RPT-Black Liquor: The paper industry's new best friend

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* Paper makers get tax credits due to a loophole

* Credits to expire at year end

* May not be renewed in current form

By Hezron Selvi

NEW YORK, April 24 (Reuters) - Paper manufacturers looking for a break from the global recession finally have one -- a tax break.

A loophole in a federal law, intended to encourage the use of biofuels along with fossil fuels, has helped the industry fill its coffers with large tax rebates.

Under the law, companies that blend biofuels with fossil fuels and reduce their dependence on fossil fuels are eligible for what could be hundreds of millions of dollars in tax credits.

Paper manufacturers generally burn a biofuel called "black liquor" to power mills. Black Liquor is a by-product obtained while processing wood to get pulp for making paper.

The paper manufacturers have recently been adding small quantities of diesel to the black liquor, qualifying for the tax credits.

The credit is worth more than $3 billion a year to the industry, according to an analysis by Congress' Joint Committee on Taxation, and could serve as a lifeline as the industry fights to survive the recession.

Global demand for paper and packaging products has collapsed and led to the closure of many paper mills, as the recession sapped demand from many industries the paper and packaging makers serve.

The tax credits are a bright spot in an otherwise difficult year.

But the credits may be soon be taken away because of heavy opposition from some U.S. politicians.

"The application of the alternative fuel credit to the paper industry is controversial as the industry for decades has produced and burned black liquor for energy," analyst Joshua Zaret of Longbow Research wrote in a research note.

Senate Finance Committee Chairman Max Baucus, a strong opponent to the industry receiving these credits, said in a statement recently: "We are working to undo that unintended consequence. Unless we plug this loophole, the Federal Government is liable for billions in credits for black liquor in 2009 alone, even though the credit was never intended for this fuel."

But the paper industry is not without political supporters.

Republican Senator Olympia Snowe of the paper-rich state of Maine said lawmakers should let the industry be, calling it a "critical lifeline to thousands of paper mills across the country in these troubled economic times."

Deutsche Bank's Wilde said the most likely scenario is that the tax credits will remain through 2009, but will not be renewed beyond the year-end.

But he noted the threat of near-term legislative action to eliminate the black liquor excise credit looks like a modest negative for equity holders.

In recent weeks, the shares of paper and forest products makers have rallied on news about the credit.

The S&P 1500 Paper & Forest Products Industry index .15GSPAFP is up 95 percent since Verso Paper Corp (VRS.N) said in early March it received an incentive payment of about $30 million for operations at its Androscoggin mill in Jay, Maine.

In a regulatory filing with the Securities & Exchange Commission, Verso also expects to receive about $30 million for operations at its mill in Quinnesec, Michigan.

International Paper Co (IP.N), the largest U.S. paper and packaging maker, said on March 24 it received its first check from the IRS for $71.6 million for the fuel mixture produced and used at 15 of its mills between Nov. 14 and Dec. 14, 2008.

The company said it will continue to submit refund claims. The stock is up 17 percent since the announcement.

"In the case of International Paper, we estimated that the 2009 excise tax credit could amount to $1.27 billion," Deutsche Bank analyst Mark Wilde wrote in a research report.

Temple-Inland Inc (TIN.N), another packaging and building products maker, said it was also approved as an alternative fuel mixer, which qualifies it to claim the 50-cent-per-gallon tax credit for using biomass-generated fuel.

The company expects to use 550 million to 650 million gallons of alternative fuel annually.

Longbow's Zaret estimates the credit, which will expire at the end of this year, will be worth about $225 million to Temple-Inland.

"While the tax credits are a godsend for these companies, the flip side is that the companies may end up operating the mills for the tax credits rather than the fundamental end product itself," Zaret added. (Additional reporting by Kim Dixon in Washington; Editing by Patrick Fitzgibbons and Andre Grenon)