Progress' tax credits scrutinized

IRS auditors are examining one of the energy company's synthetic fuel plants.

Progress Energy Inc. said Tuesday that Internal Revenue Service auditors have raised questions about one of the company's coal-based synthetic fuel plants, potentially putting at risk hundreds of millions of dollars worth of annual tax credits.

Although the IRS audit is focused only on Progress' synfuel plant in Colona, Ky., any remedial action taken by the agency would likely affect the Raleigh, N.C., utility's four other synfuel facilities as well because all of them use the same manufacturing process that's under scrutiny, according to Progress spokesman Keith Poston.

At worst, the IRS could revoke Progress' ability to apply for synfuel tax credits and could demand retroactive payment for past credits, Poston said, adding: "We haven't found any evidence or any place where they've actually retroactively reversed these things. . . . We really don't envision that happening."

In a research note, McDonald Investments analyst Paul Ridzon said he agreed that a retroactive rescinding of the tax credit appeared "very unlikely," adding, however, that "a partial disallowance does not seem out of the realm of possibility."

The stakes are potentially enormous for Progress, the parent of Progress Energy Florida Inc. of St. Petersburg. Progress is one of the largest recipients of tax credits for coal-based synfuel, having reaped $950-million in credits from 1998 through the end of March. Like most companies that receive the credits, Progress produces synfuel at a loss. After factoring out those losses, the company's 2002 synfuel tax credits of $291-million resulted in a direct, after-tax benefit of $156-million to Progress' earnings. That accounted for 30 percent of the company's $528.4-million in 2002 net income.

TECO Energy Inc. of Tampa also operates synthetic fuel facilities and received about $80-million in credits in 2001. Information for 2002 wasn't immediately available.

The federal government began offering a tax credit to synthetic fuel makers during the Carter administration to help reduce U.S. dependence on foreign energy sources. But the credit has become controversial in recent years as some companies, including Progress, found a way of treating coal that brought about the "substantial chemical change" required to qualify for the credit. Critics say the process doesn't significantly benefit the country's energy needs.

As part of the Progress audit, IRS investigators "have raised questions regarding the chemical change associated with coal-based synthetic fuel manufactured at its Colona facility and the testing process by which the chemical change is verified," Progress said in a statement Tuesday.

Poston said he couldn't provide more specific information about the IRS's concerns. IRS spokesman Tim Arms said it is the agency's policy not to comment on tax audits.

Ralph Barbaro, a principal for Energy Ventures Analysis Inc. in Arlington, Va., said the risk of losing the credits is a major concern for Progress and other companies.

"These are major sources of income for these companies and if they were to lose them it'd be a significant hit on their bottom line," Barbaro said.

The audit comes as U.S. production of coal-based synfuel balloons ahead of the tax credit's scheduled expiration in 2007. Mark Morey, a coal industry consultant for Platts Research & Consulting/RDI in Washington, said in excess of 50-million tons were produced in 2002, more than double that produced the year before and up sharply from an estimated 4-million tons in 1999.

Progress' stock fell $2.42, or 5 percent, to close Tuesday at $43.75 on more than five times average trading volume.