At the end of 2023, the U.S. Treasury published proposed regulations (2023-28359.pdf (govinfo.gov) relating to the production tax credit (“PTC”) under Section[1] 45V (the “Proposed Regulations”). The Proposed Regulations are proposed to apply to tax years beginning after they are published in the Federal Register. However, a taxpayer may rely on them for tax years beginning after December 31, 2022, and before the date the final regulations are published in the Federal Register provided the taxpayer applies the Proposed Regulations in their entirety and in a consistent manner. A public hearing on the proposed regulations is scheduled on March 25, 2024.
The Proposed Regulations provide clarity on several provisions in Section 45V but unfortunately also place onerous requirements on the energy sources used in hydrogen production. Development of this industry, considering these requirements, will greatly influence whether hydrogen can fulfill the intent of reducing emissions in the heavy industry and transportation contexts. The proposed rules regarding additionality, temporal matching, and geographical matching encourage the build out of more renewables like wind and solar to fuel hydrogen production. However, the additionality requirement, in particular (premised on the argument of induced grid emissions), provides scarce benefit for current owners of wind and solar. Further, the relatively low level of 45V incentive likely available for blue hydrogen (derived from hydrocarbons and CCUS) as compared to green hydrogen is not sensitive to the practical reality that, at least in the short and intermediate timeframes, the path to a large and robust hydrogen economy likely depends on hydrogen sourced from hydrocarbons. Natural gas, in particular, may be the most effective wedge to spur a hydrogen economy (including the build out of necessary pipelines), but the Proposed Regulations don’t encourage that direction.
The Section 45V PTC was included in the Inflation Reduction Act (“IRA”) to incentivize the domestic production of clean hydrogen as part of the U.S.’s broader energy transition initiative. Unlike existing renewables provisions that were amended or extended by the IRA, the Section 45V PTC provides a new federal tax incentive for clean hydrogen production.
Like other familiar investment and production tax credits, Section 45V is a Section 38 general business credit that can be used to offset a taxpayer’s tax liability or sold to an unrelated person under Section 6418. There are also opportunities to take advantage of the direct-pay provisions of Section 6417, even without being a Section 6417 Applicable Entity.
The 45V PTC is only one prong of the nation’s hydrogen fuel strategy. Around the time the IRA was enacted, the Department of Energy (“DOE”) announced the hydrogen hubs program intended to deploy $7 billion worth of funds appropriated under the Infrastructure Investment and Jobs Act (“IIJA”). Recently, those selected for that program were announced: Regional Clean Hydrogen Hubs Selections for Award Negotiations | Department of Energy
The Section 45V PTC is equal to the kilograms of “qualified clean hydrogen” produced by a taxpayer each year times an applicable amount determined by the greenhouse gas emissions associated with the production of that clean hydrogen. The hydrogen must be produced at a “qualified clean hydrogen production facility,” defined as a facility – (i) that produces qualified clean hydrogen; (ii) is owned by the taxpayer; and (iii) with respect to which construction begins before January 1, 2033. Like Section 45 PTC, Section 45V PTC may be claimed during the 10-year period following the facility’s placed-in-service date.
Section 45V(c)(2) defines “qualified clean hydrogen” as hydrogen that is produced – (i) in the US or a possession thereof; (ii) in the ordinary course of the taxpayer’s trade or business; and (ii) for sale or use. The hydrogen must be produced through a process that results in lifecycle greenhouse gas emissions of 4 kilograms of carbon dioxide per kilogram or less and the production and sale or use of such hydrogen must be verified by an unrelated third party. Under the Proposed Regulations, “lifecycle greenhouse gas emissions” is defined by reference to the Clean Air Act and determined under the most recent Greenhouse gases, Regulated Emissions, and Energy use in Transportation model (the “GREET Model”).
To incentivize hydrogen production through lower emissions processes, Section 45V(b) provides a base “applicable amount” of $0.60 credit per kilogram of qualified clean hydrogen produced subject to percentage phaseouts depending on the “lifecycle greenhouse gas emissions” (“LGGE”) rate associated with production.
Applicable percentage phaseouts are as follows:
- 80.0% credit phaseout - Qualified clean hydrogen produced through a process resulting in a lifecycle greenhouse gas emissions rate of 2.50 kilograms to 4.00 kilograms of carbon dioxide per kilogram of hydrogen.
- 75.0% credit phaseout - Qualified clean hydrogen produced through a process resulting in a lifecycle greenhouse gas emissions rate of 1.50 kilograms to 2.49 kilograms of carbon dioxide per kilogram of hydrogen.
