Unpacking the Proposed H2Hubs Demand-Side Support Mechanism

The Regional Clean Hydrogen Hubs (H2Hubs) program, a U.S. Department of Energy (DOE) initiative, is meant to catalyze the clean hydrogen industry by using money from the Infrastructure Investment and Jobs Act to link prospective producers of clean hydrogen with prospective buyers. One risk factor that the program faces is too many willing suppliers—in large part due to the hydrogen production tax credit from the Inflation Reduction Act—but too few buyers.

To address the challenge of connecting buyers and sellers of clean hydrogen, the DOE released a Notice of Intent on July 5 to invest up to $1 billion towards establishing a demand-side support mechanism for its H2Hubs program that would support reliable demand and address market uncertainty for clean hydrogen.

Q1: Why is there a need for demand-side support in the H2Hubs program?

A1: In its announcement of the initiative, the DOE highlights that development of a demand-side mechanism as “critical to ensuring the early commercial viability of a H2Hub” and avoid delays in progress due to market uncertainty. To put the challenge into perspective, out of all project announcements, only 10 percent have achieved final investment decisions. If all announced projects were to come to fruition, they would supply up to 12 million metric tons (MMT) of clean hydrogen per year. That’s 2 MMT in excess of current total hydrogen production in the United States, most of which comes from unabated natural gas-based processes.

Before the announcement, the recently published U.S. Clean Hydrogen Strategy and Roadmap had highlighted the near-term challenge of “securing long-term, credit-worthy offtake contracts,” with producers struggling to find willing offtakers both with sufficient demand and within an affordable distribution distance. The Pathway to Commercial Liftoff report made similar assessments while adding that scaling the market would require addressing further challenges, such as lack of midstream infrastructure and manufacturing at scale. Unlocking demand would cascade certainty up the value chain, facilitating deployment of connective infrastructure and cheaper at-scale manufacturing. Both of the mentioned reports, as well as an Energy Futures Initiative report, also cited that end-users have been hesitant to commit to long-term contracts due to the expected decrease in cost of clean hydrogen and long-term risks in supply.

Thus, a demand-side mechanism could provide clean hydrogen producers with the required revenue certainty to keep projects moving forward and hydrogen end-users with the flexibility of shorter-term contracts as the market continues to grow, connective infrastructure is built out where needed, and market uncertainty is diminished.

Q2: What questions is the DOE seeking to answer in its RFI?

A2: There are three broad items that the DOE is seeking answers for in its Request for Information (RFI), and which shed some light into its approach to the demand-side initiative: how to design the support mechanism, how to choose recipients of said support, and how to identify an entity or entities to manage the fund.

When it comes to design of the support mechanism, the DOE is considering the four following schemes, allowing respondents to propose unlisted alternative schemes of their own: (1) Contracts for Difference (CfD) that would provide support based on the difference between producer’s market price and end user’s willingness to pay; (2) fixed support payments to end-users; (3) funding for feasibility analysis from offtakers near H2Hubs; (4) a “market-maker” to provide a ready purchaser/seller of clean hydrogen. Prospective awardees would then be selected under the following three—or proposed other—guidelines: (1) reverse auctions, where projects get awarded based on lowest-bid for support needed for project viability; (2) request for proposal-based, where projects are selected based on their applications meeting various criteria; (3) eligibility-based, where all projects meeting established requirements get awarded support.

Lastly, the DOE plans to seek out an independent “Implementing Entity/Entities” to manage the initiative, seeking advice from respondents on the following points: the capabilities and qualifications by which candidates should be selected; if the initiative should be managed by an entity with national scope or many entities with regional scopes; how long it would take to establish a managing entity if there are no qualified candidates; and risks associated with delegating management of the initiative to an implementing entity.

Q3: What demand-side intervention tools could help address market uncertainty surrounding emerging clean hydrogen markets?

A3: A CSIS report released last year recommended three tools to foster development of clean hydrogen markets in the H2Hubs program: exchanges or clearinghouses, federal procurement, and state policy drivers.

Exchanges or clearinghouses operate much like the proposed market-maker in the DOE’s RFI, reducing participant transaction costs by coordinating consumers’ purchase of clean hydrogen from producers. The tool’s attractiveness lies in its ability to address uncertainty in the pace and scope of the industry’s scale up. It can bundle consumer offtake up to what a single producer can provide and then make short-term, low-volume contracts to hydrogen end-users. The market-maker would also subsidize the difference between the price paid to the producer and the price paid to the final buyer. This directly addresses end user’s hesitancy to commit to long-term contracts due to forecasted reductions in clean hydrogen production costs. Furthermore, once markets have formed, this approach could easily accommodate new entrants into the H2Hubs hydrogen ecosystem—whether these are suppliers or end-users.

