A Mixed Bag

As the 2016-’17 heating season winds down, producers across the country once again confirm that, in the pellet business, Old Man Winter determines the haves and the have nots.
By Tim Portz | March 14, 2017

Crunching the numbers for the current heating season coming to an end, producers in the Pacific Northwest and Alaska report very strong years. For one producer who participated in a roundtable discussion with Pellet Mill Magazine, the 2016-‘17 heating season was the most successful season since the plant was commissioned. Contrastingly, producers in the Northeast have found themselves in the position of throttling back production, controlling costs and hoping that next year’s heating season brings colder temperatures and better market conditions.

Producers who participated in the following discussion include: Chad Schumacher, Superior Pellet Fuels; Stan Elliot, Pacific Coast Pellets; Ken Tucker, Lignetics; and Stephen Faehner, American Wood Fibers. Collective insights from these pellet manufacturers underscore that the success of producers serving residential markets correlates tightly to the intensity and duration of the winter in their respective regions,

Compared to the 2015-‘16 heating season, how were sales this year?

Schumacher: 2015 started off as a pretty good year for us, but the second half of the 2015-‘16 season was very bad—January through April were some of our worst months. The 2016-‘17 heating season, from August through November were some of the worst months, compared to the same period of time in other years, that we’ve ever experienced. Since then, December through March have been very good, more representative of 2014, in terms of sales numbers.

Elliott: For us, it was much better, it was really a spectacular year. We operate on a calendar year, so it is always a little more difficult to parse out how the heating season went, because of the big surge that hits before the end of the year, or afterward. We had a fairly slow start to the season in 2016, but basically, from August on, it was outstanding. I should preface that we lost another local producer, a player in the Pacific Northwest. The retailers that producer serviced had to find other sources, so we were the recipient of a couple of really nice accounts. That, certainly, is a specific example of why our year was better than we would have expected.

Tucker: We have six facilities that are pretty evenly split, three in the West and three in the East. The three in the East, two of them are in the mid-Atlantic, and the one in Maine would be considered in the Northeast. For our facilities in the West, our sales were great. We started out strong, and it just continued to be strong, which is good because we haven’t had a really good season in the West for the last couple of years. This year, the West was outstanding. However, our facilities in the East are down about as much as the West was up. In the East, compared to last year, our sales were down as much as 40 percent, while our sales out here [West] were probably up 40 percent.

Faehner: We have two plants here in the East, one is in the mid-Atlantic, and one is more in the Midwest. I think our experience is very similar to what Ken described. Both of those facilities are off in a substantial way, maybe not 40 percent, but close to that. This follows a couple of other soft years in the mid-Atlantic. That said, the last part of this year has kicked in a little bit, but generally, the past few years have been very poor.

As this heating season wraps up, how does your carryover inventory compare to what you had on hand last year at this time?

Schumacher: I look at carryover inventory from two perspectives. One, the carryover inventory in my yard. Second, I think about the carryover inventory our customers have. On a residential customer basis, if they have carryover inventory, it means I’m not going to sell many pellets in August and September. That will not be the case this year. We are below zero, we’re actually 33 below zero right now, and we’re definitely seeing pellets be consumed, and they’re going out the door quickly. From the perspective of carryover inventory in our yard, we are going to be at roughly 20 percent of the inventory we had at the end of last year’s heating season. Some of that is due to changes we made to our production schedules—we significantly decreased our output, and ratcheted back from round-the-clock production. That decrease has certainly impacted the amount of product we have in our yard, but we’ve actually had to ramp production back up here in February and March to ensure that we have enough inventory to make it through the next four months. Our operation remains seasonal, and we will not produce anything April through July, but in order to finish out the year, we’ve had to turn things back on and run in February and March. We’ll produce enough to get us through that time frame.