- 66.4% credit phaseout - Qualified clean hydrogen produced through a process resulting in a lifecycle greenhouse gas emissions rate of 0.45 kilograms to 1.49 kilograms of carbon dioxide per kilogram of hydrogen.
- 0.0% credit phaseout - Qualified clean hydrogen produced through a process resulting in a lifecycle greenhouse gas emissions rate of less than 0.45 kilograms of carbon dioxide per kilogram of hydrogen.
The applicable amount determined under Section 45V(b) is subject to customary annual adjustments for inflation and a 5x multiplier if certain prevailing wage and apprenticeship requirements are satisfied. It is worth noting that, unlike the Section 45 PTC and Section 48 ITC (which provide for a complete prevailing wage and apprenticeship exemption for facilities that began construction before January 29, 2023), Section 45V still requires prevailing wages be paid to laborers with respect to the alterations or repairs of the facility for the 10-year credit period.
LGGE – GREET, PER and EACs
The proposed regulations provide two mechanisms to establish LGGE: 1) the GREET Model or 2) a Provisional Emissions Rate (“PER”).
The latest GREET Model and associated guidance contemplates eight so-called pathways of hydrogen production (from the GREET manual here: Guidelines to Determine Well-to-Gate Greenhouse Gas (GHG) Emissions of Hydrogen Production Pathways using 45VH2-GREET 2023 (energy.gov)):
- Steam methane reforming (SMR) of natural gas, with potential carbon capture and sequestration
- (CCS)
- Autothermal reforming (ATR) of natural gas, with potential CCS
- SMR of landfill gas with potential CCS
- ATR of landfill gas with potential CCS
- Coal gasification with potential CCS
- Biomass gasification with potential CCS11
- Low-temperature water electrolysis using electricity
- High-temperature water electrolysis using electricity and/or heat from nuclear power plants
Facilities that do not produce hydrogen through one of these pathways likely will need to reach out to the Secretary of Treasury for a PER in lieu of the GREET determination.
The Proposed Regulations discuss at length the mechanisms by which a taxpayer might use Energy Attribute Certificates (“EACs”) (which might be RECs or “green tags” or any evidence of clean energy production) to diminish the deemed LGGE connected with hydrogen production. The requirements in the Proposed Regulations are clearly heavily influenced by a DOE whitepaper issued a few days prior to the Proposed Regulations: Clean Hydrogen Production Tax Credit (45V) Resources | Department of Energy. Thus, the Proposed Regulations demonstrate a strong preference for:
- Additionality – only counting energy from newly-built (or up-rated, relatively common in the hydropower space) renewable energy projects
- Temporal matching – only counting energy generated from renewable energy projects within the same time period as the electricity used to generate hydrogen
- Geographical matching – defined in terms of regions as described in National Transmission Needs Study released on October 30, 2023 (National Transmission Needs Study (energy.gov))
These requirements are intended to reduce the occurrence of so-called induced emissions resulting from the diversion of renewable energy already on the grid to the production of hydrogen, which would theoretically trigger the need to spin up other generators on the grid (e.g., coal or natural gas plants) to fill the production gap. The temporal matching rules are expected to become stricter after December 31, 2027 (e.g., switching from annual temporal matching to hourly) because the systems and technology are necessarily mature enough in each generating region to fulfill the EAC requirements described in the Proposed Regulations. Although these rules may be well intentioned, they will most certainly cause the production of hydrogen to be more expensive than it otherwise would have been. As a result, the government likely will receive many public and private comments on these requirements. These comments and the government’s response in final regulations likely will have implications beyond just 45V credits, as they may inform future regulations built around the technology agnostic 45Y and 48E credits anticipated for 2025 and onward.
RNG and Fugitive Methane
The preamble to the Proposed Regulations discusses at length the use of renewable natural gas (“RNG”) and fugitive methane and how they might interplay with the LGGE used for the calculation of 45V PTCs; however, these questions are not directly addressed in the regulatory language itself. However, the preamble does discuss the expectation that the consideration of RNG in the LGGE test is expected to have requirements that are logically consistent with (though not completely identical to) the requirements around the use of EACs to calculate LGGE. One notable aspect of this is that a potential deemed LGGE reduction through hydrogen produced using RNG would only be possible if that same RNG were not otherwise diverted from productive use.[2] The proposed regulations contemplate the implementation of book-and-claim accounting, similar to what historically has been used in California’s low carbon fuel standard program. In any case, the details of how a taxpayer might count RNG (or fugitive methane) in the calculation of LGGE is an open question, with the preamble to the Proposed Regulations enumerating a number of relevant and practical execution questions. Regulations that might eventually be issued in connection with the technology agnostic PTC anticipated for 2025 and later under Section 45Y (particularly 45Y(b)(2)(B)) likely will incorporate concepts similar to those ultimately developed under Section 45V
Retrofits and modifications
Section 45V(d)(4) provides that facilities that were in service before January 1, 2023, that did not produce qualified hydrogen at the time they were placed in service for tax purposes may be modified to produce qualified clean hydrogen. If those modifications allow the facility to produce qualified clean hydrogen, the facility may be able to generate Section 45V PTCs at the time those modifications are placed into service for tax purposes.
