The green hydrogen sector experienced a dramatic cycle following the passing of the Inflation Reduction Act (IRA) in 2022. A massive number of projects were announced in the first half year, with companies rushing to invest in green hydrogen projects and capture the $3/kg production tax credit (PTC) in section 45V. The enthusiasm was only met by frustration with the Treasury proposing additional rules in late 2023, known by many as the ‘three pillars’ guidance.

For the last one and a half years, the industry has been anxiously waiting for the finalization of the rule, which finally came last week in the new year. Meanwhile, the industry has slowed down drastically, with most projects delayed or canceled. The only projects left are those that have significantly derisked, using known technologies and serving existing markets. While innovations simmer, the deployment of new technology has largely stalled.

Hydrogen Lifecycle and Economics

To understand why the tax benefit plays such an important role in driving green hydrogen, we have to first break down the hydrogen lifecycle and the economic implications of the different pathways.

The whole lifecycle of hydrogen can be broken down into production, storage/transportation, and downstream applications.

Hydrogen can be produced in many different ways, leading to a color palette of hydrogen. ‘Gray’ hydrogen, produced from natural gas through steam methane reforming, is the most mature and cheapest form, costing roughly $1-2/kg. Despite the significant carbon emissions, over 95% of the hydrogen consumed today is this kind. ‘Blue’ hydrogen relies on the same process but adds carbon capture equipment on top, reducing carbon emissions by up to 95% but increasing costs to $2-3/kg. ‘Green’ hydrogen uses a different process called electrolysis, which extracts hydrogen from water while producing oxygen. While the process is typically 65-75% efficient in converting electricity to hydrogen, it unlocks the potential of 100% clean hydrogen production: when the electrolysis process is powered by renewable energy, ‘green’ hydrogen is produced. Depending on the power used to operate the electrolyzer, hydrogen produced through electrolysis can also be ‘pink’ when using nuclear-powered electricity or ‘yellow’ when using grid electricity, which usually is a mix of different energy resources. There’s also turquoise hydrogen produced through methane pyrolysis. With the technology still at the prototyping stage, its economics further anchors on its commercial viability.

The difficulties of storing and transporting hydrogen further raise the economic barriers. Hydrogen needs to be either compressed or liquefied for storage, both requiring significant energy inputs, adding to the costs. On the transportation side, while the most flexible approach is through truck or ship, this adds another $2-3/kg to the cost through Opex. The alternative, pipeline transportation, while more economically efficient, requires upfront Capex to either build or retrofit infrastructure to reduce hydrogen embrittlement.

As hydrogen can be used either as an energy resource or fuel with applications across multiple industries, the economics and growth outlook further hinges on the downstream market applications.

Hydrogen is primarily used as feedstock in industrial processes at the moment, such as ammonia production and oil refining. Although hydrogen as industrial feedstock is sold at a low price, this is compensated through the large volume of purchases. Replacing gray hydrogen with green hydrogen is the most straightforward in this case, requiring near zero Capex on the user end.

Another industrial use of hydrogen is steel making, which is driven mostly by climate awareness and hydrogen being the only solution to decarbonize the sector. Yet, to replace the current natural-gas-reliant process with hydrogen, significant upfront investment is needed to retrofit existing plants. Currently, the price parity from green steelmaking still requires aggressive carbon pricing, with emerging interests coming mostly from Europe where carbon markets are much more mature.

Hydrogen also sees potential in heavy trucking and shipping, driven by its promise to decarbonize long-distance transportation where battery solutions are limited. While the unit price of selling hydrogen to retail customers is the highest among all, rolling out fueling stations requires massive capex, eroding the economics and market incentives.

Hydrogen can also be used as an energy storage solution in the power sector. However, with the growing deployment of cheaper industry batteries, the door for hydrogen to compete in this market is gradually closing.

