When the U.S. Treasury released its final rules for the Inflation Reduction Act’s Section 45V Clean Hydrogen Production Tax Credit, it ended a contentious two and a half year debate with one of the rarest policy outcomes – a compromise that works for consumers, industry, and the climate.
These rules retain core requirements of the proposal while providing some exemptions, flexibilities, and clarifications to allow more projects to qualify and relieve investment risks. While these changes will subsidize some dirty hydrogen projects, when taken as a whole the rules are largely positive for climate and the industry – aligning with smart policy principles and avoiding the steep consequences that weak rules would have ushered in.
A long, winding path to clean hydrogen production
Hydrogen production can be loosely categorized into two camps. Electrolytic hydrogen involves splitting hydrogen from water molecules using electricity. An electrolyzer’s relationship with the power grid – whether it causes fossil fuel power plants to increase their output – affects the carbon intensity of hydrogen production. Methane-based hydrogen involves splitting hydrogen from methane molecules, typically using another source of methane to provide heat. The carbon intensity of this conventional hydrogen production process depends on the methane’s source, upstream methane leakage, and the use and performance of carbon capture equipment.
Ultimately, 45V is required by statute to support low-carbon hydrogen production (inclusive of upstream and production greenhouse gas emissions), reducing emissions approximately 60 percent to earn the lowest-tier credit and upwards of 95 percent to earn the highest-value credit. It’s also intended to spur deployment of new technologies that eventually makes them financially viable without indefinite subsidy extensions.
Treasury’s proposed rules from December 2023 largely followed evidence specifying which guardrails are necessary to ensure these hydrogen production projects achieve the emissions thresholds mandated by law. However, they left many open questions to solicit public input, including how to make reasonable, administrable adjustments to qualify more truly low-carbon hydrogen production without inadvertently subsidizing substantial shares of hydrogen production that would be far dirtier than today’s methods.
The resulting discourse generated roughly 30,000 public comments that collectively risked Treasury’s core framework – many proposals went far beyond reasonable tweaks to completely undercut the rules’ emissions integrity, with 45V threatening to become a climate and fiscal boondoggle.
Fortunately, Treasury managed to strike an impressive compromise, largely maintaining its proposal while finding opportunities to alleviate key stakeholders’ concerns and investment risks. The following sections explain where Treasury landed on its final rules, highlighting some of the most important changes in the 379-page document relative to last year’s proposed rules for electrolytic hydrogen.
Key features of the final rules for electrolytic hydrogen
Producing clean hydrogen from electrolysis generally requires electricity from new (or “incremental”), local (or “deliverable”), hourly (or “temporally”) matched clean power, collectively known as the “three pillars.” Forgoing any of these pillars drives a hydrogen emissions intensity that is two to five times higher than today’s conventional methane-based hydrogen production, contradicting 45V’s legislative requirements and Congressional intent.
Treasury’s final 45V rules largely maintain provisions from its proposed rules, with a few important changes. Broadly, they require electrolyzers to use clean energy that is:
- Built within three years of when the electrolyzers come online (with the final rules including nuclear retirement risk and state policy exemptions);
- Sited within the same U.S. Department of Energy “National Transmission Needs Study” region (with the final rules allowing a pathway for interregional trade); and
- Generated in the same hour that it is used by the electrolyzer – a condition that applies to all projects beginning in 2030 (with the final rules pushing this date back from the draft rules’ 2028 deadline and including a mechanism for hour-by-hour crediting).
While not exhaustive, we discuss six key decisions Treasury made in its final rules.
Exemptions for nuclear power plants
First, Treasury created an exemption from the incrementality requirement for nuclear power plants that are nominally at risk of retirement. In theory, if demand for nuclear power from an electrolyzer keeps open a facility that would have otherwise retired, the resulting hydrogen ought to count as clean. Treasury aimed to approximate this scenario by qualifying up to 200 megawatts per reactor that operate in organized power markets or are single-unit facilities, have behind-the-meter electrolyzers or 10-year contracts with them, and meet a financial risk test similar to the Section 45U Zero-Emission Nuclear Power Production Credit that looks at how much money reactors made in two years between 2017 and 2021.
This design is far too lenient to capture specifically those power plants that face real retirement risk. Power market prices from 2017 to 2021 are not predictive of future prices, particularly in today’s high load growth environment with the rise of data centers, AI, clean energy manufacturing, and electrification. And in the following years, nuclear power plants have benefitted from new federal policies specifically intended to prevent their retirement, including the Infrastructure Investment and Jobs Act’s Civil Nuclear Credit program as well as the IRA’s Section 45U tax credit.
As a result, this exemption will likely qualify nuclear reactors that do not need 45V to avoid retirement, and the diversion of these reactors’ electricity from the power grid to electrolyzers will generally force fossil fuel power plants to make up the difference, driving substantial induced climate pollution. These realities underlie public comments’ recommendation to not offer an exemption for clean energy resources that might retire if not for support from 45V.
Overall, this exemption might qualify roughly 10 percent of existing nuclear generation. Some small share of this qualifying capacity might actually be at risk of retirement, and it’s unlikely that every qualifying reactor will turn to hydrogen production – so, the damage should be contained. However, these loose guardrails may make it difficult to call nuclear electrolysis “clean,” and these projects will face challenging financial prospects in a post-45V world due to their dependence on a relatively expensive source of electricity.
