August 12, 2022

Inflation Reduction Act: Key Green and Blue Hydrogen and CCUS Provisions

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INFLATION REDUCTION ACT: KEY GREEN AND BLUE HYDROGEN AND CCUS PROVISIONS

Introduction

The U.S. Congress has passed, as of today, the Inflation Reduction Act (IRA or the “Act”), which is expected to be signed into law by President Joe Biden very soon.

The IRA is one of the biggest investments in clean energy in history and a major step towards reducing the United States’ greenhouse gas emissions. According to the Biden Administration, the Act will result in the investment of $369 billion in energy and climate change programs and will avoid 6.3 billion tons of cumulative greenhouse gas emissions by 2030, amounting to a 40 percent annual emissions reduction compared to 2005 levels. For perspective, without the Act, the U.S. would only be able to reduce its GHG emissions by 26 percent by 2030 (again compared to 2005 levels).

This article focuses on the clean energy provisions of the IRA, in particular incentives and provisions pertaining to hydrogen and carbon capture, utilization and sequestration (CCUS). For a brief analysis of the Act’s other provisions, including the Corporate Book Minimum Tax, see our summary of the IRA.

The Focus is on the Reduction in Emissions, not the Technology Chosen by a Hydrogen Producer

The clean energy provisions of the Act support reduced carbon sources of energy regardless of the technologies used to achieve the carbon reductions: they are “source agnostic.” This is welcome news for various industries within the U.S. that have been planning to invest in hydrogen and carbon sequestration technologies as well as conventional clean energy sources, including solar and wind. In particular, the Act does not distinguish between hydrogen produced from electrolysis using renewable sources or nuclear power, nor does it distinguish between hydrogen produced by electrolysis or from natural gas with carbon capture and storage (so-called “blue” hydrogen).

Importantly for green hydrogen producers, however, it will be possible to combine tax credits for renewable power generation facilities alongside the PTCs and ITCs for clean hydrogen production and storage infrastructure. The IRA extends existing investment tax credits (ITCs) and production tax credits (PTCs) for solar and wind power generation until 2024. After 2024, any carbon-free generation will have the option to either choose from an ITC or a PTC, whichever is more viable for each business, or choose to monetize the credits by transferring them to another unrelated third-party.

Game Changing Tax Credits and Direct Payments for “Qualified Clean Hydrogen”

The Act adds section 45V to the U.S. Internal Revenue Code of 1986 (the “Code”) to provide a tax credit for the production of “qualified clean hydrogen” produced by a taxpayer at a “qualified clean hydrogen production facility” during a 10-year period beginning on the date such facility was placed in service. As described below, the base tax credit amount is set at $.60 per kilogram of clean hydrogen but increases to $3.00 per kilogram when the hydrogen’s lifecycle carbon intensity measures between zero and 0.45 kilograms of CO2 equivalent (CO2e) per kilogram of hydrogen (H2) and when the taxpayer complies with the prevailing wages and apprenticeship requirements.

Importantly, the Act includes a “direct pay option” for the same amounts instead of a tax credit. The direct payment for hydrogen and carbon capture facilities will be available for a limited period (the first five years of production) amount. Alternatively, the IRA also includes an option for taxpayers to monetize the credits by transferring them to another taxpayer.

The potential to access a US$3 tax credit or direct payment for each kilogram of low-carbon hydrogen is truly revolutionary for the emerging green hydrogen industry. Some sources claim that it will make green hydrogen structurally cheaper than gray hydrogen and might reduce the cost of green hydrogen production to as low as $0.73 per kilograms in the U.S. Northwest. On more conservative estimates it will likely halve the cost of production of green hydrogen in many places in the U.S. In either case it immediately makes green hydrogen a competitive source of energy compared to its fossil fuel alternatives.

In addition to the PTCs for clean hydrogen, the IRA creates a 30 percent credit for energy storage technology constructed before January 1, 2025. Whilst the text of the legislation is not precise on what sorts of infrastructure this might cover, it clearly does apply to hydrogen-related storage.

