Contentious Proposed Regulations On Hydrogen Tax Credit May Be Vulnerable To Legal Challenges

• Published date: 30 January 2024
• Subject Matter: Environment, Energy and Natural Resources, Energy Law, Environmental Law, Oil, Gas & Electricity, Chemicals, Renewables
• Law Firm: Steptoe LLP
• Author: N. Hunter Johnston, Steven R. Dixon, Nick Sutter and Michelle Castaline

After extensive lobbying, a leaked draft, and a long wait, Treasury and IRS have finally issued the highly anticipated proposed regulations (the "Proposed Regulations") for the new section 45V clean hydrogen production tax credit that Congress enacted in the Inflation Reduction Act (IRA). Among other things, those Proposed Regulations impose additional requirements on hydrogen producers to source and track clean energy in order to take the tax credit. Lauded by the some in the environmental community and criticized by some potential hydrogen producers, it is unclear whether the Proposed Regulations are sufficiently grounded in the statute, result from valid rulemaking processes, or pass muster under other administrative law principles.

Summary

Section 45V expressly ties the amount of the hydrogen production tax credit to the amount of lifecycle greenhouse gas (GHG) emissions from the point of hydrogen production (the "well-to-gate" hydrogen production)'the lower the GHG emissions, the higher the credit. The statute requires measuring the GHG emissions from electrically produced hydrogen via the Greenhouse Gases, Regulated Emissions, and Energy Use in Transportation (GREET) model. Therefore, the GREET model is itself one crucial determinant of whether a hydrogen producer is eligible for the credit and the size of the credit the producer may claim. It is thus legally significant that concurrent with the Proposed Regulations, the Department of Energy (DOE) released guidelines detailing the assessment of lifecycle GHG associated with electricity used for clean hydrogen production and an updated version of the GREET model (with a newly interposed user interface and accompanying Guidelines).

The Proposed Regulations and revamped user interface for the GREET model are difficult to reconcile with the purpose of section 45V. Congress intended the section 45V credit to kick start domestic hydrogen production. That credit is worth up to $3.00 per kilogram of clean hydrogen for producers who emit the least GHG and meet other statutory criteria. But the Proposed Regulations add three new requirements, commonly known as the " three pillars," that hydrogen producers who use electricity to produce hydrogen must meet: (1) incrementality/ additionality requirements, (2) deliverability requirements, and (3) time-matching requirements. The Proposed Regulations layer those new requirements on top of the low-emission requirements that are already in the statute (which keys the value of the credit to the producer's GHG emissions as measured under the GREET model). Moreover, the new user interface integrates the three pillars as a threshold for hydrogen producers to use the GREET model in measuring GHG emissions.

The Proposed Regulations already have their detractors. Several energy industry organizations, along with Senator Joe Manchin (D-WV), have sharply criticized the Proposed Regulations and predicted that they will impede the growth of the US clean hydrogen industry and overall decarbonization. Given the vocal opposition, it seems likely that if Treasury and the IRS were to finalize the Proposed Regulations in their current form, there will be legal challenges to the validity of those regulations. One potential challenge would be that Treasury and the IRS have exceeded their statutory authority in implementing these three pillars because there is no mention of the three pillars in the statutory language. Indeed, the statute already accounts for the carbon intensity of hydrogen production in determining the amount of the credit. Another potential challenge is that DOE's Guidelines and its interposition of the new user interface on the GREET model constitute agency rulemaking but fail to comply with the notice-and-comment requirements for rulemaking under the Administrative Procedure Act (APA).

The Proposed Regulations would, if finalized, apply to tax years beginning after December 26, 2023. The publication of the Proposed Regulations in the Federal Register began a 60-day public comment period. Comments are due on February 26, 2024. A public hearing on the Proposed Regulations is slated for March 25, 2024.

Section 45V Background

Section 45V provides a ten-year production tax credit for qualified clean hydrogen that is produced at a qualified clean hydrogen production facility. To qualify, the clean hydrogen must be produced through a process that results in a well-to-gate lifecycle GHG emission rate of not greater than 4 kilograms of carbon dioxide equivalent (CO2e) per kilogram.

Depending on the lifecycle GHG emissions rate as determined under the GREET model, the amount of the tax credit can vary from $0.12/kg (for hydrogen with a lifecycle GHG emissions rate between 2.5 and 4 kg of CO2e per kg of hydrogen) up to $0.60/kg (for hydrogen with a lifecycle GHG emissions rate of less than 0.45 kg of CO2e per kg of hydrogen). If the facility meets prevailing wage and apprenticeship requirements, the full value of the credit increases fivefold. At the highest credit level, this means a jump from $0.60/kg up to $3.00/kg.

Taxpayers can also claim the section 45V credit as a direct payment for up to five years or elect to transfer the credit to another taxpayer in exchange for cash. For more information on these direct pay and transferability options, please see our previous Steptoe Client Alert, "Treasury and IRS Release Long-Awaited Guidance on Direct Pay and Transferability Elections."

Proposed Regulations

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