The Untold Upside of Low Oil Prices

Alternative energy companies typically prosper when oil prices are high, but it’s not all doom and gloom when the cost of crude nosedives.
By Ron Kotrba | December 27, 2015

A warmer winter forecast, low crude oil, propane and heating oil prices, and ample distillate stocks will be pleasing to the average household this winter, but how the wood pellet and other bioenergy industries are affected gets a bit more complicated.

As of Nov. 30, the Cushing, Oklahoma, West Texas Intermediate spot price for crude oil was $40.43 per barrel, its lowest since early 2009, and down from $106.64 a bbl in late June 2014, according to the U.S. Energy Information Administration. Residential propane prices entered the 2015-‘16 heating season at an average of $1.94 per gallon, nearly 44 cents per gallon lower than at the start of last year’s. Wholesale propane prices averaged nearly 59 cents per gallon, almost 54 cents per gallon lower than the first collection week in October last year. As of September, natural gas prices per 1,000 cubic feet for industry—a lower cost than residential or commercial natural gas—were at $3.53, down from $6.58 in February 2014 and up from a May 2012 recent low of $3.02. The New York Harbor ultra-low sulfur diesel No. 2 spot price, as of Nov. 30, was $1.345 a gallon, down from the recent high of $3.394 in February 2014. And heating oil prices are down more than $1 compared to a year ago; as of Oct. 5, residential heating oil prices averaged $2.41 a gallon, almost $1.11 lower than the same time last year. The average wholesale heating oil price at the start of the cold season was $1.63, nearly $1.04 below the first week of last year’s. EIA says a combination of warmer weather and lower crude oil prices this winter is contributing to the lowest expected average residential heating oil expenditures in nine years. Furthermore, distillate fuel inventories in the Northeast U.S.—and globally—were ample heading into the winter due to slowing economic growth in emerging economies, the major driver of distillate consumption in recent years.

So what does all this mean for the wood pellet and other bioenergy industries? It’s a mixed bag, certainly, but not the doom and gloom one might expect. “If you look at the logistics side of the equation, a drop in oil prices means the cost of diesel for railroad and truck transport is lower, leading to an increase in profitability,” says R. Delbert LeTang, founder and CEO of SG Preston, a bioenergy startup with four biobased segments—SGP Biomass, SGP Wood Pellets, SGP BioEnergy and SGP Biofuels. The company most recently made news in October when it announced an agreement with Houston-based EPC contractor IHI E&C to develop five renewable diesel projects scaled at 120 MMgy each.

“At one time we were supplying wood chips to major global biomass company in the far Northeast when diesel prices were up as high as $4 a gallon,” LeTang says. “That translates into a delivered cost for wood chips that’s fairly high. For end-product pricing, customers look for parity with petroleum products and high input costs make that more challenging. But when those input costs, or related costs for transport, decrease 40 to 60 percent, the companies that are more customer-centric pass on that savings to their customers while keeping some for themselves. It can have a very positive impact.”

Cory Schrock, plant manager of Fiber By-Products Inc., an 80,000-ton pellet mill in White Pigeon, Michigan, says the company was founded by his father in the early 1990s to provide a service to area sawmills and other wood industry manufacturers by contracting for their waste vs. them paying for disposal. The company amassed a fleet of diesel trucks to haul the raw material and its refined mulch and animal bedding products for which it was developing growing markets. “By the time 2004 came around, the business had grown, and there was more wood fiber and scraps than we knew what to do with,” Schrock says. The growing pellet market got the company’s attention, and by mid-2006, it was steeped in the pellet manufacturing business. The company manufactures its ProPellet brand and fills various private label bags.

With its own fleet of trucks, Schrock says lower diesel prices are a positive for the company’s bottom line. “We have about 18 trucks running every day, and lower diesel prices are always a welcoming site,” he says. “It costs us less. Our trucks are getting about 6 miles per gallon, and they’re running about 300 miles per day. That’s a large expense.” Schrock says with new emissions regulations and controls, operating costs for diesel fleets have never been higher. “We get less miles per gallon, and with the high fuel prices over the past few years, it really hurt the industry,” he says.

Rockford, Illinois-based Equustock LLC started in 2001 as a company built around pet products such as cat litter, horse bedding, animal pellets, pine shavings and oil adsorbents. “Then we sort of stumbled into fuel pellets by using a byproduct of our feedstock to make the pellets, and we developed a brand,” says Claire Brant, owner and managing partner of Equustock. The brand is Big Heat Fuel Pellets, but Equustock also does contract packaging. Its fuel pellets are sold in Home Depot, Menards, Lowe’s and other retailers. Over the years, the firm has contracted with and acquired several plants, totaling 10 facilities today with 150,000 tons of active pellet capacity. “Some we own, some we partner with, some we have an exclusive partnership with,” Brant says, adding that the company operates a fleet of 50 to 60 trucks. “If the delivery side costs less, sometimes customers will negotiate tough to get their price down to offset that, but I haven’t really seen anything at this point,” she says. “Orders are not slowing down now.”

Lower freight costs can broaden the radius around a pellet mill within which its goods can be economically delivered. “For us, it started at 700 miles,” Brant says, “but over years as fuel prices rose, this shrunk to 350 miles. But this year we can see a benefit from the lower cost of shipping, and we are increasing that radius to between 500 and 600 miles.” 