The bottom line is this: when combined with the ITCs for renewable power production and energy storage infrastructure, the entire upstream value chain for green hydrogen production infrastructure, from well (i.e., electron generation) to gate (i.e., the outlet of storage facilities), is now subsidized by the U.S. government.

This positions the U.S. as among the most competitive places in the world to develop green hydrogen projects across the value chain. It will inevitably spur other countries to develop subsidies of their own to ensure domestic production, and the IRA should therefore be viewed as a significant boost to the development of a worldwide hydrogen economy.

Support for CCS Facilities Boost Blue Hydrogen Production

The Act amends Section 45Q of the Code to provide tax credits for the construction of carbon capture facilities. Any carbon capture, direct air capture or carbon utilization project that begins construction prior to January 1, 2033, will qualify for the Section 45Q tax credit. Additionally, the Act not only extends carbon capture tax credits through 2033 but also lowers the requirements for additional carbon capture facilities to qualify. The Act increases the Section 45Q base tax credit for carbon capture by industrial facilities and power plants to $85 per metric ton for CO2 stored in geologic formations, $60 per ton for the beneficial utilization of captured carbon emissions and $60 per ton for CO2 stored in oil and gas fields.

Energy Innovation and Green Industry also Supported

The IRA encourages technological developments in energy innovation. Under the Office of Clean Energy Demonstration (OCED), the IRA creates a $5.8 billion program, available through September 2026, to invest in projects aimed at reducing emissions from hard-to-abate energy intensive industries, such as iron, steel, cement and chemical production, and includes retrofit facilities.

Key Provisions – Hydrogen and CCUS

Below is a summary of the provisions of the Act pertaining to clean hydrogen and CCUS.

Clean Hydrogen – Section 45V

  • The IRA creates a PTC or an ITC for clean hydrogen, giving the owners of production facilities the option to elect either of the two.
  • The IRA creates a 10-year incentive for clean hydrogen production with four tiers. For a facility to qualify, the hydrogen it produces must not exceed lifecycle greenhouse gas emissions rate greater than 4 kilograms of CO2 equivalent (CO2e) per kilogram of H2, for which the PTC would be $0.60 per kilogram of hydrogen (H2). (From a global comparative regulatory perspective this is a relatively loose, easy-to-satisfy definition of what it means to be “clean hydrogen.”)
  • If the carbon intensity is between 0–0.45 kilograms of CO2 equivalent (CO2e) per kilogram of H2, the PTC would be as high as $3 per kilogram of H2. This is likely to make green hydrogen projects immediately economically viable by significantly increasing the economic attractiveness of green hydrogen produced from renewable sources while keeping certain incentives for blue hydrogen produced from natural gas.
  • The base credit amount is at least 60 cents per kilogram of qualified clean hydrogen (subject to the above carbon intensity limits), multiplied by an emissions factor depending on the GHG emissions factor provided by the fuel, up to the $3 level mentioned above. These rates of tax credits are adjusted for inflation for the calendar year in which the qualified clean energy is produced.
  • To qualify as a “qualified clean hydrogen production facility,” the facility must meet the following criteria:
    • It must be owned by the taxpayer claiming the PTC or ITC;
    • The facility must produce qualified clean hydrogen; and
    • The facility’s construction must begin before January 1, 2033.
  • Eligibility criteria includes retrofit facilities. However, the clean hydrogen credit cannot stack with the carbon capture and sequestration tax credit. No clean hydrogen credit will be allowed for a facility which is already qualifying for the carbon sequestration credit.
  • The Act also offers a bonus credit multiplier if prevailing wage and apprenticeship requirements are met, wherein the applicable credit may be multiplied by five. Without this bonus credit hydrogen manufactured with 0.45 – 1.5kg of lifecycle emissions would only receive 33.4 percent of the $0.60 credit; with 25 percent for 1.5 – 2.5kg of CO2e and 20 percent for 2.5 – 4kg. These amounts will be multiplied by five where the facility meets the prevailing wage and apprenticeship requirements. However, to benefit from this requirement, the construction of such hydrogen production facility must commence within 60 days of the Secretary of the Treasury publishing the necessary guidance with respect to the prevailing wage and apprenticeship requirements.
  • Alternatively, taxpayers have the option to either elect to receive an ITC in lieu of the PTC for a base credit of up to 6 percent, or 30 percent if prevailing wage and apprenticeship requirements are met.

