Analysis reveals Inflation Reduction Act clean energy subsidies at work

By Colton Poore

Several clean fuels needed for combating climate change are now on the path to being cost-competitive with their fossil fuel equivalents thanks to the Inflation Reduction Act of 2022, Princeton researchers have found.

The landmark piece of legislation established an unprecedented set of financial incentives for deploying low greenhouse gas emissions technologies, including ones to promote the production of low-carbon hydrogen and synthetic liquid fuels.

The researchers, presenting their work in Environmental Science & Technology, analyzed six different hydrogen production pathways and nine different pathways for producing synthetic liquid fuels. They identified the clean fuel pathways that stand to benefit most from Inflation Reduction Act subsidies, those that are likely to remain uncompetitive even with subsidies, and key uncertainties in the implementation of the tax credits that could shape the law’s success in promoting clean energy deployment. Their research was first published online on August 30 and was highlighted on the front cover of the journal’s October 17 issue.

“The incentives in the Inflation Reduction Act completely shift the economic favorability of several low-carbon technologies,” said first author Fangwei Cheng, associate research scholar at the Andlinger Center for Energy and the Environment. “Our goal was to understand which technologies stand to benefit the most from the law, and whether the law’s incentives are enough to allow cleaner technologies to compete with their fossil fuel-derived equivalents.”

Hydrogen: Electrolysis and carbon capture rise to the top

Hydrogen has attracted interest for its potential use as a clean fuel that does not emit carbon when burned. Yet while consuming hydrogen creates no carbon emissions, the pathways for producing it come with widely varying carbon intensities.

Currently, 95% of the hydrogen produced in the United States is created through steam-methane reforming (SMR), also known as gray hydrogen, in which steam reacts with methane at high temperatures to produce hydrogen and carbon dioxide. In addition to direct emissions from the SMR process, upstream methane leakages also contribute to gray hydrogen’s high lifecycle greenhouse gas intensity, which reaches the equivalent of 10 to 12 kilograms of CO₂ for each kilogram of hydrogen produced.

While cleaner pathways have been developed, in which either the carbon emissions from SMR are captured and stored (blue hydrogen) or electricity generated without carbon emissions (e.g., wind or nuclear energy) is used to create hydrogen from pure water in a process known as electrolysis (green hydrogen), they are more costly to produce than gray hydrogen in the absence of policy support.

The Inflation Reduction Act changed the playing field. The researchers’ analysis revealed the legislation has made blue hydrogen at least as cheap as gray hydrogen through either the 45Q tax credit for carbon capture and storage (CCS) or the 45V tax credit for low-carbon hydrogen. Green hydrogen benefits even more from the law, transforming it from being over twice as costly as gray hydrogen to produce without the law to costing less than one-quarter as much when claiming the full 45V credit.

“The Inflation Reduction Act was designed to help emerging technologies get early footholds in up-and-coming clean energy markets, so that they can scale up and compete with their fossil fuel-derived counterparts, even after the subsidies are removed,” said Eric Larson, research leader and senior research engineer at the Andlinger Center for Energy and the Environment. “And what we see from our analysis is that for hydrogen, the act has done just that. It’s done enough to allow blue hydrogen to compete with gray hydrogen, and it has dramatically swayed the economics in favor of green hydrogen.”

While green and blue hydrogen emerged from the Inflation Reduction Act as winning pathways for hydrogen production, others received fewer benefits. Among those pathways were ones using biomass as a feedstock for hydrogen production. Because plants remove carbon via photosynthesis as they grow, by burning plant matter and then capturing the resulting carbon emissions, the process can be net-negative, actually removing carbon from the atmosphere.

Such a negative emissions process for producing hydrogen would lead to lower carbon emissions than either blue hydrogen or green hydrogen, yet the researchers found that biomass-based hydrogen production is not cost competitive with other pathways under current provisions in the Inflation Reduction Act.

The findings differ from the researchers’ previous finding, based on an analysis published in Applied Energy, that since biomass-derived pathways had the highest potential for reducing carbon emissions, their higher cost might be justified under a policy that was structured to prioritize lowering carbon emissions.

