Ethanol tax breaks a bonanza for some

By Sean Hao
Advertiser Staff Writer

The state has a sweet deal for the makers of sugar cane alcohol.

To help jump start an alternative fuel industry, Hawai'i lawmakers created incentives that could pay ethanol producers and their investors up to $2 in tax credits and rebates for every $1 spent to build an ethanol plant.

Ethanol, a grain-based fuel which can be made from sugar cane, will be added to most gasoline sold in Hawai'i by April 2006. Lawmakers are pushing the alternative fuel as a way to reduce the state's dependence on outside oil, give new life to the ailing sugar industry, create jobs and cut pollution.

The rules, signed by Gov. Linda Lingle in September, guarantee ethanol producers a market. But state lawmakers weren't sure that would be enough to draw business and took the additional step of passing five separate tax breaks that benefit ethanol producers, investors and users.

Four companies have announced plans to set up ethanol businesses here in part because of the generous tax breaks.

"Anytime you have an industry trying to get started, the more of these kinds of incentives you have the better," said George St. John, president of Worldwide Energy Group, which plans to build a $20 million ethanol plant on Kaua'i.

Worldwide received state permission to issue up to $50 million in special purpose revenue bonds. That allows the company to sell bonds which earn tax-free returns for investors.

Worldwide also plans to use the state's new ethanol facility tax credit, a 100 percent refundable credit, for plant construction costs. This allows Worldwide to write off all or most of its $20 million in construction costs against state taxes owed or to be reimbursed by the state if costs exceed what it owes in state taxes.

On top of that, Worldwide investors can claim the state's 100 percent tax credit for technology investments, some of which may be used for construction.

St. John said he sees nothing wrong with participating in multiple tax credits since the law allows it. Worldwide said that while some construction spending may result in a double tax benefit, most will be financed in other ways.

"We're certainly trying to conform to the intent and the language of the law," he said. "It's just not smart to play games and we certainly don't intend to."

Loophole eases risk

Worldwide is not the only ethanol company looking at putting together multiple tax credits. O'ahu-based Ethanol Research Hawaii also plans to claim technology tax credits to pay for research that would be licensed to planned ethanol producer Oahu Ethanol Corp. Oahu Ethanol Corp. plans to take the construction credit.

Dan KenKnight, an executive with both Ethanol Research and Oahu Ethanol, said the multiple tax breaks are needed to offset the risks of entering a new industry.

"Both (the technology and construction credits) are incentives to build an ethanol industry in Hawai'i, but in a different way," KenKnight said. The technology tax credits helps a business do the research, and the construction credits helps it commercialize the research.

Worldwide and Ethanol Research Hawaii said the state Department of Taxation authorized its use of technology tax credits.

State tax department spokeswoman Cathleen Tokishi said the department is re-examining that position in light of the possible double credit for the ethanol industry.

"It would essentially be a double benefit for the same industry, essentially for the same dollar," said Tokishi. "That may not have been intended. There are some questions about legislative intent and what it was intended to do."

State lawmakers did not intend for ethanol producers to participate in more than one tax credit program, said Rep. Hermina Morita, D-14th (Kapa'a, Hanalei), who chairs the House Committee on Energy and Environmental Protection, which passed the ethanol construction tax benefit earlier this year. But Morita acknowledged that such double dipping by the industry may occur.

"The state benefits even though the tax credits are generous," Morita said. "We wouldn't be doing it if the analysis showed a loss to the state."

Ethanol producers promise more than $100 million of new investment in manufacturing plants and about 100 direct jobs in addition to the benefit to the state's sugar industry.

Morita said the impact of ethanol incentives are expected to be neutral over time, according to cost-benefit studies. However, no state study accounted for the industry's possible use of both the facility construction tax credit and the technology investment credit.

State law prohibits ethanol producers from claiming more than one tax credit, but it does not prohibit the ethanol producers from claiming one credit and investors from claiming other credits. The technology credit can be claimed by investors, and those investors do not have to disclose publicly that they claimed the credit or how much they claimed.

Short-term costs high

In the end it may be easier and cheaper for the state to just build ethanol plants itself, said Lowell Kalapa, president of the nonprofit Tax Foundation of Hawaii.

