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Executive Summary

The reduction of energy’s carbon footprint is a driving force in energy transitions — one that is not without its challenges. In particular, the roles of legacy and scale are central and place a hyperfocus on incumbent industries to play a critical role. The role of technology is also central, and its impact will increase to the extent that it is integrated into existing energy systems to decarbonize and promote reliable, secure, cost-effective options for delivering energy services. 

The centrality of legacy, scale, and technology means that the decarbonization of hydrocarbon supply chains will ultimately play a part in any long-term, low-carbon energy strategy. The success of any commercial venture in any industry depends on coordination throughout supply chains and the minimization of costs to promote affordability; ventures that fail to recognize the economic hurdles associated with deployment costs and the inherent value embedded in the sunk costs of legacy assets risk falling into the proverbial “valley of death.” Thus, there is an opportunity to leverage existing infrastructure. Hydrogen provides a potential platform for decarbonization that can leverage legacy to achieve scale and promote the integration of new production, and potentially end-use technologies. One of hydrogen’s biggest strengths is its diversity. It can be produced in a number of different ways — including steam-methane reforming, electrolysis, and pyrolysis — so it can leverage a variety of comparative advantages across regions. Its expansion as an energy carrier beyond its traditional uses in industrial applications will depend heavily on 1) significant investment in infrastructure and 2) well-designed market structures with appropriate regulatory architectures. A lack of either will risk coordination failure along hydrogen supply chains and, thus, threaten to derail any momentum that may currently be building.

Fiscal incentives are helpful for stimulating investment, particularly when the commercial prospect is otherwise insufficient. Recent federal action (i.e., the 2021 Infrastructure Investment and Jobs Act and the 2022 Inflation Reduction Act) explicitly targets a necessary condition for market development — infrastructure and hub development — but it is not sufficient. Appropriate regulatory and market design is also needed to achieve the scale required for a liquid market to emerge around hubs. To successfully generate the scale needed for broad hydrogen adoption, policy must take a full value chain approach. Barriers to permitting and siting infrastructure and market structures that do not promote price and volume transparency can limit investment and prohibit the development needed to reach the sufficient scale for a meaningful impact.

The extent to which hydrogen markets expand across the U.S. will depend on regional comparative advantages and federal, state, and local policy frameworks. Policy is currently hyper-focused on stimulating the production of hydrogen, largely through loan guarantees, grants, and subsidies, with stimulus for demand, storage, and commodity transportation coming in a distant second, third, and fourth, respectively. This will tend to drive greater capital investment to the most heavily subsidized parts of the hydrogen supply chain. This will eventually yield binding constraints on the unsubsidized parts of the supply chain. If prices are transparent and investment is unimpeded by other policies and/or regulations, then market participants will respond to price dislocations that arise with constraints by investing along the supply chain to capture value. But if transparency is absent, investment is otherwise impeded, and/or hydrogen adoption in end-use is slow to respond, market participants will not see value and therefore will not invest. So, there must be alignment between policy support and market forces, i.e., a full value chain approach. Policy that supports demand growth for low-carbon hydrogen in large-scale applications, such as industrial uses, could create demand pull that would be more favorable for supply chain development, especially if transparency in the nascent market is emphasized.

Hydrogen hubs have emerged as central to the future of hydrogen markets. A hub provides liquidity and de-risks market participation, two key functions for a market. The existence of physical infrastructure is necessary, but not sufficient, to ensure that hub services can emerge. So, while the recent federal policy emphasis on infrastructure investment is helpful, market design must also be addressed to ensure long-term growth.

Texas is well-situated to lead in hydrogen market development, given its existing comparative advantages. These include:

1. A robust industrial sector, especially in petroleum products, chemicals, plastics, and rubber manufacturing (13.2% of U.S. GDP in these sectors, collectively, in 2021) co-located with the nation’s largest regional port capacity.
2. An existing hydrogen market with two-thirds of U.S. hydrogen transport infrastructure.
3. An investment environment that is generally supportive of infrastructure development.
4. A large natural gas production, transport, storage, and end-use footprint (accounting for 60.5% of U.S. GDP in oil and gas extraction and 24.6% of U.S. GDP in pipeline transportation in 2021).
5. Excellent geology for long-term storage of hydrogen and CO₂.
6. Deep expertise in logistics and supply chain management (accounting for 11.6% of U.S. GDP in wholesale trade and 10.0% of U.S. GDP in transportation and warehousing).

How the state leverages these strengths through local policy measures and market design, alongside federal government incentives, will determine the role Texas ultimately takes. Although the Texas Emission Reduction Plan (TERP) provides multiple incentives for hydrogen adoption, they are primarily focused on transportation and refueling infrastructure. As such, the state’s existing incentives do not necessarily match its comparative advantages for hydrogen market development. Moreover, since they do not take a full value chain approach, they do not adequately support scale. Policies that support infrastructure investment along the entire supply chain and encourage competition and transparency could catalyze hydrogen market expansion. To that end, the history of the U.S. natural gas market carries some important lessons regarding the roles of infrastructure investment and market structure in promoting market liquidity, which is seminal for hub development.

To be clear, policymakers should consider expanding the eligibility of hydrogen in existing TERP incentives to promote new production technologies, new end-uses, and new infrastructures for hydrogen market growth. But TERP is not a panacea. There are other areas where policy can play a role, including but not limited to 1) establishing a regulatory framework that promotes transparency and competition in pipeline operation and utilization; 2) streamlining permitting for hydrogen projects and related supply chain infrastructures; 3) encouraging pilot and demonstration projects to learn where economies of scale and other cost-saving gains can be made; and 4) adopting transparency measures that establish frequent reporting mechanisms for hydrogen storage and allow for better accounting of demand.

In Texas, converting current industrial uses of hydrogen to low-carbon production technologies is likely the most expedient, near-term path to broader hydrogen use. The opportunity for market growth and hub development can then be enhanced to the extent that heavy-duty transportation applications and other new or emerging uses can benefit from the build-out of large, backbone infrastructures needed for industrial-scale applications. Texas is in a very advantageous position to play a leading role in driving hydrogen market growth, but the evolution of policy and market structure will dictate whether or not this comes to pass.

This material may be quoted or reproduced without prior permission, provided appropriate credit is given to the author and Rice University’s Baker Institute for Public Policy. The views expressed herein are those of the individual author(s), and do not necessarily represent the views of Rice University’s Baker Institute for Public Policy.