Will Hydrogen Energy Be Clean Energy?

The U.S. Department of the Treasury is finalizing rules that will determine which new clean hydrogen projects will receive the IRA’s generous 45V tax incentives, and whether those projects will deliver promised climate benefits.

The Inflation Reduction Act provides a range of incentives for the development of clean energy resources in the United States. Highest profile among those incentives are hundreds of billions of dollars in tax credits earmarked for new wind and solar power projects. Yet the IRA’s most aggressive incentives aren’t directed at renewables but at clean hydrogen, which is a fuel that is viewed as crucial to decarbonizing parts of the economy that aren’t readily electrified, such as steel making, air travel and shipping.

Over the past few months, the Department of the Treasury and the Internal Revenue Service have been developing rules to define what will qualify as clean hydrogen, and what level of financial incentive hydrogen producers should receive based on the climate impact of the hydrogen they will make. Final rules are expected this year, and will ultimately determine whether clean hydrogen delivers on its climate promise.

Danny Cullenward, Vice Chair of California’s Independent Emissions Market Advisory Committee and a Senior Fellow at the Kleinman Center, explores the climate stakes surrounding the Treasury’s 45V hydrogen production tax credit. Cullenward explains the draft clean hydrogen rules, and why certain interests would like to see those guidelines relaxed. He also explores what the final rules might mean for the pace of clean hydrogen growth, and for the ability of clean hydrogen producers to thrive after the incentives expire.

Andy Stone: Welcome to the Energy Policy Now podcast from the Kleinman Center for Energy Policy at the University of Pennsylvania. I’m Andy Stone.

The Inflation Reduction Act provides a range of incentives for the development of clean energy resources in the United States. Highest-profile among those incentives are hundreds of billions of dollars in tax credits, earmarked for new wind and solar power projects. Yet the IRA’s most aggressive incentives aren’t directed at renewables but at clean hydrogen, which is a fuel that is viewed as crucial to decarbonizing parts of the economy that aren’t readily electrified, such as steel-making, air travel, and shipping.

Over the past few months, the Department of the Treasury and the Internal Revenue Service have been hard at work developing rules to define what will qualify as clean hydrogen, and what level financial incentive hydrogen producers should receive, based on the climate impact of the hydrogen they will make. The rules, which the Treasury released in draft form in December, will ultimately determine whether clean hydrogen delivers on its climate promise. As might be expected, lobbyists of all stripes have come out in force to advocate for their vision of the tax credit, known as 45V, with the Treasury receiving some 30,000 comments on its draft rule.

On the podcast, we’ll explore the climate stakes surrounding the hydrogen tax credit with Danny Cullenward, Vice Chair of California’s Independent Emissions Market Advisory Committee, a Research Fellow with the Institute for Carbon Removal Law and Policy at American University, and a Senior Fellow here at the Kleinman Center. Danny will walk us through the Treasury’s draft of clean hydrogen rules. We’ll also look at how and why certain interests would like to see the draft guidelines relaxed, and what changes to a final rule could mean for the pace of clean hydrogen growth and for the ability of the industry to sustain itself over time. Danny, welcome to the podcast.

Danny Cullenward: Thanks for having me, Andy.

Stone: The Biden administration and Congress have moved aggressively to support the development of clean hydrogen production capacity. The 2021 Bipartisan Infrastructure Law provides $8 billion for the development of hydrogen hubs, and the IRA offers clean hydrogen production tax credit, 45V. Why has the development of clean hydrogen capacity been such a legislative priority?

Cullenward: I think your question touched on a couple of the different reasons why, and I see broadly two sets of reasons why there has been so much interest. One is that there is broad bipartisan support for energy infrastructure deployment, particularly when that relates to oil and gas production in oil and gas communities, and as we’ll talk about, some of the ways to produce hydrogen involve traditional fossil and natural gas systems.

So that’s one set of constituencies that has an interest in these outcomes. It overlaps with, but is sort of distinct from the main climate coalition that has increasingly understood that when we’re trying to fully decarbonize the power sector and the industrial sector and a variety of emissions sources from activities we have today, we don’t know how to do that fully with all of the energy systems and energy carriers we have. Hydrogen is widely seen, if you can make it low-emissions enough, as one of the tools that is needed to support truly deep decarbonization. So the tax credit in the Inflation Reduction Act, which came out of the Democratic Party’s platform, has very specific emissions guidelines associated with it, which is a little distinct from the sort of deploy-and-put-money-and-steel-on-the-ground side of the Bipartisan Infrastructure Law.

