Biomass in Japan’s Best Energy Mix

Demand for imported biomass is expected to surge in Japan, in the midst of an aggressive energy landscape overhaul.
By Anna Simet & Tim Portz | December 04, 2017

As an island nation, Japan faces the same energy challenges that many of them do—a lack of resources, and a resulting high dependence on imports.  Though the country is smaller in size than California, it’s home to more than 127 million people, well over triple the population, and ranks fifth worldwide for energy consumption per capita.

Post-2011 Great East Japan Earthquake, ensuing Fukushima disaster, and a rapid shutdown of the country’s nuclear plants, Japan is making an aggressive push to transform its power sector. At the heart of the transition is the government’s Strategic Energy Plan, which, approved in April 2014, is centered on stabilizing and diversifying the county’s energy supply, as well as economic efficiency, energy conservation and carbon emission reductions. It includes upping its renewable energy consumption from 10 percent pre-Earthquake to 22 to 24 percent by 2030, with a feed-in tariff system as its key driving force. The tariff system replaced Japan’s renewable portfolio standard, and requires electric utility operators to purchase power from renewable sources, for prices and durations set by the Minister of Economy, Trade and Industry. For bioenergy, the prices have been so alluring that a firestorm of projects have been submitted for approval from the METI, and as a result, has attracted the attention of stakeholders across the global supply chain.

Incentive Structure
Japan’s feed-in tariff system includes solar, geothermal, wind, hydroelectric and bioenergy, which is categorized into three groups—woody biomass and ag residue, waste and biogas. Woody biomass is further divided into two subcategories—“unutilized wood,” or material from forest thinning and forest residues, and “ordinary wood and agricultural residues” which includes imported fuel like wood pellets.
The renewable resource combination that is part of what has been dubbed the country’s Best Energy Mix, and for a project to earn the incentive, it must first obtain accreditation, or approval, from METI. Each renewable resource has its own particular requirements, but there are several common denominators—each facility must be able to maintain its expected capacity during the anticipated term of the agreement with the electric utility; the facility must be capable of accurately measuring the renewable electricity supplied; the functions and operations of the facility must be specifically identified and reported to METI; and the installation and operating costs of the facility must be recorded accurately and periodically filed with METI.

Once a project is accredited, it may enter into an agreement with an electric utility, the terms of which are determined by METI. Electric utilities are obligated to accept requests from renewable energy producers to sign a contract to purchase its power at a fixed price, for a long-term period guaranteed by the government.

While bioenergy’s slice of renewable energy capacity has been set at up to 4.6 percent of Japan’s renewable energy mix, or 7.3 GW, if the number of currently accredited projects all came to fruition, that number would be significantly higher. That, however, is a very unlikely scenario. “The project pipeline in Japan is what I would call oversubscribed,” says William Strauss of consulting firm FutureMetrics. “If you add up all of the projects, the amount of power that would be produced is way more than the government envisioned for that slice of the energy mix.”

According to the Renewable Energy Institute, by the end of 2016, greater than 8.7 GW of bioenergy—800-plus projects—were registered under the FIT, closing in on twice the amount specified in the country’s energy plan. Just from 2015 to 2016, registered capacity increased five-fold, a surge that was caused by a looming cut to feed-in tariff prices.

Strauss says he believes the excess proposed capacity issue will self-correct, as many of the projects are based on Malaysian and Indonesian crude palm oil (CPO), which has been under intense scrutiny for alleged rainforest deforestation. “Almost half are based on CPO, and some are based on palm kernel shells (PKS),” he says. “The problem with those is that most of these IPP [independent power producer] projects will require financing—they will need debt to be built—and the lenders are very risk averse. They want a long-term fuel supply agreement in place, so there’s a lot of certainty that the project will able to produce electricity and enjoy the benefits of the FIT for 20 years.”

That kind of certainty is harder to secure with CPO or PKS, as their supply chains are not mature—like wood pellets, for example—and therefore, there is risk in fuel supply, according to Strauss. “There are no large counterparties to do a deal with for a long-term supply of fuel,” he says. “So the expectation is that many projects in the pipeline will never be built, and a good portion of those will be CPO and PKS.”

In fact, it’s likely that only about 30 percent of approved projects will achieve operations, says Takanobu Aikawa, researcher at the Japan Woody Biomass Energy Association. And though PKS has been speculated as a rival fuel source to pellets, like Strauss, Aikawa says he doesn’t believe it will be a main fuel for the Japanese power market, for the same reasons. Most of the projects that come to fruition, Aikawa says, will use wood pellets.

