Fueling Change: Understanding the Impacts of the Proposed Rule for Hydrogen Tax Credits on Greenhouse Gas Emissions from the US Energy Sector

The Inflation Reduction Act (IRA) of 2022 is the first federal law to support comprehensive climate mitigation efforts in the U.S. The law includes subsidies for diverse low-carbon energy technologies, including those used to produce hydrogen. Since burning hydrogen does not emit greenhouse gases, it could replace fossil-based products and their combustion emissions. However, different hydrogen production technologies can lead to different upstream emissions. Thus, the net impact on emissions from hydrogen must account for how hydrogen is produced.

The primary method for producing hydrogen today is steam methane reforming (SMR), which uses natural gas and generates significant CO₂ emissions. Another technique, electrolytic hydrogen production, uses electricity. The emissions from this process vary depending on the source of the electricity used. Under the IRA, subsidies are available for "clean" hydrogen production, designated as "45V." However, the definition of "clean" in this context has sparked extensive debate and is the focus of a recent proposed rulemaking the Treasury Department released in December 2023. This article summarizes the public comment the Open Energy Outlook Initiative submitted to the Treasury Department on the proposed rulemaking.

Early analysis indicates that "clean" hydrogen production is contingent upon meeting three specific criteria, collectively known as the "Three Pillars." These pillars determine the extent to which hydrogen production is considered clean by defining requirements for incrementality, time-matching, and deliverability. Incrementality requires that electricity used for hydrogen comes from clean electricity sources that would not have been built or operated in the absence of the electrolyzer demand. The time matching pillar requires that the operations of the electrolyzer match the production of incremental clean electricity over a year (annual matching) or at each hour (hourly matching). Finally, the deliverability pillar requires that the electricity used for hydrogen production be sourced from within the same region.

While prior analyses of the Three Pillars requirements used models with considerable technological detail, their scope was narrow, capturing only one or two years and focusing on a segment of the United States. Most limiting, these studies only considered emissions from the electric power system, neglecting the broader impact of electrolytic hydrogen in other sectors and potentially substituting for fossil fuels across the entire energy system.  Such an approach is akin to estimating the emissions associated with making a solar panel without considering the clean electricity it produces and the generation that it displaces.

We use the Tools for Energy Model Optimization and Analysis (Temoa), an energy system optimization model, to evaluate the implications of the Three Pillars requirements on energy-wide greenhouse gas emissions. Temoa allows us to consider the cross-sectoral impacts of new hydrogen production under different assumptions regarding the Three Pillars. For the analysis, we used a database of the energy system created as part of the Open Energy Outlook Initiative.  We used five scenarios to understand the specific implications of the Three Pillar requirements between 2025 and 2039. Such scenarios include a baseline scenario without the 45V tax credits and four scenarios with increasing regulatory stringency regarding hydrogen production pathways eligible for the tax credits. In the least stringent scenario, all electrolytic hydrogen, regardless of the source of electricity used for its production, would be eligible for the full 45V tax credit. In the scenario with the most stringent requirement, only hydrogen produced under the requirements of the Three Pillars would qualify for the full tax credit. 

• Our analysis suggests the 45V tax incentives encourage early investment in hydrogen energy infrastructure. However, there are challenges with accelerating the development of hydrogen production projects over the next decade. These constraints result in similar hydrogen production levels across all the 45V tax scenarios we analyzed.
• In the first period of the analysis (2025-2029), hydrogen production due to the 45V tax credits leads to a slight increase in annual CO₂ emissions in the power sector, compared to a scenario without the tax credits. By the second period of the analysis (2030-2034), hydrogen produced in the scenarios that include the incrementality requirement drives a slight reduction in the emissions from the power sector compared to a scenario without any 45V tax credits. By the third period of the analysis (2035-2039), annual emissions from the power sector decrease relative to the baseline scenario without the tax credits, even in the scenarios with less stringent requirements on the source of the electricity used for hydrogen production. Interestingly, there is no noticeable difference in emissions from the power sector between the annual and hourly matching scenarios. The reduction in power system emissions over the analysis period results from increased renewable generation and a slight decrease in fossil-based generation.
• To fully understand the impact of these tax incentives on emissions, we have to consider the whole energy system. Our energy system optimization model suggests small increases in annual cross-sectoral greenhouse gas emissions associated with the 45V tax credits, regardless of their stringency related to the Three Pillars requirements. While the incrementality requirement results in lower incremental emissions from the entire energy system compared to the scenario with laxer electricity sourcing requirements, the hourly matching requirement provides negligible benefits. Furthermore, the difference in cumulative greenhouse gas emissions from the entire energy system between 2025 and 2039 across all the scenarios is less than 1%. Compared to the power system results, this finding underscores the challenge of accurately estimating consequential emissions factors for hydrogen, as the chosen system boundary significantly influences the calculated values.
• The very slight increase in system-wide annual greenhouse gas emissions associated with the 45V tax credits results from changes in sectoral energy demand. Specifically, the incentivization of hydrogen production under the 45V tax credits brings about shifts in the demand for natural gas and electricity, particularly in the industrial sector. As demand for electricity increases for electrolytic hydrogen production in the scenarios with the 45V tax credits, electricity demand in the industrial sector decreases, while natural gas demand increases slightly. Conversely, hydrogen finds new applications in producing Fischer-Tropsch liquids and fuel cells for heavy-duty transport.