Stone: Okay, so large amounts of hydrogen are used and produced today. Hydrogen is used to make fertilizer. It is used in oil refining, yet most of that hydrogen we use today is what’s called “grey hydrogen.” What is grey hydrogen? How is it produced, and what is its climate impact?

Cullenward: Nearly all hydrogen produced today is made from natural gas, primarily methane, and that’s almost all from a fossil source. So this is traditional oil and gas. This is the gas side of oil and gas, and basically it’s primarily methane, which is CH4. There are a couple of different processes by which the carbon is stripped off and the hydrogen is separated from the carbon and then the methane molecule. That’s basically where it comes from today. It’s a fossil fuel feedstock. It’s emissions-intensive, both in the sense that it produces CO2 as a waste stream when you split apart the methane, and it’s also emissions-intensive because, particularly in the United States, our oil and gas production system has a lot of methane leakage associated with production at the wellhead and distribution of the gas in the transmission network. So both of those aspects are very emissions-intensive today, and if you want to see hydrogen either in its current uses or in some of its potential future uses be climate-aligned, we really need to drive those emissions down.

Stone: So we have a two-fold challenge coming down the road, right? We need clean hydrogen that’s going to be used in these hard-to-address industries, and we’re going to need a whole lot of it. So clean and a lot. What is the scale of clean hydrogen we’re going to be talking about, and what are the options for making it?

Cullenward: There’s actually quite a bit of interesting debate about exactly how much we need, and that’s part of what makes this issue so interesting. Some people say we just need kind of an unlimited amount. We’re going to replace everything with hydrogen. That’s a very extreme view. There are others who think we may not actually need as much of this as we currently use. Wherever you come down on this debate, the scaling is really significant because today, the cleanest ways to produce hydrogen involve producing it from water and electricity, where you take water, H2O, and you split the hydrogen and the oxygen. There’s no carbon there, so there’s no carbon pollution, but it’s quite energy-intensive, and it involves some relatively newer technology. It’s called “electrolyzers” that are in their early days. Basically, very little of today’s supply is made in that way. If you want to see any substantial growth, wherever you land on that spectrum of are we going to have all the hydrogen or just quite a lot of hydrogen, there’s a huge gap between where we are today and where you want to see that outcome, no matter where you are on that spectrum.

Stone: I want to get the definitions correct here. There is green hydrogen, and there is clean hydrogen. What is each of those?

Cullenward: In the hydrogen world, people have attached colors to the different pathways. I personally find it a little bit more distracting than clarifying, particularly because as we start to enumerate new pathways, there is a whole rainbow of colors, and it’s really hard to keep track of everything. When you hear “green hydrogen,” that refers very specifically to electrolyzer-based production, where you take water and electricity, and you make hydrogen without carbon pollution.

You also hear “grey hydrogen.” That’s where you take conventional fossil methane, and you use a couple of different processes to produce hydrogen, including that carbon pollution. There are a couple of other colors that are out there. We’ll probably end up talking about “blue hydrogen,” which is when you take that same fossil carbon production system, but you try and capture some of the CO2 pollution that comes at the last step. And these colors, again, sometimes are more distracting than helpful. A big part of the debate here is which of these pathways can possibly become clean enough?

I think most people would agree there are ways to get green hydrogen clean enough, although we’ll talk about how that’s actually still quite hard to do. There’s a lot more debate and controversy about whether any of the other pathways could possibly qualify for a reasonable definition of “clean.”

Stone: If something is going to be “green hydrogen,” produced with electrolyzers, using electricity, that electricity needs to be truly clean for it to be “green,” right?

Cullenward: Exactly, and that turns out to be a much more complicated question because you can say, “I’m a hundred percent powered by renewables, but these hydrogen production facilities, these electrolyzers consume so much electricity that when we add new loads to the grid, there are indirect effects. If you pull clean energy off the grid to supply your new electrolyzers, you’re going to cause higher emissions on the grid.

Stone: So this is really the drama we’re at at this point in time. The Treasury and the IRS have the task of determining how clean hydrogen or green hydrogen will be defined for the purposes of receiving the tax credit. And the importance of these rules that Treasury and the IRS will define are incredibly important in determining the carbon footprint of hydrogen. Why are the rules going to be so important?

