February 22, 2024 [Lexology]- After years of cost constraints and regulatory uncertainty, low-emission hydrogen production is poised for rapid growth – and regulators have laid out a series of incentives that will further cement its role in the global energy transition. Meanwhile, markets for biofuels such as renewable diesel and sustainable aviation fuel (SAF) are maturing, enabling major corporations to pursue lower emission targets in the short term while electrification ramps up.

Green hydrogen production to accelerate

While hydrogen energy has been around for over a decade, the European Union (EU) and the United Kingdom (UK) have recently recognized it as one of the few truly carbon-neutral energy transportation and storage options. To capitalize on this, the EU has reached a provisional agreement in its Renewable Energy Directive (RED) III to ensure that hydrogen production is largely green – that is, fueled by renewable energy production rather than hydrocarbon fuel sources – by 2030.

For its part, the United States (U.S.) Treasury Department is contemplating the adoption of similar measures as business leaders look to leverage the Inflation Reduction Act (IRA)’s 45V tax credit, which is aimed at incentivizing low-carbon hydrogen production. Stricter Treasury Department guidance would require that hydrogen producers utilize clean energy sources to qualify for the credit. Such a policy would have the power to reduce carbon dioxide emissions by somewhere between somewhere between 250 and 640 million metric tons – but has generated pushback from industry.

As biofuel markets mature, demand for SAF to bolster the sector

The outlook for the biofuel industry in the U.S. remains promising – and decidedly less uncertain. The IRA’s 45Z tax credit will also subsidize biofuels with lower greenhouse gas emissions for the next decade, a stark contrast to the yearly tax credit renewals legislators have offered in the past.

What remains to be seen is whether pending U.S. Treasury Department guidance will enable corn and soybean producers to take advantage of the growing demand for low-carbon aviation fuel by contributing to SAF feedstock. The guidance that takes conservation practices like cover crops into account could be a boon for the ethanol industry, allowing them to contribute to the decarbonization efforts of major U.S. airlines.

The EU has approached biofuel as a medium-term stopgap in the energy transition. While RED III will raise the EU’s binding renewable target for 2030 to a minimum of 42.5 percent, it will also cap the usage of advanced biofuels in the transport sector to 5.5 percent, and limit them to non-food-based feedstocks – taking corn, soybean, and rapeseed producers out of the equation.

Like the U.S., the EU has also recognized the importance of biofuel in reducing the aviation industry’s carbon emissions. The European Commission recently proposed a new law requiring that SAF make up at least two percent of the fuel that suppliers provide to EU airports by 2025.

Major headwinds for business and private equity leaders

As outlined above, the hydrogen and biofuel sectors are fast approaching an inflection point, presenting industry stakeholders with lucrative opportunities.

But these endeavors don’t come without challenges. Here are two major issues business leaders should consider in the coming months:

• EU sustainability goals will vary between member states: RED III gives member states two choices: either pursue a 5 percent reduction of greenhouse gas intensity in transport using renewables, or achieve a 29 percent share of renewables in the transport sector by 2030. This compromise will make it more difficult for hydrogen and biofuel investors and executives to scale business models across the entirety of the EU. To be successful, business leaders will have to monitor regulatory developments on a state-by-state basis.
• M&A players in these markets need to differentiate themselves: When it comes to the M&A landscape, the perception is that hydrogen and biofuels aren’t bankable. But there are lucrative deals to be made, particularly through offtake agreements. For example, oil and chemical giants like BASF recently bought into a hydrogen project to get access to the company’s algorithm. If dealmakers can highlight their strong suits in this competitive landscape, they can attract investment from these global energy titans.

The future of biofuels and hydrogen is closely intertwined with that of renewables. While the bevy of incentives, subsidies, and regulations will only grow larger or more complex, these nascent industries stand to evolve swiftly in the U.S., Europe, and around the world. With enough foresight, stakeholders can capitalize on soaring demand, lofty decarbonization targets, and significant tax credits.

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