Development of the US hydrogen market: incentives and challenges

April 2023  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2023 Issue

As the US scrambles to decarbonise its economy and strengthen domestic supply chains, clean hydrogen has been identified as a potential solution to both goals in the industrial, electric generation and transportation sectors. This article explores current sources and uses of hydrogen in the US, policy incentives to expand the production and use of clean hydrogen, and challenges to developers of clean hydrogen projects.

Current US hydrogen market

Approximately 10 million metric tonnes (MMT) of hydrogen were produced in the US in 2021, compared to global production of approximately 90 MMT. Today, nearly all domestic hydrogen production uses fossil fuel pathways, such as steam methane reforming, and is produced by large and mid-sized industrial gas companies in the Gulf Coast region, the Upper Midwest and California. Hydrogen is used principally in oil refining and ammonia and methanol production, and also as a transportation fuel and in backup power systems using fuel cells. As of 2021, there were approximately 257 dedicated hydrogen production facilities, 25 hydrogen pipelines (roughly 1600 miles in the aggregate), and four underground hydrogen storage facilities in use or under development. Nearly half the hydrogen output is consumed ‘inside the fence’ at adjacent facilities. The remainder is sold to end users through bilateral contracts and delivered by pipeline or truck. There is virtually no clean hydrogen production in the US today, but between June 2021 and August 2022, nearly 375 new clean hydrogen research, demonstration and deployment projects were announced. The Biden administration’s goal is to grow US clean hydrogen production to 10 MMT annually by 2030, 20 MMT annually by 2040, and 50 MMT annually by 2050.

Defining clean hydrogen

Hydrogen produced using hydrocarbons is referred to as ‘grey hydrogen’. A palette of other colours is used to describe the varieties of ‘clean’ hydrogen. ‘Blue’ hydrogen is hydrogen produced from hydrocarbons but where the carbon dioxide emitted from the source of electricity used to produce the hydrogen is captured and either sequestered or converted into a non-emitting product. ‘Green’ hydrogen is hydrogen produced using electrolysis, which has no carbon emissions, and where renewable energy sources generate the electricity consumed during electrolysis. ‘Pink’ hydrogen is also produced using electrolysis, but the electric power is generated by nuclear power. ‘Turquoise’ hydrogen uses natural gas as feedstock but only carbon-free electricity in the production process.

Clean hydrogen can also be defined by measuring greenhouse gas (GHG) emissions in terms of kilograms of CO2 equivalents (kg-CO2e) per kilogram of hydrogen produced (kg-H2) (collectively, kg-CO2e/kg-H2), either at the hydrogen production site or throughout the lifecycle of the hydrogen production process, factoring in GHG emissions from the electric power source and leakage from hydrogen pipelines and storage containers. In September 2022, the US Department of Energy (USDOE) issued draft guidance for a clean hydrogen production standard, proposing an initial lifecycle emissions target of not greater than 4 kg-CO2e/kg-H2. This standard is not a regulatory requirement, but it matches the emissions thresholds used for many of the financial incentives for clean hydrogen.

Key policy supports for US hydrogen

The US hydrogen industry is enjoying historically high levels of federal, state and local government support, most prominently through federal tax credits, grants and loans established or expanded in the Infrastructure Investment and Jobs Act (IIJA), enacted in November 2021, and the Inflation Reduction Act (IRA), enacted in August 2022.

Tax credits

Clean hydrogen production tax credit. The IRA established a new production tax credit for the production of hydrogen in the US (or a possession thereof) using a process that results in lifecycle GHG emissions of not greater than 4 kg-CO2e/kg-H2. To qualify, the taxpayer must commence construction of the applicable hydrogen production facility before 1 January 2033. The tax credit amount ranges from $0.12/kg-H2, for hydrogen with lifecycle GHG emissions of 2.5 kg-CO2e/kg-H2 – 4 kg-CO2e/kg-H2, to $0.6/kg-H2 for hydrogen with lifecycle GHG emissions lower than 0.45 kg-CO2e/kg-H2. The tax credit amount can be increased by a multiple of five if the taxpayer meets certain prevailing wage and apprenticeship requirements with respect to the facility. This tax credit is transferable to third parties and is also eligible for direct payment from the Treasury for the first five taxable years of commercial operation. This tax credit (and the ones described below) cannot be combined on a single project, although separate but related projects may potentially receive different tax credits.

Extension and expansion of qualifying advanced energy project credit. The IRA authorised the allocation of $10bn of investment credits for qualifying advanced energy projects and expanded the definition of qualifying advanced energy projects to include: (i) equipment used to produce certain hydrogen-based fuels; (ii) stationary hydrogen fuel cells and hydrogen storage vessels; and (iii) fuel cell vehicles and components.

Extension and expansion of carbon oxide capture and sequestration credit. The IRA significantly increased the value and availability of an existing production tax credit for capturing and sequestering qualified carbon oxides, including the sequestration of CO2 emissions. This expanded tax credit will support the production of blue hydrogen by increasing the return on investment in carbon capture infrastructure. This tax credit is transferable to third parties or alternatively is eligible for direct payment from the Treasury for the first five taxable years of commercial operation.

