Pulp and paper companies in peril: tax credits in trouble, woodchip costs rising

New federal subsidies for alternative fuel producers could raise pulp costs next year for International Paper Co and other paper companies, after they were the unintended recipients this year of a windfall of fuel tax credits.

The suppliers of wood chips and timber waste will be eligible for up to $45 in government subsidies on every ton of material they sell to biomass power generators beginning next year. The payment would represent about a 56% increase over the current $80-per-ton rate for wood chips in the U.S., giving saw mills and timber land managers an incentive to sell more of their output to power companies at lower prices.

To offset the government subsidy, however, paper manufacturers may be forced to pay higher prices for the wood chips and timber they use in their pulp plants.

“There’s a potential for increased demand [for wood chips] from power generators for fuel,” said Daniel Rohr, an analyst for Morningstar Inc. “It could raise the price for International Paper’s fiber supply.”

International Paper executives are waiting for additional regulations for the new Biomass Crop Assistance Program to determine its impact on the paper industry.

“We’re looking for a level playing field,” said Tim Nicholls, chief financial officer for International Paper, during an interview with Dow Jones Newswires. ” You shouldn’t have to pick winners and losers.”

International Paper is interested in whether its own use of biofuel derived from pulp residue and biomass material, such as tree bark, is eligible for the new subsidies.

International Paper and other paper companies scored billions of dollars in federal excise tax credits this year by classifying their paper mill waste material as an alternative biofuel. The process of turning wood fiber into pulp yields a residue known as black liquor. For decades, paper companies have burned black liquor in power plants that supply electricity for their paper mills.

But by adding a small amount of diesel to black liquor, paper companies found they could claim a 50-cent per gallon excise tax credit intended to support the fledgling companies that produce biofuel fuel as their primary business activity.

So far this year, International Paper has received $1.15 billion in cash credits from the Internal Revenue Service.

“We’ve used a lot of that to pay down debt,” Nicholls said.

The fuel excise tax credits are expected to cost the federal government several billion dollars by the end of the year. Industry observers say the credits effectively bailed out several paper companies in dire financial condition from dismal end-market demand for paper this year.

“The number of bankruptcies would have been substantially higher without this program,” Rohr said.

But the paper industry’s co-opting of the fuel tax credits enraged many members of Congress, leaving them determined to wall off the industry from any future aid for alternative fuels. On Tuesday, a House amendment was introduced to block paper companies from receiving a new $1.01-per-gallon tax credit for cellulosic ethanol.

The paper industry is conceding that it has almost no chance of stopping the 50-cent excise tax credit from expiring at the end of the year.

“They don’t want any more money, but they want to make sure they’re not in competition [for wood chips] with some biomass fuel burners,” said Steven Chercover, an analyst for D.A. Davidson & Co.

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