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Black Liquor Tax Credits

November 03, 2009
Author: Suz-Anne Kinney
One of the biggest controversies of the year has been the black liquor tax credit. This tax provision—a $0.50 per gallon tax credit—began as part of the 2005 highway bill; later it was expanded by the 2007 energy bill. Originally intended to reduce the amount of fossil fuels being used, the bill provided the tax credit to any company mixing alternative fuels with traditional fossil fuels. Pulp and paper companies, which were already burning black liquor to create energy, began mixing their black liquor with a small amount of traditional fossil fuel in order to qualify for the tax credits.

The addition of fossil fuels is not the only change that pulp and paper companies have made because of the tax credit. Many assumed these companies would begin pumping out huge volumes of inventory in order to maximize the size of their tax credits. Inventories have been mostly lower in 2009, however, and prices for paper either remained stable or increased. If these companies had increased production in the middle of a global recession, prices would have decreased.

Instead of increasing production, however, these companies shifted production to virgin fiber mills and away from recycled fiber mills. The lignon in virgin fiber produces black liquor, and recycled material contains no lignon. Because paper companies shifted as much production as possible to virgin fiber mills, demand for pulpwood has actually increased. And prices have held their own, even in the midst of the economic downturn.

What will happen when the current black liquor tax credit expires at the end of 2009? If the tax credit goes away, paper companies will revert to their normal balance between virgin and recycled materials. This will lead to decreased demand for pulpwood and a softening in pulpwood prices.

A couple of things to keep an eye on as the transition occurs:

  • First, we’ve heard rumors that an extension to the tax credit is still a possibility. (We think this is a long shot).
  • The 2008 Farm Bill includes a $1.01 per gallon tax credit for biofuels from cellulose. The IRS reportedly released a legal memorandum that indicates black liquor will be eligible for the credit. If this is true, the tax credit would go into effect 1/1/2010 and last through 2012. We would expect to see even more paper production shift to virgin fiber mills if this happens. (When this story hit the internet, stock prices for pulp and paper companies improved. A day or two later, after analysts had a chance to investigate, stock prices lost the gains. We have been unable to find a copy of the IRS memo that first broached this possibility in order to form an opinion of our own, but we’ll continue to explore the issue and keep you posted.)
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