[Corp. Watch] Big Paper getting millions to pollute more

[Corporation Watch]

Pulp Nonfiction

  A tax loophole could let the ten largest paper companies
  rake in a whopping $8 billion -- where's the outrage?

By Christopher Hayes

(The Nation, April 2) -- Two years in Washington have started to make  
me feel jaded. I've come to expect that even nobly conceived laws will  
be manipulated and distorted for private ends.

	But once in a while I hear a story that gives me the queasy feeling  
that I'm nowhere near cynical enough. Such is the case with the tale  
of the paper industry and the alternative-fuel tax credit.

	Thanks to an obscure tax provision, the U.S. government stands to pay  
out as much as $8 billion this year to the ten largest paper companies.

	And get this: Even though the money comes from a transportation bill  
whose manifest intent was to reduce dependence on fossil fuel, paper  
mills are adding diesel fuel to a process that requires none in order  
to qualify for the tax credit.

	In other words, we are paying the industry -- handsomely -- to use  
more fossil fuel.

	"Which is," as a Goldman Sachs report archly noted, the "opposite of  
what lawmakers likely had in mind when the tax credit was established."

	The massive tax subsidy has barely been reported in the press, but  
it's caused a stir in the paper industry, which is struggling to stay  
profitable in the teeth of the recession.

	"Everybody's talking about it," paper industry analyst Brian McClay  
told me. "In the U.S. and elsewhere in the world -- in Canada and  
Brazil and Chile and Europe."

	On March 24 International Paper (IP) announced it had received its  
first check from the IRS for a one-month period this past fall. The  
total? A whopping $71.6 million.

	"It's probably close to a billion a year of cash," McClay said. "If  
you look at the economics of this business, to make that kind of money  
today you'd have to be on another planet." IP's stock rose 12 per
cent on the news.

	The origins of the credit are innocent enough. In 2005 Congress  
passed the $244 billion transportation bill. It included a variety of  
tax credits for alternative fuels such as ethanol and biomass.

	But it also included a fifty-cent-a-gallon credit for the use of fuel  
mixtures that combined "alternative fuel" with a "taxable fuel" such  
as diesel or gasoline. [This was intended to decrease the use of  
fossil fuels by replacing a portion of the amount used with  
alternative fuels.]

	Enter the paper industry. Since the 1930s, the overwhelming majority  
of paper mills have cooked wood chips in a chemical solution to  
separate the cellulose fibers that are used to make paper from the  
other organic material in wood.

	The remaining liquid, a sludge containing lignin (the structural glue  
that binds plant cells together), is called "black liquor". Because  
it's so rich in carbon, black liquor is a good fuel.

	The mills use black liquor to produce the heat and other energy  
necessary to transform pulp into paper. It's a neat, efficient process  
that's cost-effective without any government subsidy.

	"Seventy-three percent of the energy we use in our mill system, we  
produce," says Ann Wrobleski, IP's vice president for global  
government relations. "We feel like we're the original green industry,  
if you will."

	Not quite. In developed nations, paper is the third-largest  
industrial greenhouse-gas emitter, behind the steel and chemical  
industries.

	By adding diesel fuel to the black liquor, paper companies produce a  
mixture that qualifies for the mixed-fuel tax credit -- allowing them  
to burn "black liquor into gold," as a JPMorgan report put it.

	It's unclear who first came up with the idea -- Wrobleski told me it  
was "outside consultants" -- but at some point last fall IP and Verso,  
another paper company that was formerly a part of IP began adding  
diesel to its black liquor and applied to the IRS for the credit.

	(Verso nabbed $29.7 million for its use of mixed fuel in the final  
quarter of 2008 at just one of its mills.)

	Despite the obvious contrivance of the procedure, Wrobleski is  
unapologetic: "The credit is supposed to encourage the use of green  
fuel." Sure, I said, but isn't it a bit weird you're now adding diesel  
fuel to the process in order to take advantage of it?

	"It is what it is," she said.

	Others are less charitable. "You use the toilet every day," said one  
hedgefund analyst who's been closely following the issue. "Imagine if  
you could start pouring a little gasoline into the bowl and get fifty  
cents a gallon every time you flushed."

	No one in Congress seems to have anticipated this creative maneuver.  
This past fall the Joint Committee on Taxation computed the cost of  
extending the tax credit for three months and projected it would cost  
a manageable $61 million.

	It now appears that the extension (which was passed as part of the  
TARP) could cost as much as $2 billion before the credits expire at  
the end of this calendar year.

	In fact, the money to be made from exploiting the tax credit so  
dwarfs the money from making paper -- IP lost $452 million in the  
fourth quarter of 2008 alone -- that it will likely push paper prices  
down, as mills churn at full capacity in order to get as much from the  
IRS as they can.

	If there's a cloud hanging over the elation in the industry, it's the  
sneaking suspicion that once Congress gets wind of this racket, it  
will shut it down. "The one comment I do get from people," says  
McClay, "is whether it's going to be rescinded or re-drawn before the  
end game."

	Investment analysts echo this concern. "We think there is some  
question as to whether this tax incentive survives to year-end," a  
Deutsche Bank analyst wrote recently.

	"Most industry leaders would like to keep a low profile on this  
issue," the analyst noted. "Unfortunately, we think it is a material  
enough issue that it will draw attention." So far, though, to the  
surprise of McClay and others, there's been not a peep from Capitol  
Hill.

	Allen Hershkowitz, a senior scientist at the Natural Resources  
Defense Council and director of its paper industry reform project,  
told me the industry wields significant clout in Washington, and has  
benefited from myriad federal subsidies throughout its history, but  
that "this is really a perverse exploitation at the expense of the  
environment."

	I called the Senate Finance Committee, and a staffer told me they  
were "aware of the issue, and are talking with the IRS about the  
technical details. The committee intended the credit to be primarily  
for transportation fuel and plans to closely review the situation."

	Whether or not Congress gets around to turning off the spigot, the  
episode is a useful reminder of the persistently ingenious ways the  
private sector can exploit even well-intentioned legislation.

	Considering that the success of the Treasury Department's recently  
announced plan to rescue the financial sector depends, in part, on the  
private sector not gaming the rules, the black liquor story seems  
particularly germane.