On May 20, 2009, Canada, together with the European Union, Brazil and Chile, wrote to the United States Congress urging them to repeal a tax credit for the use of black liquor1 as a biofuel, on the basis that the credit is acting as a subsidy on the production of kraft pulp contrary to World Trade Organization (“WTO”) rules.  This is the latest example of a tax credit program presented as an environmental initiative that, on closer examination, proves to have little beneficial effect on the environment but does provide a significant subsidy to a particular sector of the economy.  The practice of presenting an activity as environmentally friendly when its primary aim is to secure some economic advantage has come to be known as “greenwashing.”

In the kraft pulp process, chemicals are used to digest the wood fibres into pulp, and extract a chemical called lignin, which is a complex natural polymer of phenylpropane. While efforts have been made to find some industrial use for lignin, for years kraft papermakers have found it most efficient to use the lignin-containing black liquor as a fuel to fire a boiler for making process steam and hot water.  In this way a toxic by-product was used as a “free” fuel, thus saving the pulp producer the cost of buying oil to fire the boiler and managing the disposal of the black liquor.

When the U.S. Congress passed a statute to provide a tax credit for biofuels, it was soon realized by papermakers that black liquor was much more valuable as a biofuel. The credit was so generous (estimates of the amount that U.S. pulp producers will receive vary from $6 billion to as high as $10 billion) that pulp producers quickly stopped burning their black liquor and, instead, started mixing it with some diesel oil and selling it as biofuel.

Of course, the pulp producers still needed to fire their boilers, and have had to purchase fossil fuels to replace the subsidized black liquor that they were selling. The distortion caused by the tax credit has had the effect of making kraft pulp a by-product of the black liquor production process instead of the other way around. Between the extra production of cheap pulp and the general lack of demand for pulp due to the current economic turmoil, the impact on Canadian and other pulp producers has been devastating. In June 2009 the Canadian government responded with the $1 billion “Pulp & Paper Green Transformation Program.” Under the program, participating pulp and paper producers are paid 16¢/litre, which they must invest within three years in capital expenditures for improvements in energy efficiency or environmental performance.

Under WTO rules, the tax credit is a prohibited subsidy contrary to the WTO Agreement on Subsidies and Countervailing Measures and it is distorting trade. The entitlement to claim tax credits provides U.S. pulp companies with an incentive to (1) over-produce and (2) sell the pulp at lower prices because they may recover part of the money in the form of the tax credits. However, Canadian pulp producers cannot sue the U.S. at the WTO. Rather, the Canadian government can pursue the legal remedy with the assistance of Canadian pulp producers as advisors. In addition, Canadian producers of pulp or other by-products of the kraft pulping process, that are experiencing price depression, may be entitled to bring a countervailing duty trade remedy case under Canada’s domestic laws. In order to be successful, however, the group filing a trade remedy case must (1) represent a proportion of Canada’s domestic production, (2) demonstrate that the U.S. tax credit is a subsidy, and (3) prove that the subsidization has caused, is causing or threatens to cause injury to the Canadian producers.

Whether this subsidy was intended as such, or was merely the unintended consequence of poorly conceived policy, doesn’t much matter. The adverse effect on the environment and the markets is the same. The problem is that if the public loses confidence in the good faith and competence of those devising and implementing policy and those taking advantage of massive incentive programs presented as eco-friendly, its support will evaporate.

Apart from the initial black liquor dueling subsidies, there are other disturbing signs that “green” initiatives are being used as cover for protectionism. While the United States black liquor subsidy was due to expire at the end of December, 2009, a provision of the U.S. Biomass Crop Assistance Program contains a provision that may allow U.S. pulp and paper producers to obtain up to $4 billion in 2010 for “biofuel” containing black liquor. Not surprisingly, the Canadian pulp and paper industry is looking for the Canadian program to be extended or enhanced. In addition, Ontario’s feed-in tariff rules for home solar energy projects (under 10 kW), published September 30, 2009, require at least 40% domestic content for projects that reach commercial production before the end of 2010, and 60% domestic content thereafter. There are other domestic content rules for projects with a capacity exceeding 10 kW. Similar examples can be found elsewhere around the world.

A properly configured program to encourage truly advantageous environmental goals is worth pursuing. However, before any tax credit or the like is approved, the activity in question should be required to meet the following minimum criteria:

• The new product or process uses less energy from the start of production, including any agricultural activities, to final consumption compared to the product or process it replaces. (The amount of any credit would be proportional to the energy savings.)
  
  
• The new product or process produces fewer emissions from the start of production, including any agricultural activities, to final consumption compared to the product or process it replaces. (The amount of any credit would be proportional to the emission savings. This will be more difficult to implement than credits proportional to energy savings. While energy has a common unit of measure, all emissions are not the same. While we can all agree that emissions of carbon dioxide (CO2) are undesirable, a process that reduced such emissions by converting the carbon dioxide to cyanide (CN–) would be even less desirable.)

In terms of lessons learned, lawyers should examine “green’ initiatives carefully and be prepared to advise their clients as to those initiatives that may have distortive effects on their clients’ industries and those initiatives that may be vulnerable to WTO challenge.  In addition, as Canada and Ontario move to implement environmental programs, businesses will have to be alert to how such programs will change the rules of the game. While rule changes are unsettling, they also create opportunities. Businesses that first identify those opportunities will have a significant advantage over their competitors.