About a mile off the twisting, two-lane road to the south of Central City, Pa., set back in the woods along a private road, past the truck scales and the raw-coal stockpile, invisible from the highway, is the Shade Creek processing plant of PBS Coals Inc. There freshly mined coal is washed, the sulfur, rock, ash and other impurities removed and the cleaned coal carried by an overhead conveyor belt across the dusty road. It goes into a building on the other side that is operated by a second company, Central City Synfuels. Another belt comes out of that building--off limits to the public--carrying what looks a lot like the same coal back across the road and dumps it on a stockpile. Then it's loaded into railcars and shipped to electric utilities.
Except it isn't coal any longer.
Forget that it looks like coal. And will burn like coal. It's now called "synthetic fuel." As such, the coal-like product, along with roughly 50 million tons of similar stuff from more than 50 similar plants in Pennsylvania, West Virginia, Alabama and other states, is worth more than $ 1 billion a year in federal income-tax credits, a corporate giveaway protected by a bipartisan group of supporters in Congress. Those who have profited from the system range from fast-buck artists to giant corporations. They include one of the nation's largest hotel operators, a commodities trader barred from the industry for fraudulent practices, a chain of electronics stores, an electric utility that unplugged the lights during the great blackout of 2003, technology firms run by friends of influential lawmakers, limited partnerships of wealthy investors and scores of individuals and businesses preferring to keep their identities secret.
To qualify for the tax credits, the makers of this so-called synfuel don't have to prove that they are making a better kind of coal, one that burns more efficiently or offers any other benefit. By IRS ruling, they need only modify the chemical composition of coal. As a result, dozens of plants have sprung up across America to carry out a process that in many cases is so slight that critics call it spray and pray, a reference to their hopes that no one will peek too closely. "You can't believe what goes on," a government official long involved with the coal industry told TIME, blaming Congress for its role in perpetuating the handout. "The people who spend the tax money don't have a clue." The IRS launched an investigation last June into the "scientific validity of the test procedures" used to measure compliance with the minimal standards, but the synfuels credit has enough support in Congress that members have tried (and failed so far) to block the IRS probe.
Why America is stuck with this wasteful program is worth holding up to the light because it demonstrates the failures of U.S. energy policy at a time when prices are rising again and America's dependence on foreign oil is once more creating economic pain. As TIME reported in July, Congress's failure to adopt a serious energy strategy over the past three decades is taking its toll on consumers in bloated prices for petroleum products and natural gas, looming shortages of certain fuels, lost jobs, rolling brownouts and little hope for any relief, given that lawmakers are fixated on passing out subsidies, like the synfuel credit, that will do little or nothing to ease U.S. dependence on foreign oil.
Two weeks ago, crude-oil prices jumped when OPEC moved to keep supplies tight by reducing its output quotas 3.5%, cutting off nearly 1 million bbl. a day from the global market. American consumers are even more vulnerable to energy shocks than they were two decades ago, in part because the U.S. government's policy during that time has failed to produce alternative energy sources. Whipsawed by lobbyists and special interests, taxpayer-supported programs have succeeded mainly in making a few people rich and protecting ineffectual schemes. To be sure, not all energy programs have been a bust. For example, tax credits that gave homeowners an incentive to install storm windows and insulate their homes got results. But the synfuel tax credit is a dead end. It doesn't increase U.S. energy production. It's just a windfall for those who have found a way to exploit it. A TIME investigation into the congressionally authorized, billion-dollar scheme shows how it works:
More than two decades ago, in the wake of the energy crises of the 1970s, Congress enacted a tax break to spur the creation of a broad-based synthetic-fuels industry to ease U.S. dependence on foreign oil. The idea was to turn plentiful coal into synthetic natural gas to heat homes and run factories or into synthetic crude oil that could be refined into gasoline and other petroleum products. The law was supposed to encourage new technology and the building of giant plants each costing upwards of $ 1 billion to turn coal into liquids or gas. For a variety of reasons, including falling oil prices and changing administrations, Washington lost interest, and the industry never materialized as it was envisioned. The original goal wasn't folly, as demonstrated across the border in Canada, where the government and industry persevered with synfuel development and built a thriving business that today sells millions of barrels of synthetic crude oil to the U.S. annually (see following story). Meanwhile, the U.S. synfuels tax credit stayed on the books, dormant until the 1990s, when those who comb the Internal Revenue Code for opportunities came up with a new kind of synfuel plant, one that would cost a few million dollars and be portable.
What happens inside them? To alter coal's chemistry so it qualifies as a synthetic fuel even though it looks and burns like regular coal, some plants merely spray newly mined coal with diesel fuel, pine-tar resin, limestone, acid or other substances. Others mix coal waste with chemicals, coat it with latex and blend it with untreated coal to form briquettes. And plant operators in some extreme cases do nothing at all. Whatever the process, it's still coal.
This may explain why synfuel owners, in addition to being reluctant to talk about their processes, are not eager to let anyone actually see one of these so-called plants. Half a dozen electric utilities contacted, from DTE in Detroit to Progress Energy in Raleigh, N.C., declined to give TIME a tour. As did plant operators.
