American pulp and paper companies have begun increasing their use of fossil fuels in order to become eligible for a renewable-energy tax credit, while also reaping millions of dollars in tax rebates.

The renewable-energy tax credit in question was originally meant to encourage transport companies to blend fossil fuels with alternative fuels to power their vehicles. However, the provision was amended in 2005 to allow for non-transportation use of the credit, allowing companies using blended fuel for other purposes to apply for the tax credit.

When the global economy sharply declined in 2008, the battered pulp and paper industry discovered the obscure provision and the potential payoff it represented.
  
Pulp mills turn wood into pulp using a process that produces an energy-rich substance called ‘black liquor’. The toxic by-product used to be dumped into the environment until a process was devised in the 1930s which made use of the substance to power the pulp mills.  As the so-called kraft process improved, modern paper mills became largely energy self-sufficient.

Recently, pulp and paper companies in the United States began adding small amounts of diesel to black liquor, in order to take advantage of the government’s tax credit.  Although the process would seem to run counter to the purpose of the renewable-energy tax credit, a September 2008 interpretation of the tax code by the Internal Revenue Service paved the way for several companies to adopt the practice.

Among the first to take advantage of the loophole was International Paper, which adopted the process in all 15 of its pulp mills in late 2008.  The company recently reported that it received a check from the Internal Revenue System for US$ 71 million as a result of using the tax credit for only one month. 

According to the New York Times, Deutche Bank estimates that International Paper could receive as much as US$1.27 billion in 2009. Overall, the loophole could cost U.S. taxpayers US$6 billion for the year.  Now that the tax credit has garnered such publicity, the Senate Finance Committee has said it is investigating.

In an April 3rd commentary, pulp and paper industry expert Kevin Mason, of Equity Research Associates, called the subsidy perverse because mills are now being paid to do what they were always doing. 

The black liquor subsidy is causing a market distortion, although “the impacts are hard to quantify right now” given that “most of the ‘evidence’ is anecdotal,” said Mason to Subsidy Watch.

When asked if he was aware of similar subsides around the world, Mason responded that there were some small subsidies for the production of alternative fuels internationally, but usually for the production of new, incremental power.  “I am not aware of anything so egregious as this black liquor boondoggle,” he added.

The subsidy is causing alarm in Canada where paper companies who have also been bruised by the economic crisis say the tax credit has lowered the production costs of U.S. pulp mills by as much as 60%. (Mr. Mason argues, however, that the figure is closer to 40%). 

As a result, both Domtar and the troubled AbitibiBowater have begun adapting their pulp mills in the U.S. to take advantage of the tax credit.