In this regard, the Proposed Regulations provide additional clarity that effectively mirrors the “80/20” requirements utilized for a number of years in the context of Section 45 PTCs and Section 48 ITCs. Notably, if a facility has in the past claimed a Code Section 45Q PTC (for carbon capture and sequestration) it can never be eligible for a 45V PTC, even if a retrofit causes the facility to be new property for every other purpose by passing the 80/20.
Verification for production and sale or use
Section 45V(c)(2)(B)(ii) provides that hydrogen is not qualified clean hydrogen unless “the production and sale or use of such hydrogen is verified by an unrelated party”. The Proposed Regulations provide clarity on this requirement. Specifically, Section 1.45V-5 provides that for a taxpayer to claim a 45V PTC for tax years beginning after December 26, 2023, the taxpayer must obtain annual reports from a qualified verifier (which is an entity that meets certain characteristics in terms of licenses and competency). These reports have 3 primary facets: 1) the production verification (covering the aspects of hydrogen production itself including validation of GHG emissions) 2) the verifiable use verification (asserting that the hydrogen is not being vented or flared or used to make electricity to make more hydrogen – effectively that the use does not violate the anti-abuse provisions of proposed regulation 1.45V-2(b)) and 3) the conflict attestation (asserting that the qualified verifier is unrelated, not compensated based on conclusions – i.e. independent). The reports have additional requirements for hydrogen produced using electricity that was generated by qualified facilities entitled to PTCs under Code Section 45 (renewables, e.g., wind) or 45U (zero-emission nuclear).
ITC election
Section 48(a)(15) provides that a taxpayer may make an irrevocable election to treat a hydrogen facility as energy property, provided that at no point that same facility claimed or will claim a Section 45V or 45Q PTC and therefore claim an ITC in lieu of a PTC; proposed Section 1.48-15 contains additional guidance around this election. Section 48(a)(15)(A)(ii) provides a schedule of the ITC applicable percentage to be used in the case of such an election that is based on the amount of CO2e generated along with the hydrogen. This schedule mirrors the schedule in Section 45V(b)(2) for the PTC variant. If any taxpayer makes an ITC-in-lieu election with respect to a hydrogen facility, that election is binding on all taxpayers that own a direct or indirect interest in the property (e.g., a tenancy-in-common). In a partnership or S corporation context, the ITC is shared by an allocation of basis similar to that in the familiar ITC rules under Section 1.46-3(f). The ITC-in-lieu election is only available with respect to expenditures capitalized and then placed into service after December 31, 2022; projects that have a construction period spanning this point in time may have a disincentive to pursue the ITC-in-lieu election (because a project that begins construction before this point may be able to qualify for a PTC whereas that same project would only have ITC eligible basis for expenditures incurred after this date).
A five-year recapture period begins on the first day of the tax year immediately following the tax year in which the asset is placed in service, which varies from the anniversary date recapture embedded in the other ITCs under Section 48. Throughout the ITC recapture period, the taxpayer must submit annual verification similar to what a taxpayer would need to produce to claim 45V PTCs under proposed regulation 1.45V-5. Recapture is triggered by underperformance with respect to lifecycle GHG determinations or failure to appropriately report as required under proposed regulation 1.48-15(e). Recapture exposure is ratable over the five-year recapture period and proportional to the amount by which a project overshot its anticipated GHG emissions rate in a given year.
Conclusion
The combination of the 45V PTC and hydrogen hubs program demonstrates an intent to nurture the nascent hydrogen industry in the US. While providing clarity, the Proposed Regulations, create difficult challenges for stakeholders in the industry. The requirements for additionality, temporal matching, and geographical matching of renewable energy sources likely will not be easily achieved. It also remains to be seen when EAC tracking and accounting systems in the various generating regions will be sophisticated enough to fulfill those requirements in the Proposed Regulations.
[1] Section refers to Internal Revenue Code Sections or Treasury Regulations Sections
[2] This is similar to the EAC preference to discourage induced grid emissions with additionality.