Cullenward: There are a couple of different reasons. One is maybe one of the most important to start with. It has to do with the nature of these tax credits under the Inflation Reduction Act. So they are uncapped. I have a colleague, Tim Sahay, who has famously labeled these tax credits “bottomless mimosas.” In the tax law, you can have as many projects and as many credits as you want. There is no limit on how many tax credits go out the door.

If Treasury were to write extremely lax rules, you could imagine a whole bunch of projects might get developed that could be very emissions-intensive, and there are estimates ranging from tens to hundreds of billions of dollars in tax credit outlays, just from this particular provision alone. So the financial scale here is massive, and the emissions consequences also turn out to be massive, if the rules aren’t set strict enough.

Even if you were to just focus on the green electrical production pathways, if we end up just pulling clean energy resources off of the grid and diverting those to the new electrolyzer loads, we’ll increase emissions of the grid. And it’s potentially large enough that that’s a very big number.

Stone: Because it has to be back-filled with more electricity generation, which could be coal or gas-fired, right?

Cullenward: In the near-term, it will be coal or gas-fired because if we’re not building renewable energy fast enough to not just keep pace with decarbonizing the grid, but also decarbonizing our new load, then we’re going to have that back-filling.

Stone: Okay, so the Treasury’s draft guidance around green hydrogen is actually quite clear. The Treasury provides three pillars that hydrogen production must adhere to, to receive the maximum tax credit. What are those three pillars?

Cullenward: Yes, so this concept of the three pillars came out of an advocacy coalition that included a broad array of environmental NGOs and some green hydrogen producers who have all been advocating for this three-pillars model. The idea of the three pillars is that there are three fundamental attributes of safeguards that you would want to see to ensure that we minimize that back-filling, those indirect emissions that come with putting new load on the grid in the form of these energy-intensive electrolyzers.

And the three pillars — I’m going to give you the name that the Treasury Department used in their rules, and then I’ll tell you what they actually mean. So there’s “incrementality,” and this is really about newness. We want to have new clean energy resources being attributed to those new electrolyzers. We want “deliverability,” meaning we want those new clean energy resources to be located in the same area of the grid, to respect the physics of the grid so we can more legitimately say, “Those are my clean electricity resources.”

And we want the clean energy resources to be matched with the power consumption of the electrolyzers on an hourly basis. In a lot of other emissions counting systems, people do annual matching. It turns out that getting to much more granular levels and matching closer to real time is really important if you want to manage those indirect emissions consequences. [OVERTALK]

Stone: Because the electricity could be produced during the day, but your electrolyzer runs at night, and it’s not really consuming that clean electricity.

Cullenward: Exactly. You’ll get that back-filling effect if you do it in that way, and in substantial amounts, to be perfectly honest.

Stone: How important will the 45V tax credit be to the economics of green hydrogen? And what are the tiers of the credit that are offered?

Cullenward: This is where things get really interesting. There are a couple of different tiers of the tax credit, and the top tier, where you have the lowest emissions, so you need the most stringent emissions performance standard, would give up to three dollars per kilogram of hydrogen. There are less stringent tiers, where you have less-exacting emissions restrictions, and those go from one dollar, all the way down to 60 cents a kilogram. So there’s a big jump from that one-dollar to that three-dollar level, and that’s a very, very generous subsidy. In fact, that’s such a generous subsidy, it probably should only go to new technologies that are inherently more complicated and inherently more energy-intensive, like electrolyzers, where there’s always going to be a cost premium between doing it clean and doing it with unabated fossil pollution.

So it’s a very, very generous tax credit at its top tier, and the amount of money, again, that could move through this system — tens to hundreds of billions of dollars — is just a huge volume of money.

Stone: Some groups, and notably some of the backers of the seven hydrogen hubs that are in development at various sites around the country at this point would like the Treasury to water down its rules for qualifying for the tax credit. What changes to 45V the guide so far would they like to see?

Cullenward: There are two sets of changes you want to see, and both broadly reflect the interest of the hydrogen hub proposals in these different regional combinations of government and private interests. They all want to see their projects qualify for the tax credit and possibly for that highest and most generous tier of tax credit.

