Hydrogen Production Tax Credits Are a Disaster Waiting to Happen

Author

Alexander M. Economides

Purpose

This article was written independently by Alexander M. Economides and first published on LinkedIn. It reflects a personal analysis of U.S. hydrogen policy under the Inflation Reduction Act, intended to spark informed debate about sustainable market design and long-term investment stability in the emerging hydrogen economy.

Original Article

The US government had the best intentions when it passed the Inflation Reduction Act of 2022, but its inclusion of sellable hydrogen production tax credits could destroy the very industry it intended to create.  On the upper end of their values, production tax credits can earn $3 per kilogram of hydrogen produced.  These credits create a huge amount of untaxable money for the companies that can earn them, and they will, with near certainty, distort the prices and supply of affected hydrogen production.  The flaws are simple: the production tax credit is too large, by far, and not permanent, lasting for only ten years.

Most forms of hydrogen production require electricity and water, the least expensive forms also need natural gas.  A large portion of the cost of production comes from the cost of these resource feedstocks.  For example, with electrolysis, whether from zero-emission power, or not, the production cost of hydrogen is mostly the cost of the electricity used (in Texas this is ~80%).  To make low-cost hydrogen using electrolysis, you need cheap or free electricity. You would need significant – therefore unlikely – technological improvements to change this fact.

One could make similar observations for many other hydrogen generation technologies, namely that their feedstock costs account for a large share (often 50% or more) of the cost of hydrogen production.  The point of all of this is that hydrogen production is not likely to become significantly cheaper with time (penny-sized improvements from efficiency gains, not dollars).

Once you include the added costs associated with the emission limits needed to earn the tax credits, the relationships are unchanged: feedstocks continue to dominate the cost of hydrogen. Although carbon dioxide emission reductions are expensive, they make up only a small fraction of the total cost of hydrogen production; that fraction is far less than the associated tax credits.  In fact, there are some cases where the tax credits exceed the entire cost of producing hydrogen and would therefore enable selling hydrogen at negative prices.

Because of this, tax credits, designed to incentivize the development of zero-carbon hydrogen production, will create the possibility for hydrogen prices that are not sustainable now, and will never be sustainable absent the tax credits. This is exactly why the second problem, the ten-year life span for these credits, is a disaster waiting to happen.

Investors will create companies to generate these tax credits and earn most of their return on investment before the credits expire. In ten years, when the credits expire, there will not have been sufficient changes to the underlying costs of hydrogen production or the associated costs of carbon dioxide storage to make up the price difference.  Instead, there will be an oversupply of hydrogen that cannot compete at the depressed prices caused by the tax credits. As a result, many of those companies will shutter; there will be no reason to continue operations after that point.  Many of the jobs these companies create today will disappear at the same time.  The bigger the industry becomes, the worse the hydrogen-specific economic downturn will be.

The solution is to either kill the credits today or be honest with the American public and make them permanent.  Regarding the first choice, the hydrogen industry can still develop without the tax credits, albeit slower.  Companies can already produce hydrogen at prices that can compete with gasoline and diesel in many US markets, and doing so should be the goal.  Those markets, augmented by the growth in industrial uses that are already underway, are sufficiently large to spur the development and improvement of hydrogen technologies.  They are profitable enough to encourage the growth needed to cause hydrogen to spread to other markets.

Alternatively, the US government should make the tax credits permanent (and consider making them smaller).  Doing so would make the hydrogen transition far more rapid and sustain lower prices.  It would also avoid the impact of the sudden tax credit losses and associated damage to the industry. Tax-credit permanency would come at a non-trivial cost to taxpayers but would serve to support the growth of a very-low or even no-carbon fuel alternative.  This cost should give everyone pause as it needs billions, or even trillions, of taxpayer dollars, but if the US government can convince taxpayers that this initiative is worth it, then so be it.  Without permanence, investors will pocket the US government money, and the US taxpayer will lose most of the value they paid for.

I believe that the US needs the hydrogen economy; how we get there matters.

Tags: Hydrogen, 45V Tax Credit, Inflation Reduction Act, Energy Policy, Clean Fuels, Opinion