Singapore (Platts)--27Nov2009/658 am EST/1158 GMT

China's Gushan Environmental Energy has spent the past five years building biodiesel plants around China in a bid to help it diversify away from fossil fuels, but it is preparing to walk away from the industry if it doesn't get the exceptions it is looking for in tense tax talks with Beijing, senior executives with the company told their US shareholders while reviewing their latest quarterly results.

Gushan, which still uses the slogan "The Bio-Energy Pioneer" in its marketing and on its Web site, could simply transform its bioenergy plants into specialty chemicals production, said the company.

The company has been locked in a bitter, and slow-moving, debate with state tax authorities in China since the country's tax bureau decided to include sales of biodiesel in a special consumption tax that was launched this year to curb demand for diesel and gasoline.

It closed its 100,000 mt/year (1,961 b/d) Fujian biodiesel plant in July for road repairs, and left it closed after a notice from the local tax authorities demanded provisional tax payments while Beijing considers Gushan's demand that biodiesel should no be taxed under the fossil fuel levy. Biodiesel is typically made in China from inedible vegetable oils and used cooking oils, and is generally considered to be a renewable fuel.

As of the end of the third quarter, only three out of Gushan's seven biodiesel plants were in production -- and they were running at less than 50% of capacity. Because every gallon of biodiesel it makes represents another gallon of potential tax exposure, Gushan has slowly started selling more specialty chemicals, like glycerin. Biodiesel plants can easily switch production between biodiesel and glycerin.

"We are diversifying our sales sources to the chemical industry and we are doing it at a slow pace in a sense because if we push too hard on the chemical side, the prices will drop as well," Wai Sun Kwong, Gushan's president, told analysts and shareholders in a conference call.

"In a way, we're sort of transitioning more towards the chemical side. If I give you an example, recently in the current months and so forth, the percentage that we're selling into the chemical industry has now gone up to roughly 50%."

Wai said the federal government was cracking down on taxes because it had grown concerned about an apparent loophole, where companies selling diesel containing only small amounts of biodiesel were claiming the tax exception for all of the diesel, after it had been blended.

"I think what happened was that there are a lot of people who have avoided this consumption tax by just claiming that they are making biodiesel. But really, it's just maybe putting a little bit of so called biodiesel into diesel products and selling it and claiming that they are selling biodiesel, therefore not paying the consumption tax," said Wai.

"I think the government is trying to closeout those players, but not realizing that it will be hurting the real biodiesel producers. That's our reading of it."

Gushan, which registered a net loss of $11.6 million for the third quarter, said it does not know when or if the central government will grant it the tax exemption it needs to produce biodiesel profitably in China.

The loss last quarter was in sharp contrast to a profit of about $11 million in the same quarter of 2008.

--Dave Ernsberger, dave_ernsberger@platts.com