So they’re interested in seeing the Treasury finalize rules in a way that is going to make their facilities eligible, and you’re seeing asks coming both on the gas side of that spectrum, because some of those hydrogen hubs are going to use gas as a feedstock. Others are going to use just electricity and those electrolyzers we talked about. You’re seeing both sets of groups make asks to bring the final rules to a place where they believe their projects will qualify.

On the green electricity side, you’re seeing states, for example, that are often seen as stalwart climate leaders asking Treasury to water down their rules right now. So I’m struck the governors of California, Oregon, and Washington sent a comment letter into the Treasury Department saying, “Can you please not apply these three-pillar standards in the way you’ve written them to our hydrogen projects? We live in jurisdictions where we’re going to require a hundred percent clean electricity in the long run, so we’re not worried about backfilling the grid in the short term.”

Stone: So they’re saying that this is going to slow things down if the rules are too stringent?

Cullenward: It’s not just slowing things down. And there’s an interesting debate to be had about if the rules are set so strict that nobody can build a project, we’ll never get the industry off the ground. And there’s a legitimate conversation there. I tend to be in the camp that says there’s so much money on the table with these subsidies, and enough people who had stepped up to say, “We can build green electricity production facilities using these subsidies,” that I’m less concerned about the pace of industrial deployment right now.

What the states and the hydrogen hub interests are saying is something slightly different. They’re saying, “We want to build our hubs, and we want our hubs to get your tax credit.” And it’s really important to them to get that, so they’re making a variety of arguments about why the protections in the draft rules are unnecessary.

Stone: That’s interesting. In a recent paper that you and Emily Grubert of Notre Dame wrote, you referenced a very interesting point. That gets to the very high electricity consumption of electrolyzers used in the production of green hydrogen. They use so much electricity that, if the electricity they consume is produced with just a little bit of a carbon footprint, that electricity and that end result — the hydrogen could actually have a higher life cycle carbon footprint than hydrogen produced through steam methane reforming. Could you talk about that?

Cullenward: So the numbers get really weird when you do this, but if you end up drawing from representative grid power, you can get very high emissions intensity. And so part of the problem we’re dealing with here is we have a tax credit that’s going to subsidize the production of hydrogen. If you’re running your electrolyzer when the marginal resource on the grid is, for example, coal power, you could end up with an extremely carbon-intensive product.

In theory, the safeguards in the text of the Inflation Reduction Act tell the Treasury Department to only make projects eligible if they can meet these life cycle standards, accounting for these indirect emissions impacts. But that’s really what the big debate is about. Will they set the standards in a place that allows or disallows that? The consequences of that decision are going to be very significant from an emissions perspective, as well as from how much money and how much steel is going into the ground in the hydrogen industry.

Stone: We talked about green hydrogen and the three pillars that would define the production of green hydrogen. Treasury, though, has been much less clear about fossil hydrogen and how and if it will qualify for the 45V tax credit. As you mentioned, many of the hydrogen hubs would like, at least to some extent, to use fossil hydrogen. In a best case scenario, qualifying for 45V will be very difficult for the methane-based projects. Tell us about that.

Cullenward: To the Treasury Department’s credit, they’re using a model that was identified in the statute to do these life cycle emissions estimates, and actually this model does not do a particularly good job of estimating the life cycle emissions of traditional oil and gas production pathways. It assumes a very low rate of methane leakage. About 0.9% of the methane that is produced ends up in the form of methane that is emitted to the atmosphere, according to this model. The best studies of US methane leakage rates tend to be in the neighborhood of 2 to 2-1/2%, sometimes 3%, and you see regional variations. Some basins have clocked in over 9% leakage.

Stone: That’s really out of line.

Cullenward: So you can see that the model is making an assumption that is very low, relative to the literature, and that ends up being a very favorable assumption from the standpoint of somebody who is going to use oil and gas production pathways, because they’re going to get generous treatment with the model. Even with that, it is almost impossible to qualify for the lowest tier of the 45V tax credit.

Stone: The 60 cents.

Cullenward: The 60 cents. To get that, with the assumption of the model, you’d need to capture more than 90% of the carbon dioxide pollution coming off of the steam methane reformer, that last part of the process that produces the hydrogen from the methane gas.

A lot of people have said, “Don’t worry too much about this because these folks aren’t going to qualify.” It’s basically impossible for a conventional pathway that maximizes the deployment of carbon capture and storage technologies just barely can’t squeak in under that lowest tier of the tax credit. And what my colleague Emily Grubert and I realized is that’s true by those numbers, but if you allow them to use methane offsets, which is something that’s in use in other policy systems, the whole story reverses.

