Talk About Unintended Consequences

MONTREAL _ Canadian forestry giants Domtar (TSX:UFS) and AbitibiBowater (TSX:ABH) are seeking millions of dollars in U.S. tax credits by transforming an alternative fuel called black liquor derived from pulpmaking into much needed cash.

Tax credits for technological innovation, eh? A good thing, eh? Except that isn't what's happening here. The forestry companies are moving to take advantage of a loop-hole in an alternative fuels tax credit from the 2005 U.S. highway bill.

You see, one by-product of the wood pulping process is this stuff called "black liquor":

Here's how it works. Wood chips are cooked in a chemical solution to separate the cellulose fibers, which are used to make paper, from the other organic material in wood. The remaining liquid, a sludge containing lignin (the structural glue that binds plant cells together), is called black liquor. Because it's so rich in carbon, black liquor is a good fuel; the kraft process uses the black liquor to produce the heat and energy necessary to transform pulp into paper. It's a neat, efficient process that's cost-effective without any government subsidy.

In other words, the paper industry produces much of the fuel it uses to make its products in the very process of making those products. It is, in that limited sense, a green industry. But the 2005 tax bill

...included a fifty-cent-a-gallon credit for the use of fuel mixtures that combined "alternative fuel" with a "taxable fuel" such as diesel or gasoline.

So clever heads within the paper industry figured: why not mix "black liquor" (an alternative fuel) with diesal (a "taxable fuel") and claim some of those government millions, even though the end result is to increase CO2 emissions (from burning the added diesel).

Domtar, though a Canadian company, is retrofitting its U.S. plants to get a piece of the action. But what about Canadian companies that only have plants in Canada? Suddenly, they are put at a competitive disadvantage, making the same pulp with higher production costs. So what do they do? Lobby for a similar tax credit on this side of the border. Pulp industry reps have already met with Stockwell Day over the issue.

(On the slightly more sane side, there is also an effort being made to convince the Obama administration that this was not what the original credit was intended for, and to have the wording changed to stop the fuel mixing practice.)