“Most studies looking at a 1.5 or 2 degrees Celsius warming target have come to the conclusion that we’re going to need a fair bit of negative emissions technologies,” Larson said. “And there are incentives in the Inflation Reduction Act for negative emissions technologies such as direct-air carbon capture. But there are none for negative emissions of the type that can be achieved with biomass-based hydrogen production.”

Synthetic liquid fuels: More support needed

The research team also studied the impact of the legislation on synthetic liquid fuels. These emerging fuels can serve as drop-in alternatives to petroleum-derived fuels, making them attractive options for lowering emissions from hard-to-decarbonize uses such as aircraft, ships, and long-distance trucking.

However, the researchers said that the tax credit (45Z) aimed at promoting clean fuels is much more limited than the ones aimed at CCS (45Q) and hydrogen production (45V). The credit applicable to synthetic liquid fuels begins in 2025 yet is set to expire after only two years in 2027. And unlike 45Q and 45V, which include provisions to provide a payment stream for eligible projects that commence construction by 2032, 45Z only offers payments for clean fuels actually produced between 2025 and 2027, an impractical timeframe for most would-be producers to construct a facility.

“If the goal is to help low-carbon synthetic fuels become cost-competitive with their fossil fuel counterparts, the 45Z tax credit should be renewed or extended,” Cheng said. “We found that if 45Z were extended for even five years, several pathways would become cost-competitive with historical jet fuel prices.”

The researchers also noted that the 45Z credit can be stacked with other policy incentives aimed at promoting clean fuels, such as the federal government’s Renewable Fuel Standard or statewide programs like California’s Low Carbon Fuel Standard. When they considered an extended 45Z credit working alongside one or both of those clean fuel standards, they found that several clean pathways become competitive with historical jet fuel prices, with one of the promising candidates being the conversion of biomass directly into synthetic liquid fuels with accompanying CCS.

The researchers pointed out, however, that the value of subsidies under both the Renewable Fuel Standard and the Low Carbon Fuel Standard has fluctuated significantly over time, making it difficult to predict what and how much support these policies will provide over the next decade.

“We wanted to showcase an optimistic scenario, where the 45Z credit is extended and with at least modest support from the federal Renewable Fuel Standard and California’s Low Carbon Fuel Standard,” Cheng said. “But to what extent those assumptions will hold true remains to be seen.”

Focusing on the fine print

While the researchers agreed the Inflation Reduction Act is poised to have a profound impact on clean energy in the United States, the degree of its success will depend in part on how the implementation rules for its tax credits are written.

If the rules are too lax, Cheng said the result could be a group of bad actors more interested in collecting tax credits than meaningfully contributing to the clean energy transition.

“You could imagine a situation where a developer builds a solar farm to generate electricity for electrolysis, which would allow them to claim a clean electricity production tax credit [45Y], along with the tax credit for low-carbon hydrogen production [45V]. They could then use that hydrogen in a hydrogen-fueled generator, for which they could potentially claim the clean electricity production credit again,” Cheng said. “That process might be lucrative from the standpoint of collecting credits, but it would be an extremely inefficient way to produce clean energy.”

A similar situation could occur for synthetic liquid fuel pathways that use biomass as a feedstock. The researchers found several conditions where it would be financially preferable to first convert biomass to hydrogen (which would allow the producer to claim the 45V credit), and then use the hydrogen to create the synthetic liquid fuels, rather than convert biomass directly into synthetic fuels. Such a situation would favor an energy-inefficient process over a more efficient one by creating more opportunities to collect credits.

“If we want to avoid these instances where actors attempt to game the system for financial benefit, it is important to write the rules carefully,” Larson said. “They can’t be too restrictive, but at the same time, they must be specific enough to ensure they result in meaningful advances in clean energy technology deployments.”

The paper, “Impacts of the Inflation Reduction Act on the Economics of Clean Hydrogen and Synthetic Liquid Fuels,” was published Aug. 29 in Environmental Science & Technology and was highlighted on the front cover of the journal’s Oct. 17 issue. In addition to Cheng and Larson, co-authors include Jesse Jenkins and Hongxi Luo of Princeton University. Alongside Luo’s research contributions, he also designed the artwork featured on the journal’s front cover. The work was supported by Princeton University’s Carbon Mitigation Initiative, Andlinger Center for Energy and the Environment, and Zero-Carbon Technology Consortium.