Biofuel boondoggle: US subsidy aids Europe's drivers

Fast-rising worries over global warming have created a biofuel boondoggle.

Called "splash and dash," "touch and go," or an unfair trade practice, it features biofuels traders who exploit a US tax credit, European drivers who get cheaper diesel fuel, and American taxpayers, who are footing the bill.

It also illustrates a cautionary tale of how government incentives, no matter how well-intentioned, can sometimes be subverted into windfalls for the few.

"You have US taxpayers providing a very nice tax incentive, and they're not receiving any energy-security benefit or added fuel to the marketplace or benefits to US development in return," says Joe Jobe, chief executive officer of the National Biodiesel Board, which represents US biodiesel producers.

So far, the subsidies involved are relatively small – conservatively estimated at $30 million last year – but they're rising fast. And while efforts to close the loophole are under way in Congress, they're complicated by competing interests.

Created under the 2004 American Jobs Act, the "blenders tax credit" was supposed to boost US production of biodiesel by encouraging US diesel marketers to blend regular petroleum diesel with fuel made from soybeans or other agricultural products. It succeeded, perhaps too well.

Attracted by the $1-per-gallon subsidy, US diesel-fuel marketers mixed away, setting off a nationwide boom in biodiesel refinery building. But no one anticipated splash-and-dash.

The maneuver begins with a shipload of biodiesel from, say, Malaysia, which pulls into a US port like Houston, says John Baize, an industry consultant in Falls Church, Va. Unlike domestic diesel-biodiesel blends, which typically contain from 1 to 10 percent of biodiesel, the Malaysian fuel starts off as 100 percent biodiesel, typically made from palm oil.

Then, the vessel receives from a dockside diesel supplier a "splash" of US petroleum diesel. It doesn't take much to turn it into a diesel-biodiesel blend that is eligible for US subsidies.

If the ship holds roughly 9 million gallons, it takes only about 9,000 gallons of traditional diesel (0.1 percent of the total) to make the entire load eligible for the blenders tax credit.

The US importer of the load applies to the Internal Revenue Service for the credit – a dollar for each of the 9 million biodiesel gallons, Mr. Baize calculates. The next day the tanker can set sail – dash – for Europe. There, the US importer resells the biodiesel, taking advantage of European fuel-tax credits that, in effect, keep biodiesel prices above US prices.

"Splash-and-dash is something Congress never intended," says Baize. "It's bad for taxpayers and it ought to be fixed now."

Signs of splash-and-dash began to show up last fall. But efforts to fix the problem only began taking shape in Congress this spring after European biodiesel manufacturers complained in March about the subsidized imports and the US biodiesel industry also complained a month later.

"This [splash-and-dash] is something our people are aware of and that's on their radar screen," says a staff aide on the House Ways and Means Committee, who requested anonymity because he was not authorized to speak to the press. "It's one of the issues that's driving closer scrutiny."

European officials are also unhappy about the practice. Such "touch and go" maneuvers could quickly become a much larger problem, warned Raffaello Garofalo, secretary general of the European Biodiesel Board, in a March 19 letter to the European Trade Commissioner.

European manufacturers are worried about all US biodiesel imports – not just the splash-and-dash variety – because the subsidized fuel is flooding their markets, cutting into their domestic biodiesel business and lowering prices.

"We want really to get a fair trade and want this unfair subsidy to stop," says Mr. Garofalo in a phone interview. "The US products get subsidies in the US, and in Europe, a double subsidy."

The industry is calling for trade sanctions against the US.

So rich is the US subsidy, however, and awash in biodiesel is the European market at present, that a third form of imported biodiesel is now reportedly hitting European shores – at US taxpayer expense. European biodiesel producers themselves are shipping fuel to US ports to get the US blenders credit and then bringing it back to Europe for sale, according to British press accounts.

But US biodiesel manufacturers and Congress may not be in a hurry to close the loophole, some insiders say. That's because the blenders credit not only benefits splash-and-dash traders, it gives US producers of soybean-based biodiesel a distinct export advantage, industry insiders say.

"The US biodiesel producers talk out of one side of their mouth and then the other, because some of their members are clearly benefiting from this credit," says one veteran industry expert, who asked not to be named because such comments could harm his business prospects. "It's their own members importing a lot of that palm oil and biodiesel."

Indeed, congressional staffers say a legislative solution is snagged at present.

"There are trade issues involved in solving this problem," says a committee aide who asked not to be named because of the issue's political sensitivity. "The tax people want to go after it, but the trade people say you can't and I don't know precisely why that is."

Mr. Jobe, however, says his US biodiesel trade association remains committed to stopping abuse of the blenders credit loophole "to the extent that it is occurring."

So far, the amounts involved look relatively modest. Although there is no official IRS tally of how much US taxpayers have spent on this program, the US Department of Agriculture does track exports of US vegetable and animal oils, a category that is mostly biodiesel, experts say. In one year, those exports quadrupled – from about 9 million gallons in 2005 to 36 million gallons last year. If biodiesel accounted for 80 percent of the total, analysts calculate that taxpayers would have paid out about $30 million in 2006.

This increase is corroborated by the European Biodiesel Board, which has tracked 50-plus shipments from the US to Europe totaling about 60 million gallons in the first four months of this year. Most of those shipments originated in Houston; Savannah, Ga.; or New Orleans and arrived in the ports of Rotterdam, Netherlands; Bilbao, Spain; or Hamburg, Germany, Garofalo says.

Ultimately, this rise of US exports points to a larger American problem: a serious imbalance between domestic biodiesel production capacity and demand, some experts say.

Although biodiesel sales in the US soared to 250 million gallons last year – more than triple the level in 2005 – domestic biodiesel plants are still operating at just half their capacity, industry analysts say. That's because the industry, spurred in part by the blenders credit, has been on a tear building new plants. Another 1 billion gallons of capacity is expected to come on line this year.

Renewable-fuel standards that mandate biodiesel blending may one day boost US domestic demand. Until then, the US industry seems set to depend more on exports – and the blenders tax credit, industry experts say.