The hydrogen economy: instrumental to achieving clean energy targets
January 2022 | SPECIAL REPORT: ENERGY & UTILITIES
Financier Worldwide Magazine
January 2022 Issue
Momentum continues to build to expand the use of hydrogen from its primary use as an industrial feedstock to become a low-carbon alternative to fossil fuels, such as natural gas, and a key component to the electrification of the energy industry. Notwithstanding the growing enthusiasm for the low-carbon ‘hydrogen economy’, various factors continue to impede the widespread deployment of commercial-scale projects. However, policymakers in the US have incentivised the development of low-carbon hydrogen projects through recent legislative and regulatory initiatives.
This article will provide a brief overview of the emerging hydrogen economy, anticipated uses for low-carbon hydrogen and the drivers for the low-carbon hydrogen markets. Next it will examine the provisions of the Infrastructure Investment and Jobs Act that promote the development of hydrogen infrastructure. Finally, it will examine additional steps that lawmakers and regulators might take to encourage the further development of the hydrogen economy.
The emerging hydrogen economy
Although a robust market for hydrogen already exists, its current uses are predominantly as an industrial feedstock. Of the approximately 75 million metric tonnes (MMT) of hydrogen produced globally each year, approximately 31 MMT are used for the production of ammonium fertilisers and another 38 Mt are used in the refining industry.
Although hydrogen has long been recognised as a potentially useful carrier of energy, most hydrogen production is very carbon-intensive. The vast majority of hydrogen today is produced from the reformation of hydrocarbons, such as methane or coal, which produces hydrogen and carbon oxides (CO and CO2). By some estimates, hydrogen production currently accounts for approximately 830 Mt of global CO2 emissions per year.
What is the hydrogen economy?
Hydrogen’s applications are emerging beyond its traditional industrial uses. Proponents of the ‘hydrogen economy’ envision the use of hydrogen as the primary carrier and source of energy across various industrial sectors. In a hydrogen economy, hydrogen is used as a means of energy storage, such as in hydrogen fuel cells, and as a means to decarbonise various industries that have otherwise proven difficult or impossible to decarbonise.
Such industries include the refining industry, iron and steel production, and long-haul transport. Hydrogen’s use as a means of ‘indirect electrification’, which is converting electric power into hydrogen to ‘electrify’ sectors that are difficult for electricity to support directly, will also contribute to a growing demand for hydrogen.
For the hydrogen economy to realise the ambitions of its proponents, hydrogen must be produced by lower carbon means than is currently the case. Various methods exist to reduce the carbon footprint of hydrogen. Such methods are often assigned colours to differentiate different production methods. Green hydrogen is produced through the electrolysis of water utilising renewable power, and results in the production of hydrogen and oxygen, without any direct CO2 emissions.
Electrolysis of water utilising nuclear energy is often referred to as ‘pink’ hydrogen, and like green hydrogen, this process produces no direct CO2 emissions. ‘Blue’ hydrogen is produced by reforming hydrocarbons, with the added component of carbon capture, use and storage. Like blue hydrogen, ‘turquoise’ hydrogen is produced from hydrocarbons, but through a method called pyrolysis and results in hydrogen and solid-state carbon byproduct.
Several interrelated factors seem to be driving growth in the number of low-carbon hydrogen projects, including: (i) environmental, social and governance (ESG) initiatives, such as pushes to achieve low-carbon or even zero-carbon emission goals; (ii) governmental initiatives to push industry to reduce greenhouse gas emissions, either through limits on carbon emissions or through incentive programmes such as section 45Q tax credits; (iii) technological advances, which are decreasing the price of hydrogen – whether through more efficient electrolysers producing ‘green’ hydrogen, or more efficient carbon capture technology allowing for less expensive ‘blue hydrogen’; and (iv) increased renewable deployment, which promotes the development of hydrogen projects for the storage of excess renewable power (for longer-term storage than batteries are capable of).
Incentives
Despite the many drivers for the increased deployment of low-carbon hydrogen, its relatively high cost, a lack of infrastructure for storage and transportation, and an unclear regulatory framework in the US hinders more robust development. However, lawmakers and regulators are taking steps to help the emerging low-carbon hydrogen industry through existing tax incentives and the newly-passed Infrastructure Investment and Jobs Act, which president Biden signed into law on 15 November 2021. In addition, lawmakers are contemplating additional incentives and regulatory guidance to promote the development of a hydrogen economy.
Various existing tax incentives promote the development of hydrogen projects. For example, section 45Q of the US Internal Revenue Code offers a credit against a taxpayer’s federal income tax liability based on the tonnes of anthropogenic carbon oxide (such as that emitted in the production of hydrogen) that is captured and sequestered or put to use in certain approved uses.
