In September 2009, we first discussed Black Liquor Tax Credits: A Closing Loophole for the Pulp & Paper Industry. Black liquor is a fuel produced from paper byproducts and small amounts of diesel fuel. This chemical qualified as an alternative fuel eligible for tax credits under legislation passed in 2007. The Alternative Fuels Provision initially began as part of a 2005 highway bill as a tax credit intended to promote alternative fuels for motor vehicles, but was expanded in the 2007 energy bill. An interpretation of the tax code by the Internal Revenue Service (IRS) paved the way for several industries, such as pulp and paper manufacturers, to avail themselves of these new tax credits. The pulp and paper industry was receiving a $0.50 per gallon credit through this legislation, which expired on December 31, 2009. Pulp producers filed for the $0.50 per gallon alternative fuel excise tax credit under the legislation intended to encourage alternative fuel use in vehicles with doubts about how long they would be able to do so. Judging by the complaints raised by influential Senators Max Baucus (D., MT) and Charles Grassley (R., LA), many thought that Congress would move to close the loophole before its December 31st expiration, but it did not. Although the loophole closed at the end of 2009, U.S. Representative Steve Kagen has introduced H.R. 4066, which would continue the tax credits in perpetuity. H.R. 4066 was referred to the House Committee on Ways and Means on November 7, 2009. Further actions remain to be concluded although industry experts are doubtful that any extension will be granted.
In the 3rd quarter of 2009, International Paper (IP) booked $525 million in credits in comparison to its $233 million in pre-tax earnings before special items, according to the company’s announcement in October 2009. The giant paper and packaging company announced on February 4, 2010 that it would receive $516 million in "alternative fuel mixture" credits for the 4th Quarter of 2009, and yet lost $101 million during the quarter. For the full year, IP secured $2.06 billion from the government for mixing a bit of diesel fuel into its black liquor, a pulp byproduct, and using the mixture to power its pulp mills. Without the credits, it would have had a net loss of $1.4 billion last year. At least 19 other publicly traded pulp and paper companies also took advantage of the black liquor tax credits in 2009. Public companies qualified for approximately $2.8 billion during the first half of 2009. Most have not reported fourth quarter numbers yet, but they are on pace to receive more than $6 billion for 2009. With about one-fourth of the country's kraft capacity owned by privately held companies, the total black-liquor credit tab for 2009 is likely to surpass $8 billion. Having nearly three times more kraft-pulp capacity than any other company in the U.S., IP was the biggest beneficiary of the tax loophole. It averaged an estimated $187 in black-liquor credits per ton of kraft-pulp capacity.
This credit is refundable, which means if a company is profitable, the credit reduces its tax bill. If a company isn't profitable, it receives a check from the U.S. Treasury equal to the credit. Because IP was losing money throughout 2009, the Treasury has been sending the company checks. However, IP has continued to pay dividends and repaid $1.3 billion in debt in the third quarter. A Bank of America Merrill Lynch analysts' report reported that these Treasury payments accounted for more than 60% of the company's earnings before deducting taxes, interest payments and amortization expenses.
Another firm that has benefited from the credit, Packaging Corporation of America, said it would use its tax credit receipts to finance much of the $295 million in new equipment that would make its mills substantially more energy efficient.
On May 11, 2009, Glatfelter, a global manufacturer of specialty papers and engineered products, was notified by the IRS that its application to be registered as an alternative fuel mixer was approved. Since the company began mixing and burning eligible alternative fuels, Glatfelter has earned $107.8 million of alternative fuel mixture credits.
The “son of black liquor,” officially known as Cellulosic Biofuel Producer Credits, could generate the next wave of billions in tax credits for U.S. kraft pulp mills before it expires at the end of 2012. The program, part of the 2008 farm bill, was designed to benefit companies that use expensive, cutting-edge technologies to distill ethanol from plant materials instead of corn. Despite Congress' intent, the IRS released a memorandum ruling that black liquor qualifies for cellulosic biofuel producer credits because the fuel is produced and used in the U.S. and is derived from lignocellulosic or hemicellulosic matter that is available on a renewable or recurring basis. However, it lacks an essential ruling from the U.S. Environmental Protection Agency (EPA), under clean air and transportation biofuel considerations, that would define black liquor as a biofuel. The EPA is not expected to rule in favor of black liquor by classifying it as a biofuel. The $1.01 per gallon credit is a non-refundable tax credit, restricting its value to companies with a tax liability.