Elliott: We anticipate having no inventory, or as close to none as you can get. We make 200 tons a day, which are typically gone at the end of the day. As orders slow down, we’ll tie our production to that. We started 2016 in March with maybe 2,000 tons on hand, and we kind of shifted our inventory plan. After we get all of our commitments in late spring, I make the sales projection of what I think we’ll need, and we factor in what we can about the weather and our own optimism. In essence, we take a sales forecast and we add 10 to 15 percent, and then we try to produce 50 percent of that to have on hand by the first of August. We are more than happy to operate through the early fall and winter months, and if the weather doesn’t pan out, or negative market conditions occur, then we simply stop producing—say, in the middle of December. The hope is that we’ll never end up with more than 3,000 to 4,000 tons on the ground on March 1. This year, we made our projections, and the weather and the customer response were better—we should have been more optimistic. That would have given us a few more opportunities in January and February. To answer the question, we will have no inventory at the conclusion of this heating season.

Ken, with multiple plants can you balance production loads at all?

Tucker: It’s pretty difficult, due to the geographic nature of where the plants are located. The plants in the West can take care of one another, because they are only about 400 miles apart. As far as inventory at our western operations, we have zero at all three locations. In retrospect—and driving these facilities in the rearview mirror is very difficult—we went into this season with what we thought was ample inventory, based on what we’ve needed over the past three years or so. It just didn’t work out this year. We’ve looked back historically, and it seems that every five or seven years, we’re short, like we are this year. But we run these plants based on historical averages. We will be running harder through the spring and summer to replenish our inventory, which is good, because that will lower our overall production costs. As far as what is happening in the East, we’ve got inventory on the ground in all three locations, but we are controlling that. The challenge is, controlling that means running fewer hours, which means higher operating costs. In the East, we are in a market where there is a lot of downward pressure on pricing, but at the same time, our costs are going up because we’re spreading them over fewer units. As far as being able to ship into each other’s markets, that’s pretty tough. It’s difficult to ship anything more than 300 or 400 miles and remain competitive, unless it’s an upset situation. We did have that a few years ago, but it didn’t get to that this year. Our costs are going to be up in the East, but down in the West, due to running more.

Faehner: We’re very similar, in that we set our plan according to what we’ve done over the past couple of years, and I appreciate what Stan said about trying to figure in all these variables, and how optimistic one can be in this market. And like Ken said, with multiple plants, there is some sharing that you can do if the proximity is right, but most of us have figured out that you don’t want to put plants on top of one another. Our inventory is up significantly over the past year, we’re probably 25 percent over where we were last year, and we were carrying inventory that was pretty substantial last year as well. Like Ken mentioned, you have this conundrum, in that you are caught between the units you are producing and the units that you are selling, and the challenges of holding on to that inventory for longer than you’d like. That is a scenario that has affected all of us, these cycles that have hit in different areas at different times. Had we even had a relatively normal winter, this would have been much different. But like Chad mentioned, you have to look at it several ways. You can’t just look at what is in your yard, you have to look at what is in the channel, and what is in the consumers’ hands, and all of those things have created a situation where, here in the East and certainly in the Midwest, there are inventories on the ground, and that is creating some interesting challenges.

How do producers weather the lean times?

Tucker: All of our plants are built to run 24 hours a day, seven days a week. All of us on this call, if we aren’t running seven days a week, we are still trying to run 24s, but it might be five days, it might be four  days, or it might be three days. The first thing we look at—because we can’t control the weather, and we can’t control the market—is spending. You confine your spending to what it is going to take to run. Then, we look at what we can do to be the most efficient. A couple of our facilities run at night only right now, because that is the cheapest time to buy electricity—after 9 or 10 p.m. It’s not a very nice way to run a railroad, so to speak, but it does save money. We have to control what we can, tread water, and wait for better times. We’ve done that successfully for about 30 years. I have been in situations where we have taken a couple months off, but that is very painful. Most of us don’t have the opportunity to simply shut down and walk away, because of our raw material commitments. In many instances, our raw material is driving our business. If we shut down for three or four months, we run a real risk of that material not being there when we come back, so we’ve just got to weather it, whether we like it or not, at a reduced level.

What kind of an impact does carryover inventory have on your operations? Is it significant?

Faehner: Carryover inventories have a huge impact. We would all like to find ourselves in a market nirvana where our production and sales all line up, but they never do. They never do, or they rarely do. It has a big impact on your cash flows. It has a big impact on operating costs. It forces you to do stuff with people that you often don’t want to do. It also challenges you to look at your business in new ways.

