The Wages of Synfuels

Some sharp operators have a new profit angle -- tax credits for "synthetic fuels."

Visit any of the 55 plants that manufacture coal-based synthetic fuels and you might think that somebody has finally gotten serious about reducing U.S. dependence on imported oil. Well, think again. While all of the plants turn out products that pass as "synfuels" -- coal that supposedly has been processed to burn more cleanly or efficiently -- the facilities are really designed to manufacture something far more valuable to their owners: tax credits worth as much as $1 billion a year.

The synfuel plants exist only to exploit Section 29 of the Internal Revenue Code, which Congress wrote during the energy crisis of the late 1970s. The idea was to stimulate private investment in the development of new energy sources; but the coal industry was largely left out of the game until 1996, when the irs ruled that Section 29 tax credits could be divvied up and distributed to investors or even sold off. This allowed companies without large tax liabilities to "profit" from the credits (buyers reportedly have included IBM and Microsoft). Almost instantly came a rush to get synfuel plants up and running by the IRS's deadline of June 30, 1998.

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Little wonder, for it's a sweet deal indeed. The tax credits are typically worth more (about $26 a ton) than the so-called synfuels on which they are based (about $22 a ton). Many of the plants simply blend coal dust or crushed coal with binders and additives, and then bake the mixture into pellets or briquettes for sale to utilities. Others do even less, merely spraying ordinary coal with low-cost chemicals. That is to satisfy the requirement under Section 29 that a synfuel "must differ significantly in chemical composition from the substance used to produce it."

The most aggressive player in the Section 29 game is Electric Fuels Corp. of St. Petersburg, Florida, a subsidiary of Progress Energy Corp., one of the nation's 10 largest power companies. Its "proprietary" manufacturing process, which it has refused to divulge, apparently involves taking otherwise marketable coal and spraying it with a gummy pine-tar emulsion -- what Mike Hughes, a company spokesman, calls the "chemical change agent." Electric Fuels expects its synfuel plants -- four of which it acquired from a company whose chairman was banned for life from the U.S. futures markets for defrauding investors in a commodity pool -- to generate up to $390 million in tax credits this year.

Governor Paul Patton of Kentucky, a state whose conventional coal operators have seen prices depressed by taxpayer-subsidized synfuel, brands it all an "outrage" and a "scam." Bill Diefenderfer, who was chief of staff to the Senate Finance Committee when Congress overhauled the nation's tax code in 1986, says that it's a "scheme we would have stopped in a heartbeat."

Last year, under prodding from a handful of coal-state congressmen, the irs agreed to review the Section 29 tax-credit program, and in May it issued new rules designed to put an end to various abuses and excesses. As it stands, though, the tax credits are currently scheduled to keep flowing until December 31, 2007, when the Section 29 program is set to expire.

But owners of synfuel plants think that's too soon. Lawmakers sympathetic to the industry recently introduced the Energy Security for American Consumers Act, which would keep the gravy train moving through the end of 2010. The legislation is backed by members of a newly formed outfit called the Coalition for Energy Independence, which, as you may already have guessed, is financed in toto by Progress Energy and other big synfuel operators.

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