Potential new investors are staying away from synthetic coal investments because the Internal Revenue Service (IRS) has once again stopped issuing new private letter rulings for their deals. Industry advocates are lobbying to change the agency's collective mind, but a recent feature in Time magazine's Oct. 6, 2003, issue, which paints these synthetic coal investments as a massive tax shelter for wealthy corporations, will hardly help their campaign.

According to the story, investments in synthetic coal plants have earned investors absurdly high returns. In one case, an investor earned $58 million in tax credits on an investment of about $2 million, winning a 2,800% return, according to Time.

Worse, a producer of synthetic coal can meet the Sec. 29 "synfuels" credit requirement of producing a "significant chemical change" merely by spraying perfectly useable coal with a chemical. The resulting chemical change serves no useful function, according to critics that range from competing American coal companies to the Canadian government.

In return for causing this chemical change, the IRS rewards investors with a tax credit of up to $27 per ton of coal, so that a plant producing 1 million tons of synthetic coal could also produce $27 million in tax credits. Current market prices for similar quality untreated coal range from $34.50 to $36.50 per ton. The very deep subsidy often allows synthetic coal to sell for 50 cents to $2.00 per ton below market prices while still offering investors very high returns.

However, the tax credit is paying for some important work, according to Fred Murrell, president of Carbon Resources of Florida, Inc., located in Bradenton, Fla. Murrell is a developer of four synthetic coal plants that turn unusable coal dust into useable coal. Murrell estimates that 2 billion tons of coal dust lies scattered through the Appalachian countryside in coal ponds - environmental waste left behind by old coal mining operations. Nearly all coal-fired power plants refuse to use coal dust because the sticky mix of sand-sized pieces of waste coal and impurities is so difficult to transport.

Murrell's plants wash and bind coal dust into briquettes in a process that is typically too expensive to do without subsidy. The IRS rules, however, don't allow credits for the physical process that is actually rendering otherwise useless waste into useable fuel. Ironically, to earn tax credits, Murrell's plants have to spray the coal with a chemical agent to produce the required "significant chemical change."

In most cases, the chemical change being made "probably does not add to the usefulness of the fuel," Murrell said. Its real purpose is just to meet the IRS requirement. Some synfuels producers, however, are working on chemicals that lower the amount of pollution the coal produces.

Congress created the Sec. 29 tax credit as part of the Crude Oil Windfall Profit Tax Act of 1980, to encourage the development of expensive new technologies to extract and use unconventional fuels from domestic sources such as oil shale, tar sand and gasified coal. Murrell's plants, which turn environmental waste into useable fuel, seem to live up to both the spirit and the letter of the act.

According to a report by Hill & Associates, the synthetic coal industry had a production capacity of 73 million tons in 2002, up from 50 million tons in 2001. By 2004, capacity is likely to expand to 118 million tons.

All of this coal is produced by about 52 plants that were operational in June 1998, the last chance for new plants to open under the tax credit rules. The plants are mobile, and can be taken apart and put back together at a new site.

Industry experts think that the synthetic coal industry will last at least until the end of 2007, when the tax credit is scheduled to expire. So far, the IRS has given out no bad news in private letter rulings issued so far, which assure investors that their plants live up to the standards of the Sec. 29 credit. But new investors are unlikely to buy into existing deals unless the IRS begins issuing new private letter rulings again.

In the past, the industry has relied on Congress to help pressure the IRS, but that support may be on the wane. An appropriations subcommittee in the House of Representatives recently killed a bill to call off the IRS' industrywide audit by an 8-to-8 vote.