Regional clean hydrogen hubs. The IIJA established a programme, and allocated $8bn in funding, to develop regional clean hydrogen hubs – partnerships among industry, government and academia to advance the production, processing, delivery, storage and consumption of clean hydrogen on a commercial scale within a defined region, where supply and demand for clean hydrogen can be balanced. The USDOE expects to support between four to six hubs, with at least one hub supporting blue hydrogen, green hydrogen and pink hydrogen, respectively, and with different hubs focusing on different industries, such as electric generation, manufacturing, residential and commercial heating, and transportation. At least two hubs will be in regions, such as the Gulf Coast, with abundant natural gas resources. The development of each hub will take years, involving a multi-phase process outlined in the funding opportunity announcement for this programme.

Loan guarantees. The USDOE administers loan guarantee and direct loan programmes that are recognised for having helped demonstrate the viability of utility-scale solar energy in the US. The IIJA and IRA allocated an additional $40bn of loan authority for clean energy projects. The USDOE has announced two loan guarantee commitments for clean hydrogen projects since the passage of the IIJA.

Grants. The IIJA created and provided $1.5bn over the next five years for USDOE programmes, one to advance electrolysis technologies toward the goal of reducing the cost of green hydrogen to $2/kg-H2 by 2026 and the other for clean hydrogen technologies research, development and demonstration projects.

Challenges and solutions in the US hydrogen market

Despite the powerful incentives available, developers of clean hydrogen projects face substantial economic, commercial and regulatory challenges that require pragmatic solutions.

Cost competitiveness. Clean hydrogen is costlier to make than grey hydrogen or other hydrocarbons. Production costs for clean hydrogen range from approximately $1.75/kg-H2 for blue hydrogen to as high as $8/kg-H2 for green hydrogen, compared to approximately $1.30/kg-H2 for grey hydrogen and less for other hydrocarbons. The quickest path to achieving cost parity may be through reducing the cost of carbon capture to produce blue hydrogen.

Demand risk. If supply of clean hydrogen increases, will demand be sufficient to absorb it? Developing new uses for clean hydrogen will require significant time and investment, including through regional clean hydrogen hubs. For now, investment should focus on replacing grey hydrogen with green hydrogen where demand for hydrogen currently exists, such as in oil refining and ammonia and methanol production.

Supply chains. Presently, about 1600 miles of hydrogen-suitable pipelines exist, concentrated in the Gulf Coast. Expanding the hydrogen economy will require massive investments in transportation, storage and dispensing infrastructure that can safely handle hydrogen. Those high costs may lead industry participants to focus on developing localised networks, such as industrial campuses, shipping ports, microgrids, and so on, featuring short haul transportation from production to storage to end use, and exports from port-based hydrogen production facilities.

Project on project risk. Many applications for clean hydrogen involve two or more separate manufacturing processes – a solar project adjacent to a green hydrogen production facility or a battery energy storage system next to fuel cell stacks. Clean hydrogen developers need to align risks through the contracting process to ensure they are not exposed to supply, construction, operational or financial risks that they cannot effectively manage.

Offtake structures. There is no spot market or futures market for hydrogen or hydrogen derivatives, making it difficult for lenders and investors to gauge price signals for clean hydrogen. Developers can address (and are addressing) this by negotiating firm offtake contracts and capacity payment structures to secure dependable cash flows for a defined term. Tolling structures may be attractive where the offtaker is a utility or water district.

Monitoring and measurement. Assessing the true ‘colour’ of hydrogen will require highly technical calculations of lifecycle emissions, involving several variables that rely on key assumptions. Transaction parties will be required to make representations and warranties as to compliance with industry and regulatory standards. There is an important role for the engineering services industry in developing green hydrogen certification standards and procedures that are acceptable to market participants and regulatory authorities.

Conclusion

The US is dedicated to expanding the production and use of clean hydrogen to reduce GHG emissions and strengthen domestic energy security. Significant challenges remain, which will require a concerted effort across government, industry and the financial sector.

 

Joshua B. Nickerson is a counsel, Lance Brasher is a partner and Karen Abbott is a senior energy & infrastructure projects analyst at Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates. Mr Nickerson can be contacted on +1 (202) 371 7268 or by email: joshua.nickerson@skadden.com. Mr Brasher can be contacted on +1 (202) 371 7402 or by email: lance.brasher@skadden.com.

© Financier Worldwide

BY

Joshua B. Nickerson, Lance Brasher and Karen Abbott

Skadden, Arps, Slate, Meagher & Flom LLP

©2001-2024 Financier Worldwide Ltd. All rights reserved. Any statements expressed on this website are understood to be general opinions and should not be relied upon as legal, financial or any other form of professional advice. Opinions expressed do not necessarily represent the views of the authors’ current or previous employers, or clients. The publisher, authors and authors' firms are not responsible for any loss third parties may suffer in connection with information or materials presented on this website, or use of any such information or materials by any third parties.