The Hydrogen Tax Credit Rules Are Effectively Dead

Few aspects of Biden’s climate law have spurred more controversy than the “three pillars” — a set of rules proposed by the Treasury Department for how to claim a lucrative new tax credit for producing clean hydrogen. Now, it appears, the pillars may be poised to fall.

The Treasury has been under immense pressure from Congress, energy companies, and even leaders at the Department of Energy to relax the rules since before it even published the proposal in December. The pillars, criteria designed to prevent the program from subsidizing projects that increase U.S. greenhouse gas emissions rather than reduce them, are too expensive and complicated to comply with, detractors argue, and would sink the prospects for a domestic clean hydrogen industry.

But lately, the campaign to dismantle the pillars has gotten both more forceful and more threatening. There’s the politically challenging hurdle that leaders of another federally-funded hydrogen program — the regional clean hydrogen hubs — have spoken out against the rules, arguing they threaten investment in hub projects and therefore job creation and economic development around the country. Then there’s the recent Supreme Court decision to overturn the precedent known as Chevron deference, which weakened agencies’ ability to defend their own rules and thereby emboldens any aggrieved parties to sue the Treasury if it keeps the pillars in place. Last week, 13 Democratic Senators, 11 of whom hail from states involved in the hubs, sent a letter calling on Treasury Secretary Janet Yellen to dramatically revise the rules or risk having them challenged in court.

The consequences of losing the three pillars can only be guessed at using models, which are built on assumptions and can’t predict the future with certainty. But proponents say the stakes couldn’t be higher. In their view, the pillars don’t just prevent carbon emissions. They mitigate the risks of rising electricity costs for everyday Americans. And without them, one of the most generous energy credits the government offers could become incredibly easy to claim, ballooning the federal budget.

The clean hydrogen tax credit was created by the Inflation Reduction Act, and offers up to $3 per kilogram of hydrogen produced, with the top dollar amount reserved for fuel that is essentially zero-emissions. The hope was that this would be enough to bring down the cost of hydrogen made from electricity to parity with hydrogen made from natural gas. If made cleanly, hydrogen could help decarbonize other carbon-intensive industries, like steelmaking and shipping.

At first, excitement for the tax credit ran high and companies quickly began making plans for new factories. Announcements of new hydrogen production capacity more than tripled from 2 million tons per year in 2021 to 7.7 million by the end of the following year, with another 6 million announced in 2023, according to the energy consulting firm Wood Mackenzie.

Then, after the Treasury’s proposal dropped last December, everything stopped. Under the three pillars, hydrogen companies that get electricity from the grid, which is still largely powered by fossil fuels, would be required to buy clean energy credits with specific attributes in order to mitigate their emissions and render their hydrogen “clean.” The credits must come from power plants located in the same region as the hydrogen production — the first pillar — that were built no more than 3 years before the hydrogen plant — the second pillar — and be purchased for every hour the plant is operating — the third pillar.

The three provisions work together to ensure that new clean power plants are brought online to meet hydrogen’s energy demand. But finding clean energy credits with these features is not easy — there aren’t many systems in place to do this yet. The Treasury took more than a year to publish its initial proposal, and leading up to it, companies lobbied aggressively for a more lenient version. There was so much money on the line that some businesses flooded the public with ads in newspapers and on streaming and podcast services delivering a cryptic warning that “additionality” — the requirement to buy energy from new power plants — was threatening to “set America back.”

Until businesses have clarity on whether the three pillars will stay or go, the industry is on ice. Several previously announced projects have been delayed. Few companies have reached offtake agreements, even provisional ones, for their hydrogen. Almost none have received a final investment decision or started construction.

“They’re losing advantage over other parts of the world,” Hector Arreola, a principal analyst for hydrogen and emerging technologies at Wood Mackenzie, told me. Momentum to develop hydrogen projects has started to shift back to Europe, which has already finalized its own definition of what constitutes clean hydrogen, he said.

It’s hard to imagine a path forward for the Treasury to keep the three pillars intact. Last week’s letter outlined the current state of play in stark terms. “Without significant changes to the draft guidance,” it said, “one of the most powerful job creation and emission reduction tools in the IRA will likely be hamstrung by future court challenges, congressional opposition, and unfulfilled private sector investment.”

Indeed, at least one company, Constellation Energy, has already suggested it would draw on the loss of Chevron deference to sue the agency if it didn’t remove the second pillar — the requirement to buy clean energy credits from recently-built power plants. (Constellation owns a fleet of nuclear power plants and is developing hydrogen projects powered by them.) In comments to the Treasury, Constellation wrote that the requirements for purchasing clean electricity “have no basis” in the law.

“People can always sue today to challenge regulations,” Keith Martin, a renewable energy tax lawyer at the firm Norton Rose Fulbright, told me. “It’s just that the odds of success have increased.” The Supreme Court’s ruling undermines regulatory agencies’ authority to interpret federal statute.

Another hydrogen company that has been fighting the three pillars, Plug Power, has already claimed victory: It put out a press release last month declaring that it anticipates receiving the tax credit, despite the fact that the rules are still not final and its projects would likely not qualify under Treasury’s proposal. The CEO, Andy Marsh, told a hydrogen trade publication that he’s “certain” the rules will be loosened. (Plug Power didn’t respond to a request for clarification by publish time.)

In their letter, the 13 Democratic senators propose that hydrogen producers should be able to purchase clean energy from existing power plants that are already supplying the grid if they are located in a state that has a clean energy standard, or as long as the power plant doesn’t reallocate more than 10% of its power to hydrogen production. They recommend losing the hourly matching requirement altogether and replacing it with annual or monthly matching, depending on when plants start construction. The senators also suggest allowing projects built in areas with “insufficient clean energy sources,” meaning places with suboptimal sun, wind, water, or geothermal energy, to source their power from farther outside the region.

