Hydrogen tax credits could help developers secure project financing: experts

Hydrogen tax credits proposed within the Biden administration's Build Back Better Act would not only help bring down the cost of clean hydrogen, the credits themselves could catalyze hydrogen projects by helping developers lock-in long-term financing, energy financing experts say.

The proposed bill would offer producers either production tax credits, which would offer up to $3/kg of clean hydrogen, or investment tax credits, which would pay for up to 30% of the cost of electrolyzers or other clean hydrogen production equipment. The amount of either would depend on the carbon intensity of a project's hydrogen production process.

The credits have been widely lauded as something that could unleash the hydrogen industry in the US, especially the prospect of the production tax credit.

"I think everyone is really hanging on the PTC for hydrogen, and the tagline is that it could be up to $3/kg," Roshni Mali, managing partner at energy investment firm Captona, said during a Feb. 9 IPFA panel discussion on future hydrogen markets.

And while anticipation around the credits has been mounting, experts are also highlighting how the credits would have the added benefit of helping projects gain access to financing.

"Obviously if we have these tax credits, I think it will make projects much more economically viable, but you still need to know how to finance these projects," said James Berger, a partner at the Norton Rose Fulbright law firm, during a Feb. 8 ICF International panel discussion on hydrogen economics. "Just because there're tax credits doesn't mean you're going to be able to get bank financing or tax equity financing."

Credits help draw financing

Many renewable projects depend on two streams of cash flow: the revenue generated through offtake contracts with fuel buyers, and the revenue generated when renewable producers sell the tax credits themselves. While the first category is highly market dependent and can often result in a nominal loss, the revenue stream from tax credit transfers are more reliable.

But that's only if the credits are consistently in place. The renewable fuels sector in general has struggled with policy inconsistency with regard to tax benefits, with credits typically following an unpredictable cycle of phase outs and extensions.

"It's usually the case for renewable fuels or biofuels that the tax benefits that are available will be renewed for a year, maybe two years, and then they phase out," explained John Marciano, partner at the financial law firm Allen & Overy, during the Feb. 9 panel. "Then they get renewed again and the same cycle happens over and over, which makes it hard to build out a financing structure."

But the hydrogen tax credits proposed in the Build Back Better Act, which have a 10-year duration, could overcome that inconsistency barrier. And one could look to California's Low Carbon Fuel Standard program to see how tax credits can spark industry growth despite an absence of federal support.

The LCFS issues credits to anyone who provides hydrogen as a transportation fuel, or to anyone who installs zero-emissions vehicle refueling infrastructure. Then those hydrogen developers often sell those credits to companies looking to offset their tax buden. As of 2020, the state had more than 50 publicly available hydrogen refueling stations and plans to deploy 100 more by 2026, according to the California Energy Commission. Another 24 will be privately funded.

If Congress were able to introduce hydrogen tax credits, either through the Build Back Better Act or a carve-out bill, "it's likely this will be a popular arrangement" for producers, said Brian Murphy, senior analyst of hydrogen and low-carbon fuels with S&P Global Platts Analytics.

Tax credits helps hydrogen pencil out

There could be several reasons why hydrogen producers would want to sell their credits rather than use them to offset their own tax burden, Murphy said. In some instances, a producer might be organized as a partnership, which does not have a federal tax obligation. Or producers could have a reduced tax burden if they're selling hydrogen at a nominal loss.

"Selling the credit is the only way to take advantage of it," he said.

The buyers of such credits are often large, credit-worthy companies with a heavy tax burden, like industrial or oil and gas companies.

"If you can get them to buy [credits] for multiple years, that is generally sufficient to build the financing," Berger said.

According to S&P Global Platts price assessments, clean hydrogen produced using PEM electrolysis (including capex) in Southern California cost $4.48/kg on Feb. 7, while hydrogen produced using steam methane reforming without carbon capture (including capex) cost $1.33/kg.