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Fortnightly Magazine - September 15 2000

SEEMINGLY OVERNIGHT, SYNTHETIC FUEL from coal, or "synfuel," has evolved from an industry novelty to a significant and growing force in U.S. fuel markets. (See "Benchmarks," , May 15, 2000.) RDI expects production from the 55 qualified synfuel plants to grow from just 3.9 million tons of output in 1999 to 43 million tons by 2003. This rapid expansion is a source of both elation and consternation to coal industry participants. For those that own synfuel facilities and sell synfuel to unrelated parties, Section 29 tax credits can significantly offset the company's regular tax liability. On the other hand, coal sellers without a synfuel position face further undercutting of weak coal prices and declining market share.

Though they have not quenched enthusiasm for synfuel, concerns that an explosion of tax credit claims will evoke more intense Internal Revenue Service scrutiny have nagged the industry. However, in recent months, discussion regarding the propriety of certain claims on Section 29 tax credits has become more heated.

The dialogue entered the public forum in late May, when Canadian coal producer Fording Coal Ltd. requested that Canada file a formal complaint with the World Trade Organization against the United States. Fording asked that the synfuel credit be eliminated on the basis that it provides "an unfair subsidy to [synfuel] producers."

In July, the debate returned to U.S. soil, as three U.S. congressmen from coal-producing states sent strongly worded letters to both the IRS commissioner and the acting assistant secretary of the Treasury. U.S. Reps. Rick Boucher (D-Va.), Barbara Cubin (R-Wyo.), and Scott McInnis (R-Colo.) alleged that some companies inappropriately are claiming Section 29 tax credits. They claim some synfuel companies receive credit "for a chemical change which in reality is not occurring or based upon a process that adds no value, does not enhance U.S. energy self-reliance and is not essential to the marketability of the coal."

The congressmen estimate that such "misuse" of the tax credit may cost the U.S. Treasury between $750 million and $1.3 billion annually. They have proposed a dual-pronged test to determine the eligibility of synfuel processes to receive the credit. According to proposed test elements, both of which must be satisfied in order for the synfuel to qualify for Section 29 tax credits, (1) the process must add "appreciable value" to the original feedstock material, and (2) the feedstock or synfuel must be unsaleable in absence of the tax credit.

This proposal is bound to generate even more heated discussion, as the recommended test is ambiguous and subject to multiple interpretations. As of mid-August, the IRS had not responded publicly to the representatives' request. However, it seems certain that the Section 29 tax credit will face additional debate-and possible alteration-before its scheduled expiration in December 2007.

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