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Utilities may lose big tax credit

More expensive oil could reduce or eliminate the credit for producing coal-based synthetic fuel.

By LOUIS HAU
Published April 19, 2005

Rising oil prices could mean a lot more for Progress Energy Inc. and TECO Energy Inc. than just a higher fuel bill.

It could also lead to the complete or partial loss of a controversial but lucrative federal tax credit the companies collect for their production of coal-based synthetic fuel. And that could translate into a significant hit for both companies.

"Given the current volatile oil pricing dynamic, use of (synfuel) tax credits as part of an overall financial strategy for the 2005 to 2007 period has an increased element of risk," Standard & Poors Ratings Services said in a report last week.

The tax credit was offered during the Carter administration to encourage the development of alternative fuel sources. But it has subsequently been claimed by companies such as Progress and TECO, which take ordinary coal and spray it with a chemical agent.

Because the credit was originally aimed at making newly developed alternative fuel sources more price-competitive with fossil fuels, there is a clause in the tax code that cancels out the credit when crude-oil prices reach a certain price.

If the average annual price for crude oil, as measured by a U.S. Department of Energy index, falls short of the low end of the range, the tax credit is unaffected. If the price exceeds the high end of the range, the credit will be eliminated for that year. A price that is within the range would result in a partial loss of the credit.

TECO estimates that the 2005 price range will be about $52 to $65 per barrel as measured by the Energy Department index, which is typically about $3 per barrel less than the commonly referenced oil futures prices quoted on the New York Merchantile Exchange. Nymex oil futures prices hover around $50 a barrel, but had been north of $55 this month.

TECO estimates that synfuel-derived income will account for about 30 percent of its earnings per share this year. Progress expects synfuel to account for up to about 20 percent of its 2005 earnings per share, excluding one-time items.

Progress is contending with stiff challenges in its synfuel operations. The Internal Revenue Service is considering whether to require the company to pay back hundreds of millions of dollars in tax credits IRS auditors said it wasn't qualified to take at four of its synfuel plants.

In its 2004 annual report, TECO said it has hedged its risk by entering into derivative transactions that remove about 35 percent of its exposure to the credit.

"It is a concern," TECO spokeswoman Laura Plumb said Monday, adding, "Obviously, no one can accurately project oil prices."

Progress, the Raleigh, N.C., parent of Progress Energy Florida of St. Petersburg, has not hedged its synfuel exposure, but believes oil prices aren't likely to remain high enough to cancel out the tax credit this year, spokesman Garrick Francis said.

"We've been following it closely," he said. "At this point, (losing the credit) doesn't seem like a strong possibility. As prices fluctuate, we'll continue to watch it."

Paul Patterson, an energy analyst for Glenrock Associates in New York, warned his clients last month about the potential effect rising oil prices could have on synfuel makers.

It is too early in the year to determine whether oil prices will affect the 2005 synfuel tax credit, he said Monday. But he added, "It could get quite substantial if it were to happen."

[Last modified April 19, 2005, 01:19:14]