Airlines Overbook—Should Bagged Pellet Producers?

As the industry looks ahead to the 2017 heating season, many producers might ask themselves, should we overbook? Like the airline business, the pellet business runs on thin margins, so no company can face many bad years.
By Stan Elliot | June 04, 2017

Over the past few months, we have all watched news stories of airline passengers being removed from overbooked flights. While these stories provide exciting videos of anguished customers, the news rarely explains why airlines overbook. No airline wants to bump passengers, but financially, they do try to reach 100 percent capacity in order to maximize their profits, and keep fares as low as possible.

What about U.S. bagged pellet producers? Should they risk overbooking their production, thus irritating retail partners, in order to maintain the lowest possible costs? As any production analysis will tell you, the best way to keep your cost per ton down is to keep your plant running at, or near, full capacity. A 50,000-ton-per-year plant has many fixed costs that must be covered, whether the plant produces 25,000 tons or 50,000 tons.

Unfortunately, if it only runs 25,000 tons, the average cost per ton may increase $10 to $15 per ton, since you have fewer tons to absorb the plant’s fixed costs. In a price-sensitive market like heating pellets, this cost difference can be the difference between making money and losing money.

Let’s take a look at the past few seasons to see if a case can be made for overbooking. Most pellet producers try to line up a long list of retail accounts whose commitments, or sales history, closely matches the producer’s production capacity. If you can produce 50,000 tons, you try to find the right mix of retailers that will purchase those 50,000 tons.

The Northeast pellet heating market is the largest in the U.S. The winters of 2013 and ‘14 were record-setting years with much colder-than-normal weather throughout the Northeast states. Pellet manufacturers struggled to keep up with demand, and many companies added capacity in order to capitalize on growth opportunities. Unfortunately, the winters of ‘15 and ‘16 were both much warmer than normal, and sales plummeted as homeowners required fewer tons to heat their homes. Several pellet producers have reported drops in sales of 25 percent in 2015, and an additional 30 percent drop in 2016. When demand drops so dramatically, production must also drop. Many companies were forced to run at 50 percent capacity, or less.

As the industry looks ahead to the 2017 heating season, many producers might ask themselves, should we overbook? If you sold your full capacity of 50,000 tons in ‘13 and ‘14, but sales dropped to 37,500 in ’15, and then dropped again to 22,500 in ‘16 with the same retail partners, how do you plan for ‘17? If the cold weather patterns of ‘13 and ‘14 return, you may not need additional retailers. If the winter weather is again mild, however, you may want to try to overbook (i.e. add new dealers) in order to cover the potential shortage.

In the western states, the situation is reversed. The winters of ‘13 and ‘14 were very mild El Niño years, and pellet sales were down. However, the winter of 2016 was colder than normal, and sales exceeded everyone’s expectations. Western pellet producers were caught off-guard, and some minor shortages occurred. Demand has continued to be stronger than normal into mid-spring, which has delayed the ability of most producers to start building inventories for next season.

One example can easily demonstrate the difficulties that pellet producers face. Our company received a nonbinding commitment from a multistore retailer for the upcoming ‘17 heating season, for 5,250 tons. Along with the commitment, the retailer shared some store pellet sales over the past several years. These stores had sold as high as 5,000 tons during a recent harsh winter, and a low of 2,268 tons during a mild winter. So, do they decide to reserve the entire 5,250 tons for this account, or try to find another retailer to commit to 1,000 to 2,000 tons, in case this dealer only needs 2,268 tons this season?

Since neither the retailers, nor the pellet producers, can predict the weather, we must all face the fact that weather is the No. 1 factor in determining sales.

Like the airlines, if we overbook, we may be forced to deal with unhappy customers. If you disappoint your customers, you risk losing them. If we underbook, we face the prospects of higher product costs, and loss of income. Like the airline business, the pellet business runs on thin margins, so no company can face many bad years. In the end, communicating honestly with your customers and planning for a variety of outcomes seems to be the best option.

Author: Stan Elliot
Chairman-elect, Pellet Fuels Institute