July 31, 2024 | By Dorian Hunt, Head of Renewables
The space program has helped to pioneer some very important technologies: ice cream that tastes like chalk, those silver blankets in which athletes convalesce after a particularly grueling session, nearly limitless existential dread, photovoltaics, fuel cells, etc. Once my senator starts taking my calls again, I hope to get a tax credit for chalky ice cream and write about it, but for now I will settle for fuel cells. As we transition to a new tax credit regime in 2025 and later under Code Section 48E and 45Y, it’s worthwhile to consider how tax incentives available for fuel cells might differ as compared to how they function under current Section 48.
What’s a Fuel Cell, Though?
Before we talk taxes, let’s talk about fuel cell basics. Fuel cells are used in a wide variety of contexts including for transportation (e.g. buses, ships), materials handling (think forklifts) and stationary power generation. For the latter category, it is common for fuel cells to be integrated with combined heat and power systems to improve the overall efficiency of the conversion of a fuel source into usable energy. As the users of the electrical grid contemplate a graceful journey further into the 21st century, resiliency is always part of the conversation and fuel cells can play a role in that effort. That is, fuel cells are among the technologies often used for backup or primary energy behind the meter.
Fuel cells have a variety of uses, but they can take many different forms. For the most part, however, the primary electricity generation in fuel cells is derived from hydrogen. Perhaps too simply, hydrogen within a fuel cell undergoes an electrochemical reaction whereby the hydrogen interacts with some oxygen and in the process a couple of electrons are knocked off and those electrons are the primary usable energy output. As an aside, solar photovoltaics work somewhat similarly except in those cases a photon knocks off some hydrogen from a photoelectric material. The most common fuel cell in use today is known as a Solid Oxide Fuel Cell (“SOCF”). A SOCF can use a number of different fuel sources to ultimately derive hydrogen, which is then converted to electricity. For example, a SOCF might “reform” methane (natural gas) through a couple of steps (reforming and water gas shifting) into a mix of carbon dioxide and hydrogen. This is called steam methane reforming (“SMR”). The hydrogen, once separated, can be used in an electrochemical reaction to produce electricity.
What Does Any of This Have to Do with Taxes?
I’m glad you asked. Fuel cells have long been eligible for investment tax credits (“ITCs”) under Section 48(c)(1). A fuel cell power plant that “begins construction” before January 1, 2025 and 1) has a nameplate capacity of at least 0.5 kW (or 1 kW in the case of a linear generator assembly) and 2) has an electricity only generation efficiency greater than 30% can be eligible for a 6% ITC on eligible costs (subject to special fuel cell limitations based on nameplate capacity) which can be increased by fulfilling prevailing wage and apprenticeship (“PW&A”) requirements, or fulfilling the requirements for certain “adders” such as those for domestic content. A fuel cell power plant is generally a stack of fuel cells and all the other stuff required to make it usable (i.e. balance of plant) that “converts a fuel into electricity using electrochemical or electromechanical means”. The conversion of a fuel into electricity by electrochemical means in most cases implies the use of hydrogen (paired with something like a platinum catalyst on an anode). There are some applications whereby certain alcohols like methanol and ethanol can be used directly to create electricity, but those use cases aren’t as popular. So, let’s assume now that the electrochemical requirement implies that we’re using hydrogen.
From Whence Cometh Our Hydrogen?
Bear with me, I am going somewhere tax-related with this and not just trying to write a Popular Mechanics article on fuel cells. The proposed regulations for Sections 48E and 45Y (“Proposed Regulations”) delineate two major buckets of qualified facilities 1) Combustion and Gasification Facilities (“C&G Facilities”) and 2) Non-Combustion and Gasification Facilities (“Non-C&G Facilities”). Per the Proposed Regulations, the restrictions and reporting requirements for C&G Facilities are anticipated to be more stringent and cumbersome than those applied to Non-C&G Facilities. So, when claiming tax credits under Sections 45Y or 48E, the C&G versus Non-C&G classification matters quite a bit. For some technologies like wind, solar, hydropower and others, the distinction is clear but because of the myriad potential fuel cell energy sources, fuel cells can fall into one bucket or another. Per Proposed Regulation 1.45Y-5(b)(4), a C&G Facility “means a facility that produces electricity through combustion or uses an input energy source to produce electricity, if the input energy source was produced through a fundamental transformation, or multiple transformations, of one energy source into another using combustion or gasification.” Proposed Regulation 1.45Y-5(b)(3) provides that gasification “means a thermochemical process that converts carbon-containing materials into syngas, a gaseous mixture that is composed primarily of carbon monoxide, carbon dioxide, and hydrogen.” It would seem as though SMR fits under this definition of gasification. Therefore, a fuel cell that derives its hydrogen from SMR is different, from a tax credit perspective, than a fuel cell that derives its hydrogen from a source other than C&G, such as through the production of hydrogen through an electrolyzer whose electricity is derived solely from renewables. So, under Section 48 a fuel cell is a fuel cell regardless of the source of its hydrogen. Under Sections 48E and 45Y, the Proposed Regulations provide that a fuel cell may have different operational and reporting requirements depending on how its hydrogen is derived.
The standards for assessing greenhouse gas (“GHG”) emissions for Non-C&G Facilities have a relatively limited scope as described in Proposed Regulations Section 1.45Y-5(c). Proposed Regulation 1.45Y-5(c)(1)(i) would also provide that emissions that may relate to a Non-C&G Facility but do not occur “in the production of electricity” do not need to be counted as GHG emissions. As an example, a non-C&G Facility would not have to include the emissions from a generating step up transformer. Further, for a non-C&G Facility the “greenhouse gas emissions rate … must be determined through a technical and engineering assessment of the fundamental energy transformation into electricity” taking into consideration “all input and output energy carriers and chemical reactions or mechanical processes taking place at the facility in the production of electricity.” For C&G Facilities, GHG emissions must take into consideration the lifecycle greenhouse gas emissions, as described in section 211(o)(1)(H) of the Clean Air Act. The starting boundary for C&G Facilities, therefore, is much earlier in the electricity production process and must take into consideration, for example, the processes necessary to produce and collect or extract the raw materials used to produce electricity from combustion or gasification technologies. It remains to be seen how many technologies and installations will practically be able to fulfill these requirements.
Conclusion
It remains to be seen what might survive, what might be removed and what might be added if the Proposed Regulations become final regulations. I expect we’ll have incremental clarity as we attend the hearings on the Proposed Regulations and review questions and comments submitted. Depending on the classification of fuel cells as C&G facilities or otherwise could impact the overall after-tax value proposition of fuel cells generally.