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How IRS Could Make or Break Clean Energy

IRS guidance on hydrogen tax credits could undermine EPA’s carbon pollution rules or save them

Last Updated July 19, 2023.

The fate of hundreds of millions of tons of carbon pollution is hidden in a technical IRS decision coming this summer on the Inflation Reduction Act’s (IRA) clean hydrogen tax credit. If IRS folds to industry pressure, it will increase carbon pollution, undermine the future of a truly clean hydrogen industry in the US, and do enormous damage to the Environmental Protection Agency’s (EPA) critical carbon pollution standards before they can even be finalized. 

Will death and taxes come for the grid? It’s time for the Biden administration to make sure that IRS does not undercut our race for clean energy. And they need to hear from you. The stakes are high, and polluters would prefer the public get lost in the details. Instead, let’s take a look at the pollution hidden in the fine print—and why it’s not too late to stop it.


What is clean hydrogen?

As leading advocates from NRDC and Energy Innovation have been pointing out for months, at stake is a lucrative and uncapped tax credit from the Inflation Reduction Act for producing clean hydrogen. Hydrogen is a potent fuel that can be burned without greenhouse gas emissions—and therefore could be used to cut carbon pollution from sources that burn fuel if it is also produced without increasing emissions. However right now, most hydrogen is produced through a dirty refinery process using fossil fuel-heated steam to break apart molecules of fossil gas—a process known as “steam methane reforming.” We don’t need more of that. 

Infographic showing that clean hydrogen, with good IRS guidance, can meet the demand and regulation, and displace fossil fuels in industry and power generation.

IRS has broad technical and legal authority to ensure that the IRA tax credit only goes toward subsidizing clean hydrogen. 

In contrast, clean hydrogen comes from using renewable power to split apart water molecules through a process known as electrolysis, using a unit called an electrolyzer—avoiding fossil fuel use altogether. This clean hydrogen can then be used to replace fossil fuels in high-heat industrial processes like steel-making or in power plants. 

The challenge is that it takes a lot of electricity to produce hydrogen, so the electricity powering this process has to come from clean, carbon-free sources in order for the hydrogen to be truly clean energy. To address this dilemma, the tax credit from the IRA increases as emissions from production decrease to favor production with clean electricity that does not spur emissions increases on the grid. This means more public money from our country’s biggest climate bill is directed to the products that are the best for our climate

So, with a process that is extremely energy intensive and hundreds of billion dollars or more of funding at stake, the consequences of what counts as "clean" hydrogen are astronomical. And IRS is in the process of issuing guidance to answer that question now.

Determining what counts as “clean” is trickier than it sounds. Our power grid gets electricity from a mixture of fossil fuel gas, coal plants, and renewable energy sources. When there are surges in demand, the grid meets these needs by triggering production in the cheapest available (or “marginal”) source. This is not generally not the cleanest source, and almost always comes from a methane gas power plant.

That’s a big problem. The potentially hundreds of electrolyzers needed to keep up with the demand for clean hydrogen will require a tremendous amount of electricity. But if this electricity is coming from dirty methane gas, what is allegedly “clean” hydrogen can produce massive carbon pollution each time an electrolyzer switches on, thus undercutting the benefits of the fuel they are making

In fact, the potential demand for power from a growing hydrogen industry, underwritten by what could be a hundred billion dollars in taxpayer money, could actually increase grid emissions by hundreds of millions of tons of carbon dioxide, according to some expert estimates.

A white crate with open doors revealing hydrogen electrolyzer technology

In order for hydrogen to be truly clean energy, electrolyzers (pictured above) must be powered by carbon-free sources. (© 2021 Sunfire/Flickr CC BY-ND 2.0)

Three things IRS must consider in its clean hydrogen production credit guidance

It would be absurd if IRS misinterpreted the IRA, a climate law, and poured public money into making the climate worse. That’s why advocates, including our colleagues at NRDC and Energy Innovation, and several companies and industry groups are calling for IRS to implement “three pillars” in its guidance to ensure that hydrogen does not undercut our race to clean energy: 

1. New clean supply or additionality: Electrolyzers should be powered by new clean energy that is not already on the grid. (Buying credits from existing clean energy doesn’t cut it because that can just shuffle power around the grid without actually decreasing climate pollution—the marginal gas plant just powers another user.) 

