or use of qualified clean hydrogen is to obtain the benefit of the [S]ection 45V credit in a manner that is wasteful, such as the production of qualified clean hydrogen that the taxpayer knows or has reason to know will be vented, flared, or used to produce hydrogen."

Renewable Natural Gas and Fugitive Methane

Finally, RNG and fugitive methane used to produce hydrogen is not addressed by the proposed regulations but will be the subject of future regulations IRS will propose. IRS is soliciting comments now on twelve topics related to RNG and fugitive methane, including lifecycle GHG emissions considerations for RNG and electronic book and claim systems for RNG tracking. The proposed regulations also note that IRS expects to require RNG/biogas-derived hydrogen to originate from "first productive use of the relevant methane," meaning the time when a biogas producer first begins using or selling biogas for productive use. This would mean that biogas used for a different purpose in a previous taxable year "would not receive an emission value consistent with biogas-based RNG but would instead receive a value consistent with natural gas in the determination of the emissions value for that specific hydrogen production pathway." The concern here seems similar to the one motivating the incrementality requirement for electrolytic hydrogen discussed above. Biogas/RNG producers should be mindful of these proposed limitations and the forthcoming regulations.

Conclusion

The proposed regulations give significant direction regarding how IRS intends to apply the Hydrogen PTC, but they are not yet set in stone. Comments from the public could persuade IRS to shift course or account for considerations it has not addressed. Although it is unlikely that the agency departs significantly from the major components of its proposed framework, IRS is soliciting comments on several alternative approaches to certain requirements, which it is considering adopting in the final rules. The rulemaking process can be lengthy and subject to delays and other challenges. This is the time to ensure that IRS has before it a complete record on which to set appropriate and effective regulations for the Hydrogen PTC that will help grow the U.S. clean hydrogen economy. Comments on the proposed regulations are due on February 26, 2024.