ITCs – Section 48

  • The existing ITCs for various energy sources, including solar energy, fuel cell energy, combined heat and power property, small wind property and offshore wind property have been maintained at 30 percent for facilities constructed before January 1, 2025.
  • Additionally, the Act creates a 30 percent credit for energy storage technology constructed before January 1, 2025.
  • In addition to the aforementioned credits, the IRA provides additional bonus credits as follows:
    • a 10 percent bonus if the domestic manufacturing requirements for steel, iron or manufactured components are met, and
    • a 10 percent bonus for projects located in existing energy communities.

CCUS – Section 45Q

  • The Act extends the tax credits under Section 45Q for carbon capture and direct air capture (DAC) to projects beginning construction before 2033 and provides additional modifications, including an enhanced credit for DAC and lowering the carbon capture threshold requirements at facilities.
  • The IRA has lowered the annual thresholds of the amount of carbon a qualifying facility must capture:
    • 18,750 tons of carbon oxide for power plants;
    • 12,500 tons of carbon oxide for industrial facilities; and
    • 1,000 tons of carbon oxide for DAC facilities.
  • Electricity facilities that use carbon capture to reduce their emissions by at least 75 percent would also qualify for tax credits.
  • Similar to the tax credits for hydrogen production facilities, the credits for carbon capture are divided into a base credit and a “bonus” credit, equal to five times the base credit, if the prevailing wage and apprenticeship requirements are met, like the PTC and ITC. The amount of the credit depends on how carbon dioxide is captured and the purposes for which it is utilized.
  • The qualifying facilities will be eligible for the following credits for each metric ton of carbon captured/sequestered:

S no.

Technology

Base Credit

($/metric ton of CO2)

Bonus Credit
(Base Credit x 5)

($/metric ton of CO2)

1.

Carbon captured and used for enhanced oil recovery (EOR) or utilization

$12

$60

2.

Industrial Source (direct sequestration)

$17

$85

3.

DAC (used for EOR or utilization)

$26

$130

4.

DAC (direct sequestration)

$36

$180

  • The taxpayer will qualify for a bonus credit when it complies with the prevailing wage and apprenticeship requirements and commences construction within 60 days after the Secretary of Treasury publishes guidance for the prevailing wage and apprenticeship requirements.
  • Projects will be entitled to benefit from a direct pay incentive for the first 5 years after the carbon capture equipment is placed in service, however, nonprofit organizations and co-ops can receive direct pay for all 12 years of the credit. Additionally, the taxpayer may opt to transfer the credits to a third-party.

Prevailing Wages and Apprenticeship Requirements

Given the crucial role the prevailing wages and apprenticeship requirements will most likely play in these benefits, a brief summary is as follows:

Prevailing Wages

  • To benefit from the prevailing wage requirements, the taxpayer is mandated to make sure that all mechanics and laborers are paid prevailing wage during the construction of a project and for any alteration and repair of such project during the relevant credit period.
  • The Act provides correction procedures and directs the Secretary of the Treasury to provide further guidance.

Apprenticeship

  • In order to comply with the apprenticeship requirements, the taxpayer is required to make sure that no less than the applicable percentage of total labor hours for the project’s construction are undertaken by certified apprentices.  
  • The Act provides correction procedures and directs the Secretary of the Treasury to provide further guidance.

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Omar Samji

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