Avoiding and Preparing for Volatility in Feedstock Availability and Pricing

By Eric Kingsley | August 30, 2018

For two decades, I have worked with developers and financers to build or acquire biomass energy projects, including electricity generators, wood pellet mills and liquid fuel plants. I have had the opportunity to work with a full range of developers—large utilities converting coal plants to wood fuel, sophisticated investors that have enjoyed success in other energy arenas and now are looking for opportunities in wood, and ambitious entrepreneurs looking to make a project work. Invariably, I am asked something like, “How do we contract to make sure that we will always have all the wood we need, and lock up the price for the next five to 10 to 20 years?”

There is usually an awkward silence after I answer, “You can’t, at least not like you’re thinking.”

Wood fuel isn’t like other commodity energy sources such as coal, natural gas, oil or even corn. There isn’t a national (or global) open, real-time price discovery system, as there is for commodity fuels. There aren’t usually lots of creditworthy entities looking to serve as suppliers, and no one entity controls the entire supply chain—for example, forest landowners own the wood, and loggers own the ability to harvest, process and transport the wood.

All of that noted, there are many things large-scale wood buyers can do to ensure a consistent, price-stable and sustainable supply of wood. First, let’s address the perception that wood prices are volatile. Simply put, they’re not. Sure, prices can move up and down, but over time, they are remarkably stable. For a project in Maine, we recently analyzed biomass prices, compared to oil and natural gas for a large-scale heating project. Over the past 20 years, biomass was not only cheaper and had a lower rate of inflation, it had significantly less cost volatility than either of the fossil fuels.

It turns out that when people mention “volatility” around biomass, I think what they are really saying is “uncertainty and unfamiliarity.”  Biomass is a localized market, dependent upon a range of factors that many aren’t familiar with. It doesn’t have open and forward pricing, like you find for oil, coal and natural gas. Biomass isn’t a standard fuel, and a financial analyst in New York or a utility executive in Houston may have reservations about the ability to get fuel, at a price that makes a project financeable. Here are some things to be aware of, and actions to take to help biomass projects secure a consistent supply at a reasonable and understandable price.

Biomass availability, and to some extent spot pricing, can be impacted by weather and seasonality. In the Northeast, for example, we know that mud season comes between winter and spring every year. When it’s muddy and the ground and roads are soft, loggers can’t work in the woods, and trucks can’t move on the roads. Plan on it. Build a wood yard large enough to get through the supply disruption, and fill it over the winter. For large-scale users of biomass, just-in-time deliveries will eventually mean an empty wood yard and an idled plant.

Biomass is a low-value forest product. Landowners make their money growing sawlogs for lumber and pulpwood for mills. Biomass is worth less than these—often a lot less. In New England, a recent analysis showed that biomass was over a third of the volume harvested, but represented just two percent of the revenue a landowner receives. In practical terms, that means nobody is trying to grow biomass, and nobody wants a biomass-only harvest. Biomass is reliant upon and supports other forest product markets. Know about the other, higher-value markets for wood, and figure out how to work within the market dynamics they create.

Some biomass can come right from other forest industries. Sawmill residue—the bark, chips and sawdust produced when cylinders (logs) are turned into rectangles (boards)—is a great opportunity to secure supply. Be aware that volume of residue will be driven by lumber demand, and never a biomass user’s needs.

Diesel is an input to every ton of wood. Diesel inputs can vary significantly by type of biomass, equipment used for harvesting and processing, and distance from the woods to the market. All of that noted, a decent rule of thumb is two gallons of diesel are used in the harvesting, processing and transport of a ton of wood chips. Suppliers have no control over the cost of diesel, and need it to deliver wood to a facility. Incorporating a diesel adjustment clause that everyone understands—one that moves up and down according to a known benchmark—can make sure suppliers are able to operate profitably, while ensuring that reductions in diesel are reflected in the price paid for biomass. If a facility has concerns about what might happen with diesel prices, and thus their wood prices, diesel prices can be hedged years into the future.

The ability to get a truck in, unloaded and out of a facility quickly is important to loggers. As trucking capacity becomes constrained, it becomes increasingly expensive to have trucks waiting in line to unload. Facilities that think they don’t eventually pay for a truck waiting an hour or more to unload are kidding themselves. Whatever number of truck dumps you think you need, buy one more—it will save you money over time.

More than almost anything else, buyer behavior is critical to biomass pricing.  While it is true that suppliers need markets to sell to, this isn’t a one-way relationship. Try running a biomass facility without suppliers. Biomass plants should strive to be a stable market for wood fuel, pay a price that allows suppliers to operate economically, and communicate with suppliers when there are problems. They should expect the same behavior from their suppliers.

On rare occasion, a situation presents itself where wood can be purchased, subject to a formulaic price, for years into the future. These are hard to come by because of the disaggregated supply chain in the forest industry—landowners control the land, and loggers control the means of harvest. Neither can contract for something they don’t control. In a few locations in the country, there are large landowners who have strong relationships with suppliers, and if this situation exists, it is a great way to secure supply and price. Expect to pay a premium for contracted supply.

Buying biomass isn’t easy, but it also isn’t rocket science. Knowing what factors influence the cost of wood in a local wood basket allows you to anticipate price changes, and develop strategies to assure supply and mitigate price risk. Treating suppliers like you care about their success (because you do, even if only selfishly) helps them become part of your success. For decades, forest industries have opened their scales and seen trucks full of wood arrive. With thoughtful planning and simple risk mitigation, wood can be relied upon as a price-stable fuel.

Author: Eric Kingsley
Partner, Innovative Natural Resource Solutions LLC