Sunday, April 19, 2009

Black Liquor Tax Boondoggle May Net Billions for Papermakers

Paper companies may claim about $6.6 billion from a U.S. tax break meant to discourage use of fossil fuels, and they’ll burn more diesel to get it.

The tax credit is an incentive to mix an alternative energy source with carbon-based fuel. Papermakers already generate electricity by burning a wood byproduct from pulp-making called “black liquor.” To qualify for the windfall they are adding diesel fuel to the black liquor, following the letter of the law while violating its spirit, said Verle Sutton, editor of the Reel Time Report, a unit of Los Angeles-based Forestweb Inc., a provider of data on the paper industry.

“It’s an absolute government boondoggle,” Sutton said. “These companies were not using fossil fuels. They only started because they needed it for the tax credit to work. So there’s a negative to the environment, not a positive.”

Papermakers are struggling amid a 27 percent drop in pulp prices in the last year through April 14 and plunging demand as publications lose advertisers and businesses cut back. Companies that claim the tax credit may bring in more cash this year from the U.S. government than they do in revenue, said Brian McClay of TerraChoice Market Services Inc., a pulp market data provider in Montreal. Two Memphis, Tennessee-based producers, International Paper Co. and Verso Paper Corp., have already received payments.

100 Mills

Approximately 100 U.S. paper mills are eligible to take advantage of the incentive because they chemically produce their own pulp using what’s called the kraft process, according to McClay. That includes makers of bags, boxes and paper for copiers and magazines. It leaves out newsprint producers and manufacturers that use mechanical means to make pulp, McClay said.

The tax break, part of a change in 2005 transportation legislation to include non-transportation industries, is set to expire at the end of the year and may be revoked before then, according to an April 5 report by New York-based Deutsche Bank Securities Inc. analysts led by Mark Wilde.

Senator Max Baucus, a Montana Democrat who is chairman of the Senate Finance Committee that oversees tax legislation, is “working on the black liquor issue to ensure that the credit is used in a manner that is consistent with the spirit and intent of the law,” according to a Baucus aide.

Revoking the paper industry’s eligibility for the alternative fuel tax credit before it expires “could have serious consequences for our companies and our nearly 1 million employees at a time of unprecedented economic challenges,” said Scott Milburn, spokesman for the American Forest & Paper Association in Washington.

‘Renewable Energy Use’

Black liquor is a thick, dark liquid created when wood is transformed into pulp, which is then dried to make paper, according to the trade group. To qualify for the credit, U.S. pulp producers must mix at least 0.1 percent of diesel fuel with black liquor. Some companies already use diesel to ignite the black liquor and keep it burning evenly, Milburn said.

“Diesel use is more than offset by the industry’s far greater renewable energy use,” Milburn said in an interview.

Paper plants generate about two-thirds of their own electricity by burning black liquor, Milburn said.

The incentive amounts to about 50 cents a gallon of the mixed fuel, said Kevin Mason, managing director of ERA Equity Research Associates Inc. in Gibsons, British Columbia.

The windfall for 30 paper-producing companies in the U.S. may total about $6.6 billion and could rise as high as $10 billion, Mason said.

‘In the Black’

Mason said he expected some papermakers to qualify for more from the U.S. Internal Revenue Service than their market values. Those companies are Boise Inc. of Boise, Idaho, with a market capitalization of $57 million as of yesterday’s close; Northbrook, Illinois-based KapStone Paper & Packaging Corp., worth $72 million; Chicago-based Smurfit-Stone Container Corp., worth about $23 million, and Verso, $35 million.

“This tax credit puts pulp-producing paper companies in the black,” said Dennis Ruggles, a director with Fitch Ratings Inc. in Chicago who follows the paper industry. “Many of them are losing money from making paper so the only money they’re making in some cases is from the tax credit.”

KapStone Chief Executive Officer Roger Stone said his company hopes to participate in the program. He said he doesn’t know how much money KapStone would get.

“We have two mills and we believe both qualify,” Stone said in an interview. “In one case we’re adding more diesel fuel to the process.”

The amount of diesel fuel burned is “miniscule” compared with the volume of black liquor, said Virginia L. Aulin, Boise’s vice president of corporate affairs.

‘$6 Billion Oops’

“What people don’t realize is how innovative the pulp and paper industry has been in using alternative fuels to reduce greenhouse gases,” Aulin said.