Stone: Tell us about that. I understand that methane offsets make this stuff look very, very clean.

Cullenward: Yes, and this is where the sort of background I have, as somebody who has studied climate policy systems in other jurisdictions, this is like every one of my nightmares happening at the exact same time.

Stone: It’s kind of crazy when you look at it.

Cullenward: It’s insane. We’re talking tens to hundreds of billions of dollars, and how much of this flows to conventional oil and gas systems? How much of it leads to really emissions-intensive outcomes is going to be based on what kinds of numbers you get to put in a spreadsheet tool to calculate your life cycle assessment for this tax credit.

One of the biggest issues turns on whether or not you’re allowed to use negative numbers for your feedstock. It’s a weird thing, so let me do my best to explain it here.

Stone: Yes, go through that for us.

Cullenward: When you have a conventional methane production process coming from fossil, oil, and gas — We just talked about how, under the Treasury’s model, it’s almost impossible to qualify for the lowest-tiered tax credit using conventional methane produced from fossil fuel systems, even with the very favorable treatment given to methane leakage.  And if Treasury in the future were to use an appropriate number for methane leakage, it simply will not qualify, full stop.

That all completely inverts if, instead of treating the methane that’s used in that production process as a source of emissions, you treat it as a negative number in the emissions accounting. And this is a very weird thing. This is called the “methane offset.” The basic idea here is supposing you’re thinking about this methane not as something you’ve pulled out of the ground and are either emitting or are turning into hydrogen through these production processes, but it’s methane that would otherwise have been emitted to the atmosphere, and you’re doing the great job of capturing it and putting it to productive use.

So if you allow producers in these systems to say, “I actually got my methane from somebody else who was going to vent it to the atmosphere,” you get to claim the climate benefit of them not venting it to the atmosphere because methane is such a potent but short-lived greenhouse gas and because the conventional ways of converting methane into its carbon dioxide equivalent multiply that methane number by a very large conversion factor. Avoiding those methane emissions can lead to greater stated climate benefits in a spreadsheet model than the actual emissions consequences of the production process. So you can end up with negative carbon feedstocks in the spreadsheet model.

Stone: So to sum up, you could use methane or methane offsets — you know, methane itself — to produce the hydrogen, and that would actually be cleaner through this math than the cleanest green electricity produced with an electrolyzer with one hundred percent carbon-free electricity.

Cullenward: Yes, and this sounds insane, and I apologize. There is no simpler way to explain it, but let me give you a concrete example of how this is happening in practice. This actually happens in my home state of California where we have a transportation of fuels policy that uses the same model and uses these same accounting techniques.

The way it works is imagine there is a hydrogen production facility located next to an oil refinery, which is the primary application, and imagine that that hydrogen production facility is collecting methane gas from the pipeline network. That’s fossil natural gas. But then suppose, for the purposes of a climate policy, the regulator allows them to treat that gas not as fossil gas, but as gas that was captured from a dairy in Upstate New York, that was otherwise the production of manure from that dairy which was going to vent that methane into the atmosphere. But instead, they’ve put it in a lagoon. They’ve covered the lagoon. They’ve captured the methane coming off of that manure lagoon. And even though that is a system that is happening in Upstate New York, which is physically disconnected, and there are no transmission flows in the pipeline network between Upstate New York and this refinery in California, nevertheless for the purposes of determining eligibility for a climate policy, the California regulator says, “What you are actually using in your hydrogen production facility is that captured methane that would otherwise have been vented into the atmosphere, and so you are a climate solution, not an emitter.”

Stone: Who exactly is advocating for this?

Cullenward: Currently the California government actually is advocating for this. This is, I think, one of the most lucrative essentially loopholes in a multibillion-dollar policy that the California government runs right now. The industry of what’s called “renewable natural gas,” which is the phrase this industry gives to describe its activities, they are very strongly interested in seeing these activities get credited under the federal tax credit because they are the people who are going to supply this putatively clean gas to the conventional hydrogen production processes that run off of methane gas.

So they are advocating very openly for this. The California government is advocating openly for this, and a number of the fossil oil and gas production-based systems would like this, too, because what Emily Grubert and I realized in our piece is it takes a very small number of offsets from these methane production processes to qualify a conventional system for the top tier of this tax credit, a tax credit designed for innovative new technologies.