The findings from our analysis underscore the complexity of assessing the environmental impacts of policy measures such as the 45V tax credits for electrolytic hydrogen. While the direct effects of the Three Pillar requirements on hydrogen production and power sector emissions may be modestly positive, the broader implications for fuel demand, sectoral shifts, and cross-sectoral emissions merit additional attention. Our analysis suggests that the stringency level of 45V tax credits would have a relatively small effect on annual system-wide emissions between 2025 and 2039. Indeed, results that differ so negligibly are likely within the uncertainty bounds of the energy system model used for this analysis. These results highlight the importance of considering the entire energy system when evaluating policy interventions, ensuring that incentives for clean hydrogen production contribute positively to the overarching goal of reducing greenhouse gas emissions and facilitating a transition to a more sustainable energy system.

Reaching net-zero emissions from the energy system by 2050 will require massive deployment of hydrogen technologies. A significant benefit of the 45V tax credits is that they incentivize early deployments of hydrogen production. However, the complex nature of the Three Pillars requirement could introduce a substantial administrative burden on both regulatory agencies and the entities they regulate. This complexity can lead to misallocating resources, increasing administrative costs for regulatory agencies, and elevating litigation risks. Such an environment may inadvertently discourage investments in hydrogen infrastructure due to the heightened uncertainty and potential for increased compliance costs. In turn, delays in investment as a response to the Three Pillars requirements could exacerbate the "chicken and egg" dilemma, where potential hydrogen consumers hesitate to invest due to uncertain supply, and suppliers refrain from investing due to insufficient demand. This dynamic could undermine the effectiveness of the 45V policy, delaying the deployment of crucial hydrogen infrastructure and impeding progress towards net-zero CO₂ emissions.

Energy system models are essential tools for comparing future scenarios under a set of shared assumptions. They provide valuable insights into the potential impacts of policies like the Three Pillars requirement on hydrogen demand, electricity consumption, and emissions across the entire energy system. However, these models inherently cannot capture all real-world dynamics influencing outcomes. Factors such as the behavior of firms and unforeseen market shifts are often outside the scope of these models. This limitation underscores the unpredictability of results derived from such analyses, highlighting the challenge of applying concepts like causality or counterfactuals within this modeling context.

The proposed 45V rulemaking is part of a critical juncture in U.S. energy policy, reflecting a commitment to clean energy and a sustainable and integrated approach to climate mitigation. The findings from our analysis underscore the complexity of assessing the environmental impacts of policy measures such as the 45V tax credits. As the Treasury Department prepares to finalize the rules, it must balance the social benefits of regulatory complexity and the need to encourage investment in clean hydrogen production to eventually meet the goals of the Paris Agreement on Climate Change. As the energy sector evolves, it will be essential for policy flexibility to address unexpected outcomes and continuously conduct comprehensive analyses that include technical and behavioral dimensions. Such adaptability can help mitigate the risks associated with regulatory interventions in the clean hydrogen sector.

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We invite you to read the comments we submitted to the Treasury Department in response to the proposed rulemaking for the 45V hydrogen tax credits. The comments include figures that summarize the results of our analysis and more detailed discussions of our findings.