Tucker: Excess inventory is also code for not being able to run efficiently in the following year. So what that means, just like Stephen said, is that you’ve got to make some tough choices. You might have to adjust staffing. You’ve got to run shorter hours. Often times, energy costs go up, because you are not as efficient as you’d like to be. Your heating costs go up, your electricity costs go up. The first thing you look at is capital expenditure. In a down market, you operate your facility on a maintenance mode only. You are just trying to get through the down cycle, awaiting better times. It’s tough. We don’t just keep running, and I know some folks do, but that ties up a lot of cash. Another challenge with building up inventory is not being in a position where you can protect it from the elements, so you’ve got to manage the risk of spoilage. It’s a big deal, and something that you’ve got to manage and keep from getting away from you.

Schumacher: Carrying a lot of inventory really impacts our ability to purchase raw material. This last year, with a high level of carryover inventory, we had to stop purchasing inbound raw material, because our yard was 100 percent full. 

Stan, would you categorize this year as the best year you’ve ever had?

Elliot: It certainly was, by a great measure. That being said, we’ve got a six-year history only, not a 30-year history like Ken. I would attribute about a third of our success to a local competitor exiting the market, a third to the weather, and another third to the fact that our brand within our market is still growing. I think we’re finally starting to see some traction in the marketplace as a relatively new player.

What is the impact of one strong year, then?

Elliott: I think our philosophy has been that, absolutely, you put some steaks in the freezer. I don’t expect that we’ll have another year like the one that we’ve had this year. So, you do the necessary repairs that maybe you’ve put off in the dry years, and you take advantage of the windfall that you have. But you can’t anticipate that you’ll have the same kind of year the following year, because we’ve all been through it. We all know that as soon as you start planning on a good year, you’re likely to have the worst winter ever.

Steven, how important is the diversity in your operations and product lines to the overall success of your organization?

Faehner: I’d have to say that diversity is really a saving grace for us. I am impressed, and somewhat in awe, of folks who are only in the pellet business. I know Ken has been at this a long time, and he has been involved with some other products as well. Other product lines are definitely a major balancer for us, but we really look at our pellet operation independently of our other businesses. It has to stand on its own—we can’t afford to subsidize it with the rest of our businesses. It’s good to have some other things in your arsenal. Additionally, pellets have a number of different uses. Most all of us are doing some kind of bedding product with pellets. We’ve all probably played around in the absorbent world a little bit from time to time, and there are other applications we are trying to explore and develop. We also have to keep in mind the response from folks outside the industry, when they observe the up years like the kind that Stan and Chad experienced this year. I think one of the things our trade associations need to do is give very good information about the markets. We’ve now teamed up with the U.S. Energy Information Agency to generate better production information, and we’re trying to help enlighten people about the realities of our market. This is an industry largely populated by small businesses and entrepreneurs who have been at this for a long time. They have put a lot of sweat equity into this, and have survived the challenging market cycles to be there when the lucrative years come along. There are pellet plants that don’t make it, and there are pellet mills that change hands. As an industry, we have to do a good job at sharing the whole story, and not just pieces of it.

What kind of discipline is required to achieve success in a heating business in this era of unpredictable weather patterns?

Tucker: It’s been little bit different for us for the past few years, as we now have a presence on both the east and west coasts. In terms of keeping the bankers happy, most of the time we haven’t had a bust on both coasts in the same year. This year, our western plants are certainly carrying the freight. In the few years prior to that, the East was carrying the freight, and the West was down. So how do we weather that? We make tough decisions. We control costs. We have to exert strong financial discipline, which is what we’ve done for 35 years. There really isn’t a magic formula.

Elliott: In this industry, I think it is unique that we have a lot of commitments with plants and raw material suppliers, and we just can’t turn our backs on them. Like Ken says, we have to be willing to make the hard decisions when we find ourselves in situations where we have to weather a tough year. We are always hoping for higher fossil fuel prices or an incentive program to boost our industry, but in the meantime, it really is a matter of business discipline.

Any final thoughts?

Tucker: The things we’re all looking forward to are when fossil fuel prices go up, and we get a string of consistently cold weather. Challenging years like this one will be a distant memory.

Author: Tim Portz
Executive Editor, Pellet Mill Magazine
[email protected]