2. Deliverability: Electrolyzers should use local sources of clean electricity that are physically delivered to them by facilities in their region of the grid. (In short, facilities can’t claim credits from a part of the grid that isn’t reacting to their facility’s demand.) 

3. Hourly time-matching: Electrolyzers must run during the same hours as the clean electricity is being generated. (This prevents facilities from  buying solar energy credits while running a plant overnight on fossil gas.) 

If IRS fails to require any one of these three pillars, we’re setting up fake “clean” hydrogen that is actually massively increasing power generation from fossil fuels, sending emissions sky-rocketing. Because power plants are often located in lower-income or minority communities as a result of decades of racist planning, that result would not just be terrible climate news—it’s a civil rights nightmare in stark tension with the President’s environmental justice initiatives.

These pillars are not new. They are accounting principles that are rapidly becoming a norm, mirroring trends in voluntary clean energy procurement, requirements in the European Union and Colorado’s new hydrogen tax credit, and which can deploy tracking tools already used in major power grids. But it should be no surprise that the dirtier parts of the power industry and some hydrogen developers—who would like the public’s climate money with no strings attached—are filling up IRS docket with claims that it is just too hard to make sure this new industry isn’t just greenwashing.

In the face of the potential for creating hundreds of millions of tons of excess climate pollution, with public money that is supposed to reduce climate pollution, some members of the power industry will continue to argue that it’s too expensive to build electrolyzers truly tied to clean energy, the grid is slowly cleaning up anyway, and we should just get started without all these “requirements.” But we have seen this movie before. 

When the government funds a whole new industry without proper safeguards, it’s easy to turn a “half-measure” into the forever “solution,” raking in public funds and polluting along the way. We’ve seen crop-based biofuels touted as gasoline replacements that turned out to be a climate disaster, fossil gas supposedly acting as a “bridge fuel” from coal power plants but actually spewing heavily-polluting super-pollutant methane—all while gas utilities illegally spend public funds to lobby against electrification and waste gas trucks that were supposed to replace diesel actually pollute more than the trucks they replaced. The Biden administration should know better than spending billions to create another dirty industry spewing malarkey.

Infographic showing that with bad IRS guidance, we will enter a

Co-firing hyodrgen that is produced with fossil fuel power overall results in increasing carbon emissions.

The power doom loop: How the decision from IRS profoundly impacts carbon pollution

Not only can a bad IRS choice spike grid climate pollution on its own, but it can also tank the President’s climate legacy—by badly damaging his critical power plant carbon pollution standards with a spiraling doom loop in which the standards themselves can fail to cut power sector carbon pollution.

That’s because those standards (as a result of the limitations placed on the EPA by the Supreme Court’s terrible West Virginia v EPA decision) must be based on technology that power plants can install on site. As such, EPA has proposed standards based on the potential to install either carbon capture technology or to co-fire fossil fuels with hydrogen in power plants. As a result, it matters enormously, what kind of hydrogen those retrofitted and new facilities use. 

Now, it’s true that the way the standards are set isn’t necessarily how they will be implemented—and advocates should continue to work both to strengthen the standards and to ensure that states opt to replace polluting facilities with renewable energy rather than costly retrofits. But some facilities still may burn hydrogen to comply with EPA’s standards.

