[BETA] Fortnightly

A tax credit for synthetic fuel wreaks havoc on coal markets.

The recent introduction of synthetic coal products has upset the fragile balance between supply and demand in the U.S. coal market. A recent study by Resource Data International (RDI) on synthetic coal finds that imbalance is being driven by the operation of more than 40 facilities that were rushed into commercial service to meet a July 1, 1998, deadline to qualify for a tax credit. Favorable treatment by the U.S. tax code will encourage synthetic coal producers to continue expanding production levels to as much as 30 million tons per year, significantly influencing utility steam coal markets for the foreseeable future.

The amount of the tax credit is based on the Btu content of the final product, less any Btus contained in the binding or agglomerating material. The tax credit amount also is based upon the cost of a barrel of oil and adjusted for inflation each year. The credit currently is worth approximately $25 a ton for synfuel with a heat content of 12,500 Btu per pound.

As development problems have been overcome and volumes increased, many synthetic coal plant developers are exiting the business by selling their ownership interests to entities with large tax liabilities that can use the tax credits. Among the buyers have been several electric utilities including Detroit Edison, Florida Progress, Pacificorp, SCANA, and TECO Energy. The plants have been purchased either by the utility directly or through nonregulated subsidiaries.

Beyond the developers of synthetic coal plants, another beneficiary of this tax credit are purchasers of traditional coal and purchasers of synthetic coal. Synthetic coal buyers have benefited from the lower prices that synthetic coal operators are passing along to the market to ensure sale of their material. Traditional coal buyers have benefited from the erosion in coal prices as synthetic coal is dumped into the market in varying degrees. By extension, coal from other source regions also is affected.

The results of increasing volumes of synthetic coal are just starting to be felt. Prices of Central Appalachian coal free-on-board barge on the Big Sandy River have fallen by 10 percent in the last 12 months, mostly due to the arrival of numerous synthetic coal plants in the area. The expected advance of low-sulfur Southern Powder River Basin coal into unscrubbed Eastern U.S. markets has slowed as well, which has contributed to depressed prices for that coal.

RDI estimates that synthetic coal production has the potential to exceed 30 million tons per year. With an average tax credit of $25 per ton, that could amount to tax credits totaling $750 million per year. This development will continue to distort regional coal markets for the next eight years, because the tax credit will not expire until Jan. 1, 2008.

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