The incentive unfairly hurts both U.S. and foreign competitors, including manufacturers who use recycled materials, said David Gandossi, chief financial officer of Mercer International Inc. in Vancouver, a pulp producer.

“This is a $6 billion oops,” Gandossi said. “It’s environmentally silly. It’s egregious. Imagine pumping diesel fuel into an 18-story boiler to benefit the environment. Guys in the U.S. have a real moral dilemma. They know they shouldn’t be doing this because it’s wrong, but in their fiduciary role they can’t walk away from the money.”

In a display of the financial pressure on paper producers, AbitibiBowater Inc., North America’s largest maker of newsprint, yesterday filed for bankruptcy in the U.S. and said it plans to file in Canada today. The Montreal-based company does not qualify for the payments.

Slowing Recovery

The tax credit’s popularity also is spurring concern that producers may end up smothering a recovery in pulp prices in the rush to reap the incentives.

“The problem for pulp producers is the tax credit encourages them to run at higher rates, which is putting pressure on already weak pulp prices,” said Mike Richmond, a paper and forest-products analyst at Salman Partners Inc., a Vancouver stock brokerage.

International Paper, the world’s largest maker of cardboard boxes and office paper, received a $71.6 million cash payment in March from the IRS for the period Nov. 14 to Dec. 14 last year, according to a company statement.

The total fiscal-year windfall for the papermaker will be an estimated $1.27 billion, about one-third of its market value, according to the April 5 report by Deutsche Bank Securities analysts.

Payment to Verso

Still to be determined is whether the tax break itself will be taxed, said Wilde at Deutsche Bank.

Verso, North America’s second-largest maker of magazine paper, got a $29.7 million incentive payment from the U.S. government in February for fourth-quarter operations at one of its mills, according to a regulatory filing. The company said it expected another check for the fourth-quarter operations at another mill.

In all, Verso will get an estimated $240 million in tax credits this year, according to CreditSights Inc. analysts Rahul Gandhi and Chris Ucko.

“The amount of money they got in one quarter goes a long way to offsetting the cash burn for the whole year, generally speaking,” Gandhi said in an interview.

Verso is controlled by New York-based buyout firm Apollo Management LP, which bought the former International Paper unit for $1.4 billion in August 2006.

Kathi Rowzie, a spokeswoman for Verso, and Apollo spokesman Steven Anreder declined to comment.


Michel Marcouiller, a spokesman for Domtar Corp., North America’s largest maker of office paper, said the Montreal-based company, which has mills in the U.S., is applying for the tax credit. He wouldn’t elaborate.

Shawn Hall, a spokeswoman for Miamisburg, Ohio-based NewPage Group Inc., the biggest U.S. producer of magazine paper, said the company was participating in the tax incentive program. She declined to give any details.

NewPage is owned by Cerberus Capital Management LP, a New York-based private equity firm that also has a majority stake in Detroit automaker Chrysler LLC. Cerberus spokesman Jim Olecki declined to comment further.

A call to Smurfit-Stone was not returned.

Federal Way, Washington-based Weyerhaeuser Co., North America’s largest lumber producer, has applied for the tax credit, said spokesman Bruce Amundson. The company posted a record $1.2 billion loss on revenue of $8 billion last year.

“We are in the process of becoming a blender,” Amundson said.

The company is mixing diesel fuel with black liquor at at least four of its five U.S. pulp mills, he said.

Fiduciary Responsibility

“We have always used some diesel at our mills though our focus has been to derive more energy from carbon-neutral biomass” such as black liquor, Amundson said. As a result of the blending, “we are using slightly more diesel fuel than before,” he said. He declined to quantify the increase in diesel consumption.

“Obviously we have a fiduciary responsibility to our shareholders so we have to take steps to qualify,” Amundson said.

Weyerhaeuser’s tax credit this year could be $263 million, according to the Deutsche Bank Securities analysts. Mason, of ERA Equity Research, estimates a $327 million credit for the company. Analysts Richard Skidmore and Alex Ovshey of Goldman Sachs Group Inc. in New York project $219 million.

“You can’t blame the paper companies if Congress hands them money and they take it,” said Bob McIntyre, director of Citizens for Tax Justice in Washington. “Using the tax code to try to change people’s behavior gives you results you never thought you would get. Congress might want to amend the law.”