The Debates Around 45V PTC

With hydrogen’s versatile role on the path to net zero, the IRA, through 45V PTC, hopes to bridge the economic gap and provide incentives to support green hydrogen production. The guidance proposed in 2023 tries to further steer the solutions towards projects that can ensure genuine emissions reductions without crowding out the alternative clean technologies. It attempts to do so mainly through these three pillars:

  1. Incrementality: the proposal requires the hydrogen facility to use ‘new’ renewable energy sources, with power plants commissioned within 36 months before the hydrogen facility’s operation, to avoid claiming existing renewable generation for the tax credit.
  2. Adjacency: It requires the renewable energy resource to be placed in the same regional grid as the hydrogen production facility, with demonstrated physical deliverability of power.
  3. Hourly matching: The rule further requires the clean power generation and hydrogen production to be matched on an hourly basis, which is different from the annual matching schema implemented in most of the current clean energy production accounting.

The guidance has created a stark divide between environmental groups and industry developers. Environmental advocates support the strict requirements for its emphasis on carbon emission integrity, while industry practitioners are concerned that the high bar to clear a project as ‘green’ will end up offering little support to the industry. Many see the hourly-matching element as particularly controversial due to the additional costs incurred to meet this criterion, possibly yielding minimal economic benefit on a net basis.

Specifically, a green hydrogen project consumes energy in two ways: either by co-locating with a renewable energy plant or getting connected to the grid. Hourly matching is economically punitive for both solutions. In the case of a hybrid project, the hourly-matching requirement forces the hydrogen plant to operate the electrolyzers intermittently following the generating pattern of renewable energy, resulting in lower production and hurting revenues. For the project to function at its full capacity, a battery component has to be added. While this can close the revenue gap, it increases the development cost. In cases when projects consume power from the grid, there’s usually no way to break down the percentage of electricity generated from renewable energy, and projects often have to purchase Renewable Energy Credit (REC) to be eligible. Under hourly-matching accounting, REC must be bought with a time stamp. The shallow supply of REC during hours when renewable energy is low in production marks up the price, driving the costs even higher.

Having factored in the feedback from the industry, the final guidance, released last week, relaxed the window of hourly matching implementation from 2028 to 2030 while retaining the ‘three-pillar’ framework. It introduced additional changes around ‘incrementality’. Under the final rule, nuclear plants repowered through the projects can also be considered as ‘incremental’ clean energy to power hydrogen, and carbon capture added within 36 months is also eligible for the projects. The final rule effectively expands the 45V from benefiting mostly ‘green’ hydrogen to also covering ‘pink’ hydrogen and ‘blue’ hydrogen as long as the carbon intensity thresholds can be met.

Expecting a Cautious Comeback

Due to the vast pathways of hydrogen from production to end use, it’s not surprising that policymaking in hydrogen is particularly difficult, as it must balance the interests of various stakeholders.

For the private sector, it’s also incredibly appealing and uncertain to invest in hydrogen.

It’s not clear which technology will win out: green hydrogen has attracted the most attention as a decarbonization pure play and should continue growing as renewable energy becomes increasingly cheaper; blue hydrogen gains momentum due to its proximity to natural gas production hence the backing from the oil and gas industry; pink hydrogen is also taking off as nuclear energy becomes the new darling of technologists; turquoise hydrogen also has a chance to win if technology can evolve quickly to prove out its economics and additional benefits in producing solid carbon at scale.

It’s also not clear which sectors will see the large adoption of hydrogen as a replacement for existing technology: despite being one of the few promising solutions to decarbonize many hard-to-abate sectors, the high green premium combining both Capex and Opex obscures the outlook and path to success.

Capital follows policies. While the final ruling opens up the pathway for pink hydrogen to compete and for blue hydrogen to be extra economical through the stacking of 45V on top of the existing 45Q carbon capture credit, it’s mostly technology agnostic by setting the bar based on the carbon intensity and providing broad support to the hydrogen industry. The landscape is further shaped by regional initiatives like the DOE’s $7B funding to develop regional hydrogen hubs and state-level policies.

That said, it’s unlikely hydrogen will come back at the speed and scale we saw in 2022, as the hype has now given way to a more clear-eyed view of the future. Gone are the sweeping promises of a hydrogen economy around every corner. Instead, serious players are doubling down on what works and investing strategically in innovations and deployments. The message is clear - hydrogen’s future remains bright, but the path to getting there requires thoughtful planning, strategic risk-taking, and cross-industry collaboration.