The market growth potential of green hydrogen projects may be hampered if proposed U.S. federal tax credit rules are adopted that incentivize a limited pathway to secure electricity supply, Fitch Ratings says. Green hydrogen projects already face material completion, operational, and market risks similar to those faced by other nascent energy technologies. The proposals will encourage truly green hydrogen production but are likely to increase project scope and capital costs while reducing efficiency, limiting project credit upside.
The Inflation Reduction Act (IRA) provides up to a $3/kg hydrogen production tax credit, which would result in a significant 50%-75% reduction in the expected cost of hydrogen production. The tax credit is essential to support material expansion of hydrogen production given its current very high cost in relation to competing fuels. The U.S. Treasury Department and IRS issued proposed regulations at the end of 2023 that specify the credit eligibility parameters, granting the maximum credit to hydrogen production with very little or no carbon emission in the entire value chain, i.e.green hydrogen.
The additionality provision incentivizes green hydrogen projects to use renewable energy from a facility less than three years old. Projects that rely on a new renewable energy facility will have to include the plant in the project scope, which increases capital costs, or identify a third party to build and operate a new facility, which elevates counterparty risk.
The renewable energy deliverability standard requiring the renewable energy facility to be located in the same region as the hydrogen project is more detrimental to efficiency and market access. Areas ideal for renewable production are not necessarily close to areas where hydrogen demand is strongest, necessitating pipelines to deliver hydrogen to demand centers. New pipeline networks will add to project scope, costs, and timelines, all elevating completion risk. In addition, a large volume of water is required to produce hydrogen, although it is a small portion of production cost. Even if large volumes of water are available at a favorable renewable energy site, longer-term water availability and cost to support forecast production are key credit concerns, particularly for projects in areas with stressed water supply such as Texas and California.
Proposed time-matching requirements result in lower capacity factors and potentially higher capital costs. Green hydrogen production from 2028 onwards must be matched to renewable energy production on an hourly basis, meaning production may only occur when the renewable facility is producing energy. Wood Mackenzie has estimated annual capacity factors would be at best roughly 46% to 72% with hourly matching, depending on the region, versus 100% for annual time matching. Projects supplied with solar energy would not be able to produce during overnight hours and would see capacity factors ramp down during the day. A hydrogen project may need to rely on two or more solar projects to acquire sufficient energy to operate at maximum capacity during daylight hours.
The federal tax credit program aims to reduce the gap between the current high cost of hydrogen to the end users and project costs, but for green hydrogen projects the revenue/expense gap is likely to persist and remain a key credit driver, absent offtakers willing to pay a much higher price, developers willing to put in a lot more equity, or final policy rules that ease restrictions on energy supply.
Source: Fitch Ratings