"Why did we have to give out the tax credits?" asked Kalapa. "Why didn't we just appropriate the money?"

The tax breaks for ethanol don't end with the producers and investors.

All sales of ethanol-blended gasoline from now until December 2006 are exempt from the state's general excise tax. That could cost the state an estimated $23 million.

And there is more. State rules require 85 percent of gasoline sold after April 2006 to have at least 10 percent ethanol blended into it. If gasoline retailers sell fuel with 85 percent or more ethanol content, they will get a reduction in the state fuel tax. This tax break is not expected to have much impact on tax revenue.

Other states that mandate ethanol use also hand out tax credits. But Hawai'i appears to be alone in offering the added technology investment tax credit and an excise tax exemption.

Ethanol production isn't a cost-effective alternative to gasoline without such incentives, industry proponents said.

The federal government also provides incentives to gasoline retailers in the form of a 5.4 cent tax credit for each gallon of ethanol-blended gasoline sold.

Savings may be small

When state lawmakers passed the ethanol tax credits, they were trying to lessen Hawai'i's dependence on outside fuel and hoping to help the sugar industry.

Three of the four planned ethanol plants in the state will be built near Hawai'i's two remaining sugar producers — Hawaiian Commercial & Sugar Co. on Maui and Gay & Robinson on Kaua'i. The fourth producer, Oahu Ethanol, plans to import molasses.

Ethanol production represents a new market for sugar, but current demand projections suggest it won't result in new sugar cane processing plants or jobs. What it should do is keep the industry alive amid stagnant prices and increasing foreign competition, said Steve Holaday, plant manager for HC&S.

"Sugar prices have been stable to down for 20 years, so you need to keep finding additional revenues from existing products to extend your life," he said.

HC&S is working with Maui Ethanol LLC, which plans to build a $20 million ethanol plant in Pu'unene that can produce 8 million gallons of the fuel a year. Maui Ethanol plans to use HC&S' annual production of about 73,000 tons of molasses to produce ethanol. That could mean an added $1.5 million a year in sales for HC&S molasses.

Plans are under way to build two ethanol plants near Gay & Robinson's Kaua'i operations — one run by Worldwide and another affiliated with Gay & Robinson.

Because the Kaua'i operation does not produce enough molasses to meet ethanol demands officials are considering importing corn as an alternative feedstock for one ethanol plant. The other facility run by Worldwide will convert Gay & Robinson's bagasse, what is left over after sugar is squeezed from the cane, into ethanol.

"That will help the core business to survive," said Alan Kennett, general manager for Gay & Robinson. "If we don't get into some of these other businesses, I don't think we could make it. Not long term.

While sugar will get a boost, state lawmakers also wanted to steer consumption toward ethanol for the environmental and consumer benefits.

Ethanol slightly reduces the state's dependence on crude oil, and creates the potential for a cleaner, more competitive fuel industry.

Those opposed to the ethanol mandate, including local oil companies, contend that it would result in less fuel efficiency and potentially higher gasoline prices.

Because ethanol is about 3 percent less fuel efficient than gasoline, cars will get 3 percent fewer miles per gallon and consumers will pay 3 percent more to drive the same distances. That would equate to about $20 million a year in added gasoline costs for consumers, according to a draft report by Irvine, Calif.-based Stillwater Associates.

In addition, gasoline producers will need to modify equipment to blend ethanol, and that could cost $10 million, Stillwater said in its report. Any added costs faced by the oil industry because of the ethanol mandate could put upward pressure on gasoline prices, according to ChevronTexaco Corp.

To offset its increased costs, ChevronTexaco may take advantage of tax credit programs among other options, said spokesman Albert Chee.

There is some hope that some of the ethanol tax breaks will flow back to consumers in the form of lower prices, said William Maloney, managing director for Maui Ethanol.

"Hopefully, some goes to the consumer," Maloney said. "That's how I see the benefit in the short-term. In the long-term, if oil prices continue to rise, ethanol will be a less expensive fuel product."

Reach Sean Hao at shao@honoluluadvertiser.com or 525-8093.