Actually, plant is a grandiose term for such operations. The facilities consist of little more than a collection of conveyor belts, nozzles, mixing vats, a few small buildings and sometimes equipment to convert the coal into pellets or briquettes. The spraying equipment is fairly simple. According to an industry consultant who asked not to be identified, it resembles "what you go through in a car wash, like the sprayers that wash your car." The plants can be easily taken apart and trucked hundreds of miles and then reassembled. "It's not that complicated to take one of these apart, load it on trucks and take it someplace else and put it back together," says an industry official. If the process seems flimsy, keep in mind that the real product is not synfuel but tax credits. And lots of people are cashing in.
Who benefits? A carnival of characters. But the most stunning numbers have been posted by big companies that wanted to boost their bottom line. The hotel chain Marriott International Inc., which has 2,500 lodging properties worldwide, bought four synfuel plants in October 2001. The next year, the first full year of production, Marriott's new synthetic-fuel operations generated $ 159 million in tax credits. Marriott had paid $ 46 million in cash for the facilities, meaning the tax credits gave the company a return of 246% on its investment in just one year. It was a welcome boost for the company at a time when the average room revenue from Marriott's traditional lodging business fell 4.8%. Moreover, the company's effective income tax rate plunged to 6.8% in 2002 from 36.1% in 2001, "primarily due to the impact of our synthetic-fuel business," according to its annual report. Consequently, Marriott paid federal income taxes at a rate below that paid by individuals and families earning less than $ 20,000 a year.
Rex Stores Corp., with headquarters in Dayton, Ohio, is a chain of some 250 retail electronics and appliance stores in 37 states--and two synthetic-fuel facilities. While sales of the company's main products have declined, its synthetic-fuel sideline has thrived. Stuart Rose, Rex's CEO, told stock analysts in June that "it's an asset that's still returning unbelievable returns for our investment." Echoed Douglas Bruggeman, Rex's vice president for finance: "We feel real good about that whole part of our business right now."
Even when a company's operating income goes down, its profits can still go up if it has tax credits on tap. PPL Montana LLC, a subsidiary of PPL Corp., the holding company for such utilities as Pennsylvania Power & Light and Montana Power, reported that "although operating income from synfuel operations declined in 2002 compared to 2001, the synfuel projects contributed $ 7 million more to net income after recording tax credits."Electric utilities that have a stake in synthetic-fuel plants and burn their own product have achieved stunning financial results. Through 2002, Progress Energy Inc., a holding company for public utilities that generate electricity in North Carolina, South Carolina and Florida, raked in $ 897 million in tax credits from the program. SCANA Corp., the holding company for South Carolina Electric & Gas, reported that it received $ 58 million in tax credits from an investment of "approximately $ 2 million" in synthetic-fuel partnerships. That works out to a return of 2,800%. Think of the numbers this way: if you invested $ 4,000 on Jan. 1, you would collect $ 116,000 the next New Year's Day.DTE Energy, the diversified energy company based in Detroit that is the parent of Detroit Edison Co.--which provides electricity to 2.1 million customers in southeast Michigan who lost their power on Aug. 14--has profited richly, generating $ 425 million in credits in the past three years from nine synfuel plants in eight states. Yet the cash flow did not seem to help DTE prepare for crunch time in its main business. It lagged behind utilities in New York and Ohio and took three days to restore power to all its customers after the blackout. And it plans to charge consumers for the $ 30 million to $ 40 million that it lost during the shutdown.SEMPRA Energy, the holding company for San Diego Gas & Electric, chalked up a comparatively low tax rate of 17% in the first quarter of this year. After questioning by a UBS Warburg analyst, the company acknowledged that the reduced taxes were attributable to synthetic-fuel tax credits of $ 45 million to $ 50 million.
And then there are all the plants' part owners that share the tax credits. Such is the case with Pace Carbon Synfuels Investors, a Delaware limited partnership with a stake in four facilities. Among the investors who have taken advantage of the tax credits: the Federal National Mortgage Association (Fannie Mae), the publicly owned but government-sponsored corporation that bills itself as the nation's largest source of financing for home mortgages; Morgan Stanley, the global financial-services firm; and Norfolk Southern Corp., which owns two major railroads in the Northeast as well as half of Conrail.
Many individuals and businesses cashing in on the tax credits prefer to remain anonymous. Earlier this year, TECO Energy, the holding company for Florida's Tampa Electric, disclosed in a filing with the U.S. Securities and Exchange Commission that it had received "more than $ 50 million from the sale of half of TECO Coal's synthetic-fuel production facilities." The buyer was not named. A TECO official told TIME that "part of the agreement that we signed says that we are not allowed to reveal the name of the purchaser." WPS Resources, the parent company of Wisconsin Public Service, sold a portion of its operation to "a subsidiary of a public company" whose name was not disclosed. Massey Energy Company sold its interest in a synthetic-fuel plant to an "unidentified affiliate of a major financial institution."
The manager at Warrior Synfuel, near Tuscaloosa, Ala., declined to identify the "private parties," as he called them, that own the plant. He said he had conveyed TIME's request to speak with them: "I believe their choice was that they didn't feel that this was appropriate."
