On April 30, 2024, the Department of the Treasury issued final regulations on tax credit transfers that allow hydrogen producers to sell tax credits earned under § 45V of the Inflation Reduction Act (IRA). Section 6418 of the Internal Revenue Code and the final regulation issued thereunder allow credit purchasers to use purchased credits to offset their tax liability. Credit sellers will be able to sell credits that they would not otherwise be able to use due to insufficient tax liability. Given such powerful incentives, many energy producers are wondering how to add “green” hydrogen (discussed below) to their portfolios by powering hydrogen facilities with wind turbines and solar panels. Here, we discuss what wind and solar producers should keep in mind as they plan, negotiate, and begin developing hydrogen plants powered by renewable energy, with a particular focus on site control.
Tax Credits and Incentives for Green Hydrogen Production
The Inflation Reduction Act (IRA) § 45V provides tax credits for wind, solar, and hydrogen producers to incentivize decarbonization via use of wind and solar plants to power hydrogen plants. This 10-year program will be instrumental to hydrogen’s profitability in the United States during the early stages of the industry. IRA credits are allocated per kilogram of hydrogen produced. In simple terms, the lower a facility’s lifetime greenhouse emissions per kilogram of hydrogen produced, the greater the tax credit. For example, facilities with emissions of less than 0.45 grams of CO2-equivalent per kilogram of hydrogen produced may claim a credit of up to $0.60 for every such kilogram, or up to $3.00 if they meet the IRA’s prevailing wage and apprenticeship requirements. Qualifying facilities must: 1) not have a lifecycle greenhouse gas emissions rate greater than 4 kilograms of CO2-equivalent per kilogram of hydrogen; 2) be owned by the taxpayer; and 3) begin construction before January 1, 2033. The credits are available “during the 10-year period beginning on the date such facility was originally placed in service.” § 45V(a)(1). Per a rule proposed by the Treasury on December 22, 2023, § 45Q’s tax credit for carbon capture and sequestration cannot be stacked with (i.e., claimed in the same year as) the § 45V tax credit.
The several means of hydrogen production are classified colloquially by color. “Green” hydrogen uses an electrolyzer powered by renewable energy such as wind and/or solar plants, whereas brown uses coal to power the electrolyzer. Using as high a proportion of renewable energy as possible minimizes carbon emissions and thereby maximizes § 45V tax credits. But remember that the wind or solar facility used for a green hydrogen electrolyzer must come online no earlier than thirty-six months prior to commercial operations of the hydrogen plant. Producers may also need to plan for occasional connections to the grid for backup power on days when renewable facilities may not provide sufficient power to the electrolyzer.
Site Control Strategies for Renewable Energy Producers Venturing into Hydrogen
Green hydrogen producers should examine whether leasing or purchasing a site better suits their needs. Each can be structured to enable you to assess the viability of a hydrogen facility on a parcel of land—including during the development of wind and/or solar facilities—before committing to a longer lease term with higher rents or spending money on a purchase. If the landowner leasing for a renewable energy plant agrees to sell land for the hydrogen facility, sale terms may be included in the wind and solar leases with the same landowner, or they may be drafted into a separate purchase agreement. If the terms of the purchase option are embedded in the wind/solar lease, the purchase option terms should include, at a minimum, price per acre; the specific parcel of land to be purchased, if known, and if not available up front, a unilateral right to designate that later; the timing of the option notice to be submitted by the lessee; the form of deed to be used; and terms and a timeline for closing on the land. The purchase option embedded in a lease should also provide for release of the hydrogen facilities from lease and rent terms upon purchase and should also be included in the recorded memorandum of lease. A purchase option that is in a separate agreement should be signed at the same time as the lease in order to ensure site control. It could also include cross-default provisions with the lease. It should include at least the same terms as are listed above for the purchase option form embedded in a lease and will likely include more terms as well. If using a separate purchase agreement, you may want to include a due diligence period, including title, survey, and environmental reviews, among other typical due diligence for an acquisition of land.
Leasing vs. Purchasing: Evaluating Options for Green Hydrogen Facilities
If proceeding with only a lease (i.e., no purchase at all), hydrogen leases should be long-term: 40-50 years, including extension rights that align with those for the solar and wind facilities that will power the hydrogen plant. A shorter lease would be disproportional to the scale of the investment and may prevent recouping the investment at all. Different types of facilities may have different rent payments even though they all share the same lease. This can be complicated and should be worked through carefully up front. For example, whereas wind projects tend to pay royalty rents, solar and battery storage facilities more typically pay rent per-acre under lease, or per acre used. The portion of land to be used for hydrogen may also have a per-acre payment. Rent provisions should also permit flexibility in deciding which portions of the leasehold will be used for wind, solar, hydrogen, and storage; build flexibility into your lease so that plans can be adjusted as the project unfolds. Keep rent increases uniform for all types of facilities if possible: if rent for land occupied by wind facilities increases by 2% every three years, the same should be true of land occupied by hydrogen facilities. Aim for a lease with unilateral termination rights: lessees should be able to terminate for any reason whatsoever during the development period. After termination if facilities were built and after expiration of the lease term, you may have to decommission your facilities and return the land to approximately its original state. Decommissioning procedures may vary between facility types and vary with state law; negotiate your responsibilities in advance so the lessor cannot ask for the moon and so that your lease complies with law. Decommissioning would not typically be a real estate requirement for the hydrogen plant if you purchase the land, versus leasing it. Safety and environmental protections must always be followed, aside from real estate requirements.
Whether they are leases or purchase options, hydrogen agreements should include a broad definition of “facilities” that includes the electrolyzer, transformers, rectifiers, electrolyzer stack modules, control cabinets, liquid and gas modules, purifiers, hydrogen purification units, driers, electrolyte storage tanks, hydrogen storage, compressors, cooling systems, battery energy storage systems (BESS), distribution and interconnection facilities, transmission facilities, and pipelines, among other things.
Like any energy project, a hydrogen project has several critical dates that a written agreement must map out in advance, and with a lease covering wind, solar, BESS and hydrogen, this can be challenging. At some point in development, you will need to designate how the property will be apportioned between solar, wind, BESS, and hydrogen. Maintaining flexibility for shifting that apportionment is important for as long as possible. Secondly, renewable energy leases typically require an increase in payment at some point after initial due diligence or an initial option, and the payments may vary depending on the planned uses of the land – wind, solar, BESS or hydrogen. For example, wind payments per acre may be significantly lower than solar payments per acre, considering the intensity of land use. Lastly, consider that timing of the Operations Date for each plant may ideally be defined as operation of the hydrogen facility, rather than having multiple operations dates, one for each of wind, solar and hydrogen, in order to best utilize the IRA. However, this is complex, one factor being whether the hydrogen plant is using the PTC or the ITC. Consult tax counsel and aim for flexibility in the lease once again.
Conclusion
In summary, the IRA supercharges potential returns for hydrogen producers who use low-carbon power sources. Producers should plan their projects scrupulously and with maximum flexibility for a changing legal landscape to ensure access to such sources, affordable and efficient transmission infrastructure, and favorable deal terms. Unlike in the early days of wind and solar, we are fortunate to have countless wind and solar energy lease agreements that can serve as models as producers design this growing industry.