On the flip side, however, biomass power, pellets and renewable fuels typically become more popular when traditional energy prices are high. “We are an alternative energy business and we like seeing high conventional energy costs,” says Schrock. “It makes our product more attractive. It may seem selfish, but in America we are trying to develop alternative energy, and when oil prices come crashing down, all our efforts seem to have been in vain and we have to start all over again.” Schrock says clearly there is a correlation between oil prices and pellet supply and demand—when oil prices are high, pellets are in high demand. “We just learn how to adjust,” he says. “There are a lot of factors that drive demand for our alternative fuel—the high cost of oil and propane is one. It really changed the wood pellet market over the past few years with new capacity coming online. We made changes here to meet that demand. Now, the demand is softening and one factor is the lower energy costs. Two, we’re still waiting for winter to start.” Schrock says energy prices’ seven-year low indicates a correction period. “Is this a new normal?” he asks. “I doubt it. The economy will come back. The world is driven by energy. As the world consumes more, prices will go back up.”

When the cost of doing business in the pellet world goes down as a result of lower oil prices, does it go down relative enough to compete with low natural gas, propane and heating oil prices? “No,” says Brant. “We benefit some in that we see lower shipping costs, and if we charge landed pricing to our customers, we benefit from that. So that may offset a lower amount of sales, I suppose.”

At this point, Brant says low oil prices haven’t forced down the price of Equustock’s pellets yet. “That’s determined by other producers,” she says. “Folks who have switched to fuel pellets as a primary source are going to continue to use them unless the price gets so ridiculously expensive they can’t afford to anymore. We’re not seeing any difference in sales, but when we hit Jan. 1, we’ll see. Of course, that may be more driven by the weather than a cost-comparison.”

Schrock says it’s a margin and volume game. “There’s a line where you lower your price and keep production high,” he says. “You’ve got to produce at volume, and figure out a way to sell your product when oil prices are so low. As a wood pellet company, the market will force us to adjust.”

While oil prices and pellet demand are beyond control of individual producers, what is within their control is the ability to operate a diversified business and allocate production into markets that are less affected by the price of energy. Brant says her approach, from the perspective of a diversified wood byproducts business, may be different than someone steeped solely in the fuel pellet business. “I keep my finger on the pulse to best know where we should allocate production for the various markets we serve,” she says. “But we do have a lot of fuel pellets out there.”

Schrock points out that Fiber By-Products has been making pellets long enough to understand how the various factors—including winter forecasts and energy markets—affect the pellet market. “We’re weathering the storm, and we can absorb the markets for the most part,” he says. “We make a quality product and we’re price-competitive. And since we do have other markets that we serve, we may have to do some adjusting here and there. We would still handle the same amount of fiber, it would just go into other markets such as mulch and animal bedding.” In its 20-plus years of business, Schrock says Fiber By-Products has never resorted to layoffs to remain profitable during downed markets. “I credit our diversity for our success,” he says. “It allows us to adjust to the markets.”

Though layoffs may not result from low oil prices in White Pigeon, Michigan, more frugal operations do. “I’m a strong believer in efficient operations, and things like having a lot of spare parts on hand helps that,” Schrock says. “During times when oil prices are low, maybe my spare parts list is more conservative, or we’re less apt to repair or change out noncritical parts.” 

For liquid biofuels, LeTang says what sustains a company’s ability to ride the tough time of low oil prices is its ability to control feedstock. “The technology we will use has the ability to use all the feedstock options, but what we will focus on is a small family of plant oils,” he says, unwilling to disclose further details. “We have direct control over this process. We de-commoditize that, and as result, we control our feedstock input price.” He says the renewable diesel SG Preston will produce comes at a fixed price and value-addition to the market with standard escalations to avoid the market lulls associated with low oil prices. “We don’t have a price that’s hedged to any index,” he says. “It may be slightly higher today, and anyone who’s looking at fluctuations in petroleum knows this will, at some point, go back to where it was and customers are asked to place hedges against that. What we offer is finished product that’s a natural hedge. We have a fixed, long-term predictable price. We designed our model to project a long-term predictable value. That’s what the customers are looking for, and it’s what the investment community is looking for.”

From a natural hedge standpoint, LeTang says SG Preston relies on its products’ strong value proposition and the value-added sale to clients, and the company’s ability to help its clients deliver a stronger end-product to their customers. “What allows us to drive and meet that is our fully integrated business model, which allows us to control the price of our inputs,” LeTang says.

Alt energy proponents can take solace in the fact that even more positives exist in a market dominated by low energy prices than just lower shipping costs or expanded product delivery radii, particularly since a common superficial observation is that the effects are generally negative given bioenergy’s popularity when oil prices are high. For instance, it can have a stabilizing effect on an industry that has arguably grown faster than may be healthy. “One of the things I hope these low oil prices will do is keep some of the folks from jumping into the industry,” Brant says. “Money guys jump in and dilute the production pool by building additional plants to alleviate the product shortages we’ve seen in the past few years. At some point the market has to say it’s saturated and let those in the business figure out how to gain capacity when they can. It may be at a tipping point now.” SG Preston is one of those companies that has put the brakes on its plans for producing pellets—not because of low oil prices though. “We put wood pellets on the back burner for now because of the lack of visibility in regulatory markets overseas,” LeTang says.

Even the perception of a strained bioenergy market due to low oil prices may have a Darwinian effect on the pellet sector as natural selection plays out, and those companies less apt to adapt to changing market conditions are phased out or absorbed by bigger, stronger competitors. “The good news about wood pellets is there are some opportunities there—the market may force consolidation, and that’s not bad,” Brant says. “As a company, we’re in acquisition mode right now, so as people get tied up in the comparison of oil and gas to pellets, and pellet profitability goes down, it’s a good opportunity for us.”

Author: Ron Kotrba
Senior Editor, Biomass Magazine
[email protected]