This credit will directly benefit developers of ‘blue’ hydrogen projects. In addition, several tax credits apply to some sectors of the hydrogen economy, including the following: (i) an investment tax credit (ITC) equal to 30 percent of the cost of investment in fuel cell power plants generating electricity; (ii) an ITC equal to 30 percent of the cost of investment in qualifying advanced energy projects (although, due to the exhaustion of allocated funds for this credit, it is as a practical matter currently unavailable); (iii) a credit for individual taxpayers for the cost of residential fuel cells; (iv) a tax credit offered to purchasers of alternative fuel vehicles; (v) an ITC equal to 30 percent of the cost of alternative fuel vehicle refuelling property; and (vi) an excise tax credit for sales of liquid hydrogen fuel.
The Act includes many incentives for the development of low-carbon hydrogen infrastructure. The provisions in the Act supporting hydrogen can generally be divided into three categories: research and development, subsidies and regulatory initiatives.
The Act establishes a clean hydrogen research and development programme, which charges the secretary of energy to work with the private sector to achieve the following goals. First, to advance research and development to demonstrate and commercialise the use of clean hydrogen in the transportation, utility, industrial, commercial and residential sectors. And second, to demonstrate a standard for clean hydrogen production in the transportation, utility, industrial, commercial and residential sectors by 2040. Among the initiatives specifically enumerated in the Act is a clean hydrogen electrolysis programme to improve the efficiency and reduce the cost of hydrogen electrolysers.
The Act allocates approximately $9.5bn to fund various grants and other spending programmes to advance the hydrogen industry in the US, including the following. Regional clean hydrogen hubs, which are defined in the Act as “networks of clean hydrogen producers, potential clean hydrogen consumers, and connective infrastructure in close proximity”. And clean hydrogen manufacturing and recycling, which provides grants for research, development and demonstration projects to advance new clean hydrogen production, processing, delivery, storage and use equipment manufacturing technologies and techniques, as well as the reuse and recycling of clean hydrogen technologies.
The Act contains several provisions designed to improve the framework of regulations and standards around the hydrogen economy. For example, the Act directs the secretary of energy to consult with the Environmental Protection Agency to work with stakeholders to develop standards for the carbon intensity of clean hydrogen production that will apply to activities carried out pursuant to the Act.
Further legislation is likely
Although the Act contains various incentives for hydrogen, additional important incentives for hydrogen are in the pipeline. Legislators are considering additional tax incentives and contemplating the regulatory framework for hydrogen. With passage of the Act, Congress has now turned its attention to the Build Back Better Bill, which contains numerous tax incentives designed to incentivise clean energy development.
Of importance to the hydrogen industry, the Bill would increase the amount or availability of the existing tax incentives discussed above, including: (i) increasing the section 45Q tax credit amount for sequestered carbon oxide from $50 to $85 per metric tonne; (ii) expanding or increasing the credits and the taxpayers to whom such credits would be available, such as master limited partnerships; (iii) introducing an election to receive ‘direct pay’ treatment for the credits, which would allow taxpayers that do not have a tax liability to convert the credit to a cash payment; (iv) a production tax credit for hydrogen, which would provide a dollar amount of credit per kilogram produced using low-carbon methods, with a reduced credit amount for methods of production that are not as low-carbon as others, i.e., ‘green’ hydrogen would receive a higher dollar credit per kilo than ‘blue’ hydrogen; and (v) expansion of the Section 48 ITC to cover energy storage, which would include hydrogen storage.
Further, on 28 October 2021, several senators introduced an additional bipartisan package of legislation intended to promote the development of clean hydrogen. One of the proposed bills, the Hydrogen Infrastructure Finance and Innovation Acts, includes a provision requiring several regulatory agencies, including the Federal Energy Regulatory Commission (FERC), to assess the jurisdiction over the siting, construction, safety and regulation of hydrogen transportation and to report their findings to Congress.
Conclusion
As the hydrogen economy expands, hydrogen will be used in a variety of ways and is therefore expected to play a vital role in the transition and decarbonisation of the energy sector. The Infrastructure Investment and Jobs Act will stimulate the rapid decarbonisation of the energy sector through billions of dollars in appropriations that will advance the hydrogen industries in the US.
In addition, the Act, section 45Q tax credits and future hydrogen-related legislation provide regulatory certainty and federal support, and create incentives for industry players to invest in and promote the development of clean hydrogen. Although more regulations and technological advances are needed, hydrogen’s use in the energy sector will continue to grow as hydrogen becomes instrumental to achieving clean energy targets.
Thomas Holmberg and Barbara de Marigny are partners and Megan Lawhorne is an associate at Baker Botts. Mr Holmberg can be contacted on +1 (202) 639 7965 or by email: thomas.holmberg@bakerbotts.com. Ms de Marigny can be contacted on +1 (713) 229 1258 or by email: barbara.demarigny@bakerbotts.com. Ms Lawhorne can be contacted on +1 (202) 639 1303 or by email: megan.lawhorne@bakerbotts.com.
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Thomas Holmberg, Barbara de Marigny and Megan Lawhorne
Baker Botts
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