Monday, November 16, 2009

Black Liquor Bonanza: Earnings Exceeding Projections of Experts and Congress

Never underestimate the power of American ingenuity when it comes to taking maximum advantage of tax breaks. And never underestimate the ability of Congress to mess up a calculation involving money.

Pulp and paper companies' 3rd Quarter earnings statements suggest that the industry is earning more black-liquor credits than analysts thought possible and far more than Congress projected.

Publicly traded companies racked up more than $1.8 billion in the controversial credits for the pulp byproduct from the U.S. government, according to an exclusive Dead Tree Edition analysis of Securities and Exchange Commission reports. Most of the companies would have been unprofitable without the credits, and some were unprofitable even with them.
Through the end of September, the public companies had earned more than $4.7 billion for mixing diesel fuel with the pulp-mill byproduct and then burning the mixture to power their mills. (See the accompanying article, Black Liquor Scorecard: $4.7 Billion Through September, for a listing by company.)

With more than one-fourth of the country’s kraft-pulp capacity in the hands of private companies, the numbers indicate that the industry earned well over $2 billion in credits during the quarter and about $6 billion during the first nine months of the year. At this rate, by the time the program expires at the end of this year, the U.S. pulp and paper industry will blow past the $8 billion that analysts had said would be the maximum it could earn from controversial program.

ERA Equity Research Associates, which earlier this year projected the program would yield $6.6 billion, recently estimated it would $8.5 billion. The earlier estimate assumed an 85% operating rate, but U.S. mills have been running full steam for months because of rising prices and the generous subsidy. Some companies’ numbers suggest their mills are squeezing more than the usual amount of black liquor from the wood they process into pulp.

Congressional Goof
Congress still seems to be using a $5 billion estimate for the program, an error that could affect healthcare legislation it is considering. The faulty estimate is based on a September report from its Joint Committee on Taxation (JCT) stating:

"For the first six months of 2009, and just for liquid fuel derived from biomass, more than $2.5 billion in cash payments has been claimed. The bulk of that $2.5 billion is attributable to paper manufacturers using “black liquor” and a small quantity of diesel fuel in their boilers (a stationary fuel use). Because the paper
manufacturers have no excise tax liability, they receive the full amount of the claim as a cash payment from the Treasury."

That statement was the basis of tax expert Martin A. Sullivan's projection that the so-called Son of Black Liquor credits could be worth $25 billion to U.S. pulp mills. If six months of the black-liquor loophole was worth $2.5 billion, then the full year should be worth $5 billion. And because the new cellulosic biofuel producer program will be twice as generous and last three times longer, simple math put the potential payments at $30 billion. Sullivan estimated that only $25 billion would be paid out for black liquor because the program will require the credits to be used to offset income taxes.

The healthcare-reform legislation passed by the House earlier this month arrives at the same number. By proposing to close the Son of Black Liquor loophole, the House figured it was "finding" another $25 billion to help pay for new healthcare programs.

But based on the Third Quarter financials, publicly traded companies alone could create enough black liquor for $44 billion in Son of Black Liquor credits. Adding privately held companies would push the number close to $60 billion -- or about $50 billion if we accept Sullivan's reasonable assumption that a small portion of the claims would not be paid out.

Using the JCT estimate to project the size of the black liquor or Son of Black Liquor credits failed for two reasons:
  1. Many companies were late to the black liquor party. Few were mixing diesel into their black liquor at the beginning of the year, and some didn't start until March.
  2. Because of uncertainty about whether the credits are taxable income, some companies are not claiming the credits as they are earned but rather are waiting to include them with their 2009 income tax returns. Buckeye Technologies's Third Quarter financial report explains why: "We have treated the credits received in cash as taxable income and the income tax credits as non-taxable income."
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