But this topic may be dead before the EPA’s ruling is issued, as some legislators target restricting the eligibility of black liquor for cellulosic biofuel credits as a potential source of funding for healthcare reform. This measure, which could save the federal government $24 billion in biofuel tax credits over 10 years, was attached to healthcare reform legislation as a manager’s amendment. The Affordable Health Care for America Act (HR 3962) was introduced on October 29, 2009. On November 7, 2009 the House of Representatives passed it by a vote of 220-215. The Senate passed its version of healthcare legislation, by a vote of 60 to 39, on December 24, 2009. As the Senate healthcare legislation had a somewhat smaller price tag than the House version, Senate Democrats did not need to include the son of black liquor tax credit to fund their proposal. Instead, they hoped to include the $24 billion in tax credit savings on the recently passed jobs bill. However, the majority leader, Harry Reid of Nevada, scaled back the jobs bill, and the son of black liquor provision was not included. The proposed jobs bill passed the Senate on February 24, 2010. Senate Democrats have said they plan to press ahead with other excluded components of the jobs plan later this year, which means the black liquor provision could be used as a cost saving measure down the line.
On Feb. 7, 2010, President Obama invited Republicans to a bipartisan healthcare summit. Since no consensus was met during the summit, the two bills may go to reconciliation before Congress makes its final decision on whether the son of black liquor tax credit restriction will make it into the final healthcare legislation proposed to the President.
The legislation restricting black liquor from being considered as part of the cellulosic biofuel producer credit will likely pass through Congress in some form regardless of status of The Affordable Health Care for America Act. In addition, it is likely the EPA will restrict black liquor from being classified as a biofuel. Thus, the cellulosic biofuel producer credit is not likely to be the next loophole for the paper industry. The $1.01 son of black liquor tax credit would have been twice as advantageous to the industry in comparison to the $.50 per gallon original black liquor tax credit.
According to the Association of Independent Corrugated Converters (AICC), the expiration of the black liquor tax credit and the lack of a legitimate increase in market demand are the primary reasons for the announced increases in containerboard prices for January 2010. The AICC has reached this conclusion simply by reading reports by the industry’s analysts whose commentaries focused mainly on the expiration of the black liquor tax credits instead of industry fundamentals.
With the original black liquor tax credit ended and unlikely to be extended, and the son of black liquor tax credit in stalemate, the paper industry is expected to change dramatically. Industry experts report a growing fear that some paper mills will simply shut down their machines for a month or longer until demand returns to a point in which it makes sense financially to run them again.
Analysts say the key way for paper manufacturers to address their problems is to take some of the current supply out of the market. These analysts argue that reducing supply is the only way for paper mills to attempt price increases. They continue to observe that paper is no longer the fairly predictable, demand-driven market it once was. The loss of the tax credits may result in machine shutdowns and a lot of supply being taken out of the marketplace, which could lead to more price increases in 2010. While operating rates have been in the 70% to 75% range for coated-paper machines, they need to be at 92% in order for mills to remain stable. The feeling in the marketplace is that the demand taken out of this market in the last year may never fully return.
With the U.S. dollar relatively weak, there hasn't been a lot of international paper coming into the marketplace. European paper isn't much of a factor because it is too expensive for paper makers there to produce and ship to the U.S. while making a reasonable profit. It's a different equation, though, for Chinese paper makers, who have much lower expenses. Sheet-fed paper from China is making inroads into the U.S. marketplace, but paper for magazines and catalogs hasn't made as much of a dent in the market. It's not easy to bring paper all the way from China and make money, but it is believed that it will get there eventually.
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