While Japan’s energy plan specifies that biomass material must be sustainably sourced, what that designation entails is still being determined, and power producers aren’t likely to take chances on their long-term fuel sources not meeting the criteria. Aiwaka points to a recent government report, which revealed that there are a lot of power plants that have proposed to use palm oil, and it invoked severe criticism of the energy plan. “Therefore, the government will require an internationally recognized certification scheme, such as RSPO for all palm oil projects,” Aikawa says. “Regarding solid biomass—wood chips and pellets—the government has been requiring forest certification so far, but this palm oil scandal could strengthen its verification process.”

There are domestic wood chip projects proposed as well, but they, too, involve challenges, Strauss says, and again, mostly in terms of demonstrating sustainability. “It’s a difficult market,” says Strauss, on domestic wood chips. “The landownership structure, and harvesting wood—it’s not easy to go in and do managed forestry like we see in North America. So some of the domestic wood chip projects will never be built, either.”

But when it comes to projects utilizing domestic resources, Aikawa adds, wood chips will be the leading fuel. As plans progress, power producers that invest in sustainable procurement systems together with forestry sector will gain an advantage, he says. “The same is true for imported biomass—this kind of long-term strategy will be a key to success.”

In all of this, there is good news for the wood pellet industry. “There are many long-term fuel supply agreements to be had, and that will support the project financing for these IPPs,” Strauss says, adding, compared to current global wood pellet production of about 60 million tons, it’s estimated new projects in Japan will create new demand for 4 million to 5 million tons—and maybe even more.

For now, the majority of wood pellet imports consumed in Japan are shipped from Canada. Producers there have found themselves at an advantage to those in the Southeast U.S., a region that has taken the biggest bite out of the bustling European market, but has not been able to capitalize on opportunities in Japan—at least, not yet.

Pellet Demand, Supply
In 2016, Canadian wood pellet exports to Japan surpassed 272,000 metric tons. That number is well above its exporting counterparties south of the border, but pales in comparison to the 1.6 million-plus metric tons the country exported that year to Europe, which still takes in around 80 percent of Canada’s total pellet exports. Out of the roughly 347,000 metric tons of wood pellets imported into Japan in 2016, around 75 percent was imported from Canada. That number dipped a bit to around 65 percent in 2017, with Vietnam picking up a little market share, but still a distant second, followed by China.

The most obvious advantage that Canadian producers have is proximity to Japan, says Gordon Murray, executive director of the Wood Pellet Association of Canada. “Our pellet plants are closer, and we have a reputation of high quality,” he says.

As aforementioned, sustainability is a big concern to the Japanese project developers, and Canada is best in class when it comes to forestry management. “They appreciate our almost universal forest certification,” Murray says. In Canada, most of the forests are government-owned, and close attention is paid to wood leaving crown lands.  “They have pretty rigorous methodologies on setting the allowable cut every year, to guarantee the forests are being sustainably managed,” Strauss says. “The Southeast U.S. doesn’t have the level of forest certification that western Canada does, it’s more risk-based, and that’s why the Sustainable Biomass Partnership is so popular with producers there.”

Both Murray and Strauss emphasize that the Japanese value relationships, and Strauss adds that many western Canadian producers have longstanding relationships with Japanese companies. “There is a large presence already trading into Japan and western Canada for lumber and other forest product materials,” he says. “Vancouver is a big hub for trading, so those relationships kind of carried over into the wood pellet space, and that matters when doing business in Japan, that buildup of trust.”

Those kinds of relationships could lead to strategies similar to the one recently deployed by Sumitomo Corp., which recently purchased a 48 percent stake in pellet producer Pacific Bioenergy Corp. PBEC operates facilities at three British Columbia locations—Prince George, Chetwynd and Ft. St John—and collectively produces more than 550,000 metric tons of pellets annually, the bulk of which has been exported to customers in Asia and Europe.  “Sumitomo is looking to increase their biomass presence in Japan, and the investment in Pacific Bioenergy is one way of securing supply,” Murray says. “Other companies have formed strategic relationships with the Japanese trading houses, and whether they become ownership stakes, I couldn’t speculate, but in terms of having secure relationships with the trading houses, that is key.”