Federal procurement at scale could create enough initial demand while demonstrating political commitment to support deployment of clean hydrogen. Any federal government agency could also incentivize clean hydrogen uptake by acting as a purchaser of end-use products or their components, i.e., instructing contractors to use green steel—produced using clean hydrogen—when constructing federal buildings. The DOE’s national clean hydrogen strategy also suggested that government agencies could act as catalyzers of private sector uptake via “early demonstrations and bundled demand for subsequent offtake.” However, note that this tool’s effectiveness is reliant on the federal executive branch maintaining a steady authority and long-term commitment for the emerging clean hydrogen economy. There is also the risk that forecasted federal end-uses fall short of forecasted supply, leaving the government with stranded hydrogen and no willing buyers.

States can also implement their own procurement policies and regulate utilities to help develop clean hydrogen markets. Leading the way when it comes to direct procurement policies is the state of Colorado, which signed into law tax credits for end-users of clean hydrogen in hard to abate sectors this past May. This approach directly aligns with the “fixed support payments to end-users” that is being considered in the RFI. Additionally, many states have already released detailed statewide actions plans with sector-specific targets that rely on clean hydrogen as a decarbonization pathway, such as California’s net-zero climate action plan, or are assessing clean hydrogen’s role in helping reach climate targets, such as New York’s Public Service Commission studying clean hydrogen as a tool to decarbonize its grid.

Q4: How would the demand-side mechanism interact with the 45V clean hydrogen production tax credit?

A4: Upcoming guidance of the 45V hydrogen production tax credit, which awards up to $3 per kilogram of clean hydrogen produced, has seen plenty of heated debate when it comes to the accounting of clean hydrogen’s lifecycle emissions intensity, as covered in a recent CSIS commentary. Proponents posit that without strict guidelines, the government would be subsidizing “dirty” hydrogen. Detractors worry that strict requirements would stifle deployment and prevent movement down cost curves that would be derived from the industry scaling up.

Successful implementation of the demand-side mechanism would address detractors’ concerns by unlocking offtake agreements and bringing announced projects closer to securing final investment decisions. However, it is worth noting that the initiative’s billion-dollar fund is bound to have emissions accounting requirements that align with the H2Hubs program’s guidelines. Given that the program was passed as part of the Bipartisan Infrastructure Law, it has a broader definition of clean hydrogen that does not incorporate the strict requirements being debated for implementation of the 45V tax credit. While this does allow more projects to qualify for the demand-side support, it raises concerns about the emissions intensity of the H2Hubs in the short term.

This dilemma paves the way for the 45V tax credit to take on the role of a mid- to long-term guardrail of the nascent clean hydrogen economy. It could either play said role through two implementation pathways: (1) as a complement to demand-side interventions via a phased-in approach of guideline strictness as the demand-side mechanism phases out, or (2) as a safeguard to demand-side interventions via strict requirements from the start. The former would strengthen projects’ offtake prospects in exchange for a near-term potential increase in emissions, while the latter would reward early implementers of the three pillars while galvanizing proper carbon accounting of clean hydrogen early on in the nascent sector.

Q5: Have other countries with emerging clean hydrogen markets implemented demand-side interventions?

A5: In recognition that production subsidies alone will not be enough to drive investment in clean hydrogen projects, countries have started setting up demand-side incentives to prop up their budding hydrogen sectors.

In Europe, Germany’s H2Global has been a pioneering demand-side initiative, a government funded intermediary conducting auctions both on the supplier and offtaker side while subsidizing the difference from said auctions. The United Kingdom is also moving ahead with a CfD-style initiative, supported by the government’s Hydrogen Business Model, in hopes of awarding up to 1 gigawatt’s worth of contracts across two allocation rounds. The European Commission is also setting out plans for an auction-based model through the €3 billion European Hydrogen Bank (EHB) initiative, with there being talks of extending the H2Global initiative into the EHB scheme and Germany adding a further €1 billion in funding. Japan recently announced an upcoming CfD-style scheme alongside its updated national hydrogen strategy, adding that it plans to raise over $100 billion in public and private investment for development of the country’s hydrogen supply chain. Canada is also developing an economy-wide carbon “CfD” scheme as part of the Canada Growth Fund to support its clean hydrogen investment tax credit.

These examples showcase the popularity of CfD- and market-maker-style approaches both as demand-side incentives and hydrogen deployment strategies. This stands in stark contrast to the fixed, supply-centric support implemented by the United States via its tiered 45V tax credit—with Colorado’s end-user tax credit as the sole demand-side initiative in the country thus far, underscoring the urgency of setting up a national demand-side support mechanism for clean hydrogen.

Joseph Majkut is director of the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Mathias Zacarias is a research associate with the CSIS Energy Security and Climate Change Program.

Mathias Zacarias
Research Associate, Energy Security and Climate Change Program
Joseph Majkut
Director, Energy Security and Climate Change Program