Exemptions for states with specific policies in place
Second, Treasury created an exemption from the incrementality requirement for states with specific policies in place intended to guard against the consequences of forgoing this pillar. In theory, if an electrolyzer is built in a state with a cap on its climate pollution and a standard for eventually achieving a clean power grid, any induced emissions from its operations should be offset elsewhere, resulting in a net-zero emissions impact.
Treasury aimed to set reasonable bounds by tying a state policy exemption to having a 100 percent clean electricity standard by 2050 or earlier and having a carbon cap program that includes elements like coverage of at least the electric sector, a declining cap, and an allowance price band of approximately $25 to $90 per ton of carbon dioxide equivalent. These rules effectively qualify California and Washington.
As raised in public comments, this exemption may be too lenient. Carbon cap programs often struggle with leakage. For example, Washington exports much of its excess hydropower, but if it instead uses that power for hydrogen production, other states relying on that power would likely see regional fossil fuel plants ramp up to cover the difference, all else equal. Separately, California’s program has cost containment reserves that, when surpassed, release additional emissions allowances – meaning a successful electrolysis industry could push prices into a range where induced emissions are permitted.
Fortunately, these states will still have to comply with deliverability and hourly matching requirements, which at least promote flexible electrolyzers – a core component to building an industry that can survive long term. The exemption also will qualify some projects that ought to earn the credit, such as electrolyzers that use excess hydropower that was going to waste rather than being exported to another system (i.e., due to transmission constraints) or projects whose emissions are actually offset within the state. Lastly, there simply may not be enough projects in these states to push allowance prices up significantly, as electrolyzer economics are generally best in regions with more favorable wind resource quality and lower transmission fees.
No broad carve-outs for existing clean energy
Third, Treasury did not include a broad carve-out for existing clean energy. In its draft rules, Treasury sought a way to qualify using clean energy that would otherwise be curtailed – a source that would not induce emissions elsewhere on the grid and ideally would qualify for 45V. Due to the administrative complexity of such an exemption, Treasury considered the idea of qualifying 5 to 10 percent of all existing clean energy in order to approximate the amount of clean electricity that is either curtailed or at risk of retirement.
Fortunately, Treasury recognized that such a mechanism would be a poor proxy for what it was hoping to capture and would end up driving substantial emissions. Treasury also chose to not implement a more targeted approach to capturing otherwise-curtailed clean power, noting the high administrative complexity for qualifying a small share of electricity that likely would not make-or-break any project’s economics.
Allowances for inter-regional trade
Fourth, Treasury expanded on deliverability to allow for interregional trade. Electrolyzers and clean energy projects can now be sited in different regions if they demonstrate transmission rights, deliverability on an hour-to-hour basis (i.e., providing verifiable scheduling, dispatch, and settlement data), and track the transactions in relevant energy attribute credit (EAC) registries. This change is reasonable and should allow more flexibility in siting projects while minimizing pollution impacts.
Delay to hourly matching phase-in date but with no grandfathering
Fifth, Treasury pushed the hourly matching phase-in date from the start of 2028 to 2030, in part to give EAC registries enough time to develop and roll out hourly tracking software. This might not be necessary, as major registries like PJM-GATS and M-RETS are already offering – or will soon offer – hourly tracking services, and any delay will drive induced emissions. However, it was far more important for Treasury to require hourly matching to kick in for all projects regardless of whether they begin operations before the phase-in date (i.e., no “grandfathering” of annual matching rules for existing projects), and its inclusion of this provision will limit the annual-matching period’s climate harm and ensure the buildout of a flexible electrolyzer base.
Hour-by-hour crediting
Lastly, Treasury instituted hour-by-hour crediting with a ceiling on annual emissions. In the draft rules, an electrolyzer would be awarded one credit tier for its total annual hydrogen production depending on its annual average emissions rate for that year. This created significant operational risk, as a small share of “missed hours” of using grid power could have meant the difference between a $3 per kilogram (kg) or $1/kg credit for the year’s output.
The new system awards each hour with the credit tier that it earned, under the wise condition that the electrolyzer’s annual average emissions remain below 4 kg of carbon dioxide equivalent per kg hydrogen. This threshold matches the IRA’s definition of “qualified clean hydrogen.” It also sets a ceiling that guards against gaming risks that could have granted electrolyzers top-tier subsidies for mostly dirty hydrogen production.
We initially argued against hour-by-hour crediting, as this system opens the door to significant climate pollution. However, the emissions ceiling ensures that 45V will still only subsidize low-carbon hydrogen, and this extra flexibility removes an operational risk that would have greatly increased financing costs and locked out otherwise-desirable projects.
45V’s upshot – a compromise all sides can live with
The final 45V rules are undeniably a compromise, with changes that will increase climate pollution relative to the proposed rules. However, the concessions seem tailored to release political pressure and reduce investment risk while ensuring most money flows toward genuinely low-carbon projects that are designed for long-term viability.
In other words, the changes chip but don’t shatter the foundational pillars for truly clean hydrogen production. A ruleset that is perfect for climate, investment, and political realities likely does not exist, but this middle ground succeeds in balancing emissions integrity with administrability – and sets course for a hydrogen industry worth building.