Beth Deane, the chief legal officer for Electric Hydrogen, a company that has historically supported the three pillars, told me in an interview she thought these proposals represented a good compromise. “Bottom-line, the effectiveness of green hydrogen as a decarbonization tool is being artificially held back,” she said later in an email. “We need to give up perfection on both sides of the three-pillar debate and find the ‘good enough’ solution that lets early mover projects move forward with less stringent requirements.”

But other proponents told me the letter carves out so many loopholes that the pillars would remain in name only. Rachel Fakhry, the policy director for emerging technologies at the Natural Resources Defense Council, told me the letter was “outrageous” and “a giveaway buffet.” Daniel Esposito, a manager in the electricity program at the think tank Energy Innovation, told me he can’t imagine any scenario where these exceptions don’t result in an emissions boost rather than a reduction.

That’s because the electrolyzers used to produce clean hydrogen consume a lot of power and are expected to cause fossil fuel plants — which are more flexible than renewables — to run more often and stay open longer than they otherwise would. Without a requirement to buy power from new clean sources and a prescription to match operations with clean energy throughout the day, there will be no demand signals to bring (often more expensive) clean resources onto the grid that can, for example, produce power at night when solar panels aren’t generating. Power system models from Energy Innovation, Princeton University researchers, the Rhodium Group, and the Electric Power Research Institute have all found that there could be significant emissions consequences if the three pillars were relaxed in ways suggested in the letter.

“This effectively unlocks more than 10 million metric tons of dirty electrolytic hydrogen,” Esposito said, based on some back-of-the-envelope estimates. That would cost something like $30 billion per year. Put another way, he said, every $300 paid out by this program could subsidize one ton of CO2 emissions. Put a third way, he added, it could set the U.S. back two to three percentage points on its commitment under the Paris Agreement to reduce emissions 50% to 52% by 2030 — and we’re already off track.

The authors of the letter say they’re “confident” these fears are overblown. They cite a competing analysis published last year by the consulting firm Energy and Environmental Economics and paid for by the trade group the American Council on Renewable Energy, which found that requiring companies to match their operations with clean energy on an hourly basis, rather than an annual basis, does not ensure lower greenhouse gas emissions. They also cite research by an energy modeling group at Carnegie Mellon and North Carolina State University, which found that the difference in cumulative emissions between scenarios with less stringent requirements and the full three pillars comes out to less than 1% by 2039.

Paulina Jaramillo, a professor of engineering and public policy at Carnegie Mellon who worked on that research, told me the three pillars add a level of regulatory complexity to hydrogen production that is not worth the cost in terms of the emissions savings. In general, she said, she saw no need for the rules, and that the Treasury should subsidize electrolytic hydrogen regardless of where the electricity comes from. “We need to deploy this infrastructure,” Jaramillo told me. “We need to deploy it now so it’s available later.”

The other camp of researchers disputed Jaramillo’s group’s findings, chalking them up to a series of differences in assumptions and approach. They also call the industry’s bluff on the claim that the three pillars are too hard and expensive to comply with. Esposito pointed out that a small group of hydrogen companies has already told the Treasury that if the rules were finalized as-is, they planned to build enough capacity to produce more than 6 million tons of hydrogen per year.

Fakhry argued that we are already seeing the risks of losing the three pillars play out in real time as power-hungry industries like bitcoin mining and artificial intelligence grow. Bitcoin mines have driven up emissions and energy costs around the country. Utilities in Pennsylvania are sounding the alarm that an Amazon data center seeking to divert power from an existing nuclear power plant could shift up to $140 million in costs to other electricity customers. As I wrote in Heatmap last year, this debate is not just about hydrogen — think of all the other energy-intensive industries that will have to electrify before we can reach net zero.

Plenty of stakeholders still believe that the Treasury can find a middle ground by making the three pillars more flexible. The American Clean Power Association, which represents a wide range of energy companies, has proposed loosening the hourly matching aspect for projects that start construction before 2028. Fakhry acknowledged the need for flexibility, but her recommendations are much more narrow than the senators’. For example, she would allow hydrogen producers to buy power from existing nuclear plants, but only if they are at risk of retirement and the purchase would help keep them open. Esposito said Energy Innovation would support power procurement from existing clean resources that are curtailed, meaning they produce power that currently goes unutilized.

Both Fakry and Esposito also downplayed the threat of lawsuits, arguing that Treasury did exactly what it was instructed to do by the law. The IRA specifically says that hydrogen emissions should be calculated per a section of the Clean Air Act that says any accounting should include “significant indirect emissions.” Treasury has interpreted this to include the induced emissions caused by a hydrogen plant, and received letters of support from the Environmental Protection Agency and Department of Energy backing this interpretation.

However, as Martin, the tax lawyer, told me, by overturning Chevron deference, the Supreme Court has just given “677 federal district court judges greater latitude to substitute their own judgment for subject matter experts at the federal agencies.”

Asked for comment on the Senators’ letter, a Treasury spokesperson told me the agency is still considering the many thousands of comments the agency received on the proposed rules. “The Biden Administration is committed to ensuring that progress continues and that the IRA’s investments continue to create good-paying jobs, lower energy costs, and strengthen energy security.”

Even if Yellen heeds the Senators’ advice, the department may not be able to avoid a lawsuit. “We will use every tool available to us — including the courts — to either defend a strong final rule or challenge an unlawful one that reflects the asks in the letter,” Fakhry told me.

There’s also a realpolitik argument here that the industry might want this all to be over more than it wants to kill the three pillars. “The number one thing people want is business certainty,” Esposito told me. “I don’t think people want this to drag on for another two years.”