Let me just give you a couple of numbers from the piece to give some context for this. A traditional grey hydrogen production process, where you just take that fossil methane, and you pull the hydrogen off of it — There are no pollution controls on it. That can’t get anywhere close to qualifying for the tax credit. Full stop. But if you allow that producer to say that 25% of their methane gas comes from one of these captured methane sources, that’s sufficient to get them to qualify for that top tax credit tier, that 3 dollars per kilogram.

So offsetting just a quarter of the feedstock production process in this manner takes you from completely out of the money to earning the maximum possible revenues under this tax credit. If you do that same calculation with carbon capture and storage — remember I told you that even if you have maximum carbon capture and storage, you could just barely, maybe get to that 60-cent tax credit. Four percent. Four percent of your methane, if you source it from one of these offset sources, gets you to the top tier of the tax credit.

Stone: Wow, because methane is such a potent greenhouse gas.

Cullenward: Yes, and when we run the CO2 equivalent numbers on that, it multiplies that, the potency of that gas, and you get these really negative numbers for the feedstocks, which allows you to blend just a little bit of the negative number to offset that positive number of your emissions.

Stone: You know, it seems so ridiculous, and I want to ask you a very general question. I’ll almost take a step back here in kind of the 30,000-foot view for a moment. Why would the Treasury entertain these offset proposals or ideas, knowing that the climate impact truly is uncertain. We don’t know if the methane offsets would truly be additional. You’ve just talked the whole thing through. Why would Treasury potentially consider this? Are they considering it?

Cullenward: So in their proposed guidelines, which came out just after the winter holidays in December, they basically had this fully articulated proposal for what they want to do with the green standards, the electrolytic hydrogen standards. And when it comes to the gas side of the picture, they basically didn’t articulate a full proposal, and they had a long series of very detailed questions. I think it would be fair to say they are considering it. They’ve not told us what they think about it, but they’re asking questions about it.

I don’t know what to say other than there’s a lot of political pressure, and this is one of the sort of, again, at 30,000-foot levels, I have been a big proponent of industrial policy in using financial incentives, which tend to be much more politically palatable than tools like carbon pricing, which can be very effective if you can do it, but it’s very hard to get done. One of the challenges with these kinds of policy mechanisms is that everybody wants to access the incentive, so everybody wants to lobby to get the rules set in a way that makes them eligible.

So it’s a very difficult political problem, and I think actually the interaction with the hydrogen hubs is maybe the best way to describe this. You have basically 8 billion dollars in hub funding from the Bipartisan Infrastructure Law that’s on the table. There is broad regional diversity, lots of different hub proposals from lots of different places. Very few of them set up to do a strict low-emissions approach. They all want in on this. And so you see, including letters from some legislators who people think of as really strong climate advocates, coming from states that have a long tradition of working on climate policy saying, “Please let my projects qualify.”

And that’s one of, I think, the really challenging aspects of the politics of tax credit implementation, is you have a very broad range of constituents saying, “I would like this money, too.” That makes it very hard for a policy-maker to say, “I know there are consequences here, and I’m forced to all of those consequences. I’m going to tell everybody no.” There’s a lot of political pressure to get to yes.

Stone: One of the arguments I’ve seen in favor of more relaxed 45V rules is that it would allow the clean hydrogen industry to scale up more rapidly, at the expense potentially of the climate impact or climate benefit that it would offer. What is the argument here, just to understand more clearly the balancing between moving quickly and moving cleanly?

Cullenward: That’s a good question, and I think it’s a fair debate to be having. I worry — I’ll tell you what I think after I try to introduce it, but the basic idea here is that if we really want to see a truly low-carbon hydrogen industry which doesn’t exist today, we have to build it. And if you were to set the standards in a way that basically nobody could comply with, you’ll never get that industry.

Now my personal view is that that is typically used as an attack line against environmental safeguards. There is a legitimate interest in making sure that there’s a balance between the emissions outcomes and the pace of development, and I do think that’s a legitimate issue. But I’m really struck when I think about the history of other incentive-based policy programs, how quickly you end up with massive dysfunction in regulatory capture. And I can think of no better example than, for example, our corn ethanol policies, which you will find nobody on the analytical side who thinks that these are sound ways to reduce gasoline consumption and lower climate impacts. But they are so broadly popular with the farming industry and across a broad range of bipartisan coalitions, it has basically proven impossible to reform the corn ethanol subsidies that we have at the federal level.