If that happens and IRS fails to make sure that hydrogen is truly clean, we’re in a doom loop: The EPA standards draw increased demand for hydrogen. Hydrogen production raises the demand for power. That power demand is met by fossil fuel plants, which are now more profitable and operate longer, as a result of all that extra demand. The more power they produce, the more their owners need hydrogen—which is produced from a grid that remains dirty and will stay dirty, as a result of the doom loop. And downward we spiral, with dirty hydrogen driving demand for dirty marginal gas plants and prolonging their pollution. 

EPA knows this. In fact, in their proposed rule (page 76, to be precise), EPA is very clear that only “low-GHG hydrogen” works to break us out of the doom loop. As the agency puts it: Co-firing hydrogen at combustion turbines when that hydrogen is produced with large amounts of GHG emissions would ultimately result in increasing overall GHG emissions, compared to combusting solely natural gas at the combustion turbine. 

In a bit of classic agency deadpan, the proposal explains that spiking climate pollution with a climate pollution control would be an “anomalous result.” That’s quite an “anomaly”: the climate pollution standards would cut between 600 million metric tons to a billion metric tons of CO2, while high-carbon hydrogen could emit hundreds of millions of metric tons—raising climate pollution at comparable scale at which EPA is trying to lower them. Now, these systems are complex, so there’s not an apples-to-apples comparison, but the risk is clear. Depending on how fast the doom loop spins, IRS could slow EPA’s sprint against climate pollution to a crawl or even make it run in place.

But EPA would have to struggle mightily to break out of the doom loop on its own. Only IRS can set the standard for what counts as clean hydrogen under the 45V tax credit. This credit awards billions to clean hydrogen producers that can demonstrate extremely low lifecycle greenhouse gas pollution, but IRS guidance must establish clear rules to ensure clean hydrogen actually meets the stringent climate pollution limit, so hydrogen’s new electricity demand isn’t met by fossil gas and coal plants. 

We are left with a policy choice which will set the course of the second Biden term: Strong IRS guidance will ensure hydrogen producers will bring clean energy online to secure 45V funds. However, weak IRS guidance, which would align hydrogen with the fossil fuel industry, would create political incentives to oppose new climate rules and give the new industry a huge publicly-funded incentive to lobby against cleaning up the grid and other sectors, along with delaying the retirement of expensive fossil fuel power plants.

Dive deeper: 45V tax credit explained

Though EPA is proposing to set its own regulatory definitions for its rules, those definitions, even if finalized, would be up against billions of dollars flowing the wrong way from IRS if 45V goes wrong. If IRS folds, EPA will be standing alone against a tide of dirty hydrogen with limited tools at its disposal. In that scenario, we’ll all need to support EPA efforts to limit the damage—but EPA shouldn’t have to start deep in a hole created by another federal agency, and the White House has a chance, now, to make sure IRS is pulling for the team.


Power cycle: IRS’ pathway to keep hydrogen clean

A better future is possible. IRS has broad technical and legal authority to adopt the “three pillars” in their guidance, ensuring that the IRA tax credit only goes toward subsidizing truly clean hydrogen. And if they do, we could see a world in which the hydrogen industry helps fund a cleaner, greener, power grid. In that world, not only do the ever-fewer power plants burning hydrogen use truly clean fuel, but there will be fewer combustion facilities because more renewable energy will also come online. 

In that world, clean hydrogen means more renewables; more renewables mean less “marginal” gas power and less coal, and less gas and coal mean ever cleaner hydrogen that can be used where it’s actually needed. That’s a world in which fossil plants retire, consistent with environmental justice and climate needs, and where truly clean hydrogen helps us clean up other hard-to-decarbonize industrial sectors. A virtuous cycle, not a doom loop.

Which path will we choose? That comes down to the Biden administration’s IRS and to public pressure. It’s time to see the threat lurking in those tax policy weeds, to make sure IRS supports the EPA rather than blowing up the President’s pollution-cutting legacy, and for the Biden administration to make sure we’re power-cycling forward. It’s not too late; tell President Biden and IRS today to “follow the three pillars and keep hydrogen clean.” 

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