August 08, 2004 | By Keith Martin in Washington, DC

SYNFUEL plant owners face another round of trouble with the Internal Revenue Service.

The agency is moving on audit to disallow tax credits claimed by two utilities on the output from several synfuel plants that each owns or owned on grounds that the plants were not placed in service in time.The 
plants had to be operating by June 1998 to qualify. The credits are currently $1.1036 an mmBtu on the synfuel produced. The credits were supposed to serve as an inducement to US companies to produce 
“synthetic fuel from coal.” The credits at issue in the two audits run into the hundreds of millions of dollars. The agency is expected to move to disallow credits on the same grounds in some other pending audits.
A number of audits closed last year and earlier this year without any adjustment in the credits. IRS field agents tried unsuccessfully in those audits to argue that the plants fail to produce “synthetic fuel”; the plants add chemicals in most cases to already usable coal.

Meanwhile, the tax credits are scheduled to run through 2007, but will phase out automatically if oil prices return to levels reached during the Arab oil embargo in the 1970’s. With oil prices escalating, questions are being asked whether there is danger that the credits will disappear.

A phaseout is not expected this year. The average wellhead price for domestic crude oil would have to surpass $50 a barrel. That is the average price for the entire calendar year. The average price through May was $32.65, according to US Department of Energy figures. 

A phaseout would have occurred in 2003 as oil prices moved across a range of $50.14 to $62.94 a barrel. Thus, if the average wellhead price in 2003 had reached $53.98, then credits would have been reduced by 30%. The range is adjusted each year for inflation. The 2004 price range will not be known until April next year. 

Oil futures contract prices on NYMEX may provide an early guide to whether a phaseout is a risk next year. “For 2005, we will need to see sustained prices in excess of $55 a barrel at NYMEX to cause a problem,” one hedge fund manager said.

A check of the average wellhead price for the last 14 years against NYMEX prices shows a fairly consistent pattern where the NYMEX price is $3 to $4 a barrel above the average wellhead price used by the IRS.