And so the big warning sign that I’ve tried to make in this case is if you build a bunch of facilities in the hydrogen industry with low environmental safeguards, you’re going to have a significant problem. You’re either going to build facilities that are completely uneconomic, without the tax credit, and therefore will lead to stranded assets once the tax credit expires.

Stone: They are no longer economic. They stop running. [OVERTALK]

Cullenward: You can’t make it work, or worse, you’re going to create a constituency that needs ongoing tax credit support. So here we have the most generous tax credit policy in US policy history, designed around innovation and building a new industry. If you make that accessible broadly to lots of people, and they build facilities that would otherwise be uneconomic without it, you’re going to end up with stranded assets if you haven’t sited these facilities in places where there is abundant, cheap, clean electricity. And that is actually one of the reasons, from a fiscal accountability perspective, that environmental stringency really matters.

The other piece of this — I know this gets wonky really quickly — but if you imagine a gas production facility that uses carbon capture and storage to reduce its life cycle emissions, that is one of the ways people talk about reducing emissions from these facilities. The thing is, you can unplug those pollution controls when you don’t want to run them, because they’re very expensive to run, and you wouldn’t do that unless there was an incentive, like a tax credit, to do it.

And so you have a similar issue with these methane offsets. Suppose you like methane offsets. Well, you don’t have to buy them if you don’t want to after the tax credit window expires. So we risk building a lot of projects that claim to be low-emissions because they use pollution control technologies, where they’ve purchased methane offset credits, which they can simply stop doing. They can unplug their pollution control technology. They can stop buying their pollution reduction credits once the tax credit expires.

So we’re talking about potentially building a lot of infrastructure that can become extremely high-polluting after the tax credit window expires and just produce conventional gas-based hydrogen.

Stone: And that tax credit window is ten years from the start of operation. You’re saying, really, one of the key challenges here that has to be kept in focus is the use facilities need to be in a position to continue running the economic one-stat tax credit goes away. Otherwise, the whole benefit of these ten years of the tax credit — it’s not building something.

Cullenward: Exactly. We need to build these facilities in places where they can cheaply run once the tax credit expires. One of the virtues, from my perspective of the safeguards like the three pillars on the green electrolytic side of the policy spectrum is that if you build the electrolyzers in places where you can build new and match hourly consumption of the clean electricity, those are the places, they physical places where you should have higher confidence that those electrolyzers will be able to produce hydrogen at low cost after the tax credit window expires.

Stone: And what does that mean for the hydrogen hubs that are in places where carbon-free electricity isn’t so easily produced?

Cullenward: It means we’re setting ourselves up for a real dilemma if we build and fund those projects. Now again, there is no rule that requires that the hydrogen hubs also receive the tax credit, and the hydrogen hubs have their own direct source of funding, but those are projects that are likely to be much more emissions-intensive in those circumstances. [OVERTALK]

Stone: And there could be carbon-capture tax credits for some of those facilities, right?

Cullenward: You have to pick between the two, and so some might prefer to do the carbon-capture tax credit instead of this hydrogen production process, which is another reason why maybe you don’t need to set the standards here in a way that accommodates everybody. But yes, projects do have to choose. They can only pick one of those two tax credits.

Stone: And to clarify, that would be carbon capture on systems to produce hydrogen. It would be fossil fuel-based.

Cullenward: Yes, we were talking about how it’s almost impossible to get, even with carbon capture technologies and no offsets, to get a fossil-based hydrogen production pathway to qualify for the lowest tax credit tier — that 60-cent credit here. They can always get the 45Q carbon capture and storage tax credit. It’s a little less lucrative, which is maybe why some are interested in the hydrogen tax credit, particularly if they can use offsets to bump that up to three dollars, but they have that option, and there are no emissions safeguards there. So they don’t have to meet any of these standards. They don’t have to enter into this conversation.

Stone: So if 45V doesn’t work for them, they can go to 45Q, right?

Cullenward: Correct.

Stone: Okay, let me ask you a final question. I think you’ve covered some of this, but what recommendations, what would you like to see out of the Treasury in its final rule? Any particular changes from the draft?

Cullenward: I’m mostly concerned at this point that there have been a lot of asks to water down the green electricity standards. I’m really, to be honest, kind of shocked the major regulators in California all signed a letter falsely stating, “If you build new electrolyzers, add new load, our policies require a hundred percent of that load to be matched with clean electricity.” That’s just false.

So we’re seeing enormous pressure to weaken the standards for green production. I hope the Treasury will hold the line, precisely because if we build and subsidize facilities in places that cannot afford to build cheap and abundant new, clean electricity, we’re building hydrogen in places where they will become stranded assets or permanent handouts. I don’t think we want either of those outcomes.

On the gas side, I’m really nervous because you could end up seeing a lot of pipeline gas-connected hydrogen production that uses things like offsets to make these claims, and I just wish Treasury would simply say, “No negative emissions feedstocks. We’re not going to entertain these games.” If you want to push carbon capture and storage, great. Go ahead and push that, but we really shouldn’t allow people to make claims that they’re not actually burning gas because somebody else did something somewhere else during offset. That’s really the wrong way to run policy.

To the extent the Treasury Department either feels pressured or feels legally they need to entertain some of that stuff, Emily Grubert and I wrote a short comment letter to the Treasury Department saying, “Look, don’t allow blending. Don’t allow a project to say, ‘I mixed in 4% offsets, and now my whole project should earn the top tier of the tax credit.’ If you really want to treat that as a feedstock, make it a separate feedstock, and make a facility run a hundred percent on that particular feedstock. Don’t allow blending.”

And the other most important thing is don’t allow those negative numbers. What you’re basically saying with a negative number emissions on a feedstock is you’re saying it’s okay that somebody else was going to put that methane in the atmosphere, and you get credit for them not doing that. We shouldn’t be giving credit for people avoiding pollution like that.

If you want to say, “This is a biogenic feedstock, and it’s a lower emissions source than a fossil feedstock,” I’m listening. I think there’s a possible discussion there. But it’s those negative numbers that blow everything up, and that’s really what they should print of it.

Stone: When should we expect the final rule?

Cullenward: I hesitate to guess. We’re expecting the draft rule for a very long time. This is a very complicated issue. It’s either more complicated because there is actually another set of tax credits that’s the last major set of tax credit policies under the Inflation Reduction Act. You might know that there have been various production and investment tax credits for wind and solar historically. They’ve been one of the primary ways by which those industries became commercially mature, and they’ve been in sort of boom/bust reauthorization cycles that have been enormously harmful to the industry’s continuous operations.

One of the benefits of the Inflation Reduction Act is those tax credits are going to be combined into so-called “technology and mutual tax credits” that are going to broaden their eligibility to some of the new, exciting clean energy technologies like geothermal, for example. But many of these same issues we just talked about that are on methane offsets are going to come up in the context of those technology-neutral tax credits, where you could imagine somebody saying, “Well, I might be burning methane here at this power plant, but it’s actually that special methane I captured from a dairy.” And so just like the hydrogen producer might say, “That’s a negative number. Give me the full tax credit,” you’re going to see those same debates come up.

Stone: So you’re going to be setting a precedent here.

Cullenward: Yes, and so I hope the Treasury will take its time to really think about the precedential consequences of what this means for this extremely generous and uncapped hydrogen tax credit, because they’re going to face the exact same set of issues when it comes to these very important technology-neutral electricity generation tax credits that we expect them to be working on soon.

Stone: Danny, this is so complex. There are so many facets to it. Thank you very much for explaining it so clearly.

Cullenward: My pleasure. Thanks for having me.

Stone: It has been a pleasure having you.

Today’s guest has been Danny Cullenward, a Senior Fellow at the Kleinman Center for Energy Policy, a Research Fellow with the Institute for Carbon Removal Law and Policy at American University, and Vice Chair of California’s Independent Emissions Market Advisory Committee.


Danny Cullenward

Senior Fellow
Danny Cullenward is a Kleinman Center Senior Fellow. He is a climate economist and lawyer, a Research Fellow with the Institute for Carbon Removal Law and Policy, and the Vice Chair of California’s Independent Emissions Market Advisory Committee.

Andy Stone

Energy Policy Now Host and Producer
Andy Stone is producer and host of Energy Policy Now, the Kleinman Center’s podcast series. He previously worked in business planning with PJM Interconnection and was a senior energy reporter at Forbes Magazine.