While Vietnam gained some market share in 2016, there are questions about the industry’s sustainability practices there, and that may be a hindrance on further growth. “Most of their production is going to South Korea, which has less strict sustainability criteria, but that’s changing,” says Strauss. “There could be some sustainability concerns with Vietnam, but on an opportunistic level, if the Japanese are looking to fill in some low-cost supply on a spot basis, they might continue to turn to them,” Murray adds. “But if they want to make sure they have a reliable, secure and long-term supply, and are willing to pay a bit of a premium, we’re pretty optimistic we’ll be able to hold market share.

We still want to balance our production into Europe, to make sure we’re being prudent in terms of having diverse portfolio of customers, but definitely, we want to continue to benefit from our competitive advantage going into Japan. They value the sustainability, they value long-term, reliable supply, and we can offer all of those things. We aim to just keep building on that.”

Strauss says he believes that, though there is the challenge of longer distances by ship, Southeast U.S. producers like Enviva, which now has an office in Tokyo, are strategizing to become suppliers into Japan. “I expect they will have some success. Overall, North America will continue to play a significant role in that market I think, but there will be other players.”

Pinnacle Renewable Energy is one Canadian producer taking advantage of the bustling Japanese market. The longest-established wood pellet producer in Canada, Pinnacle is the world’s third-largest pellet producer, with nearly 1.5 million tons of annual capacity, and with current construction and expansion projects, that number will exceed 2 million tons in 2018. “Pinnacle is working flat out on a number of wood pellet fuel supply proposals in Japan,” says Vaughan Bassett, senior vice president of sales and logistics. “There is serious interest in long-term Canadian supply because of our proximity, quality, sustainability and actual track record in Japan.”

Bassett notes the different dynamic between making deals with customers in Japan versus Europe, where the company sends the bulk of its exported production. “The Japanese have a very much longer-term commitment to biomass than we have seen in Europe or the U.K.,” he says. “This is supported by the FIT, which is good for 20 years, versus 11 years in the U.K., for example. So wood pellet supply contracts that we are negotiating today in Japan start from around 2020, and will have a contract term of 10 to 20 years, taking them out to 2040 and beyond.”

Bassett adds that although Pinnacle expects subsidy support to continue in Europe, right now, it is only guaranteed to somewhere between 2024 and 2026. “Therefore, contracting certainty can’t extend beyond this time in Europe, currently,” he says. “This is unsatisfactory for European biomass users, but plays neatly into the Japanese requirements. Those wood pellet suppliers that are able to swing production from Europe to Japan will likely do so over time, to take advantage of the longer subsidy horizon available there. Pinnacle is well situated in this respect.”

For those North American producers seeing success with locking in long-term supply agreements with Japanese power producers, Strauss advises them to err on the side of caution, to safeguard themselves against one of a couple perceived flaws of the FIT.

Challenges With, Opportunities Beyond the FIT
The FIT has provided a generous subsidy—especially projects approved prior to October of this year. “It was 24 yen per kilowatt-hour (kWh)—now lowered to 21 yen, until they adjust it again,” Strauss says. “That translates into about $200 per megawatt-hour, depending on the exchange rate. They [power producers] can afford to pay for pretty expensive fuel, getting that much money for electricity sales.”

However, that rate is fixed over 20 years, and there is no adjustment for potential inflation. That leaves both sides of the equation in a bit of a predicament. “The power station has to make a deal on fuel supply such that the price of the pellets, or fuel, doesn’t increase so much over the term of the contract, that it takes away the margins,” Strauss explains. “In the early days of the contract, you’re getting 21 yen per kWh, and let’s say with pellets, it is 10 yen per kWh for generation costs. If pellet costs go up every year, at some point, if your total cost of generation exceeds 21 yen per kWh, you’re losing money. So the contracts have to be such that—the deal with the pellet supplier—has a known starting rate, and some kind of a fixed, annual escalator and terms such that at the end of it, the fuel cost isn’t so high that it kills the profit margins for the generator.”

That transfers the inflation risk to the pellet producers, who must ensure that the cost of producing pellets doesn’t increase faster than the fixed escalation rates. “And that’s a challenge,” Strauss remarks. “There hasn’t been much escalation in recent year—in fact, none in Japan, and low in North America—but suppose wood costs go up, or diesel fuel costs rise a lot—then their cost of producing pellets will go up, but the price they are getting for them is already fixed by that offtake agreement. So producers need to be careful in the kinds of deals they make, and also make sure that they do not see their profit margins go negative.”

Another flaw of the FIT, Aikawa says, is that it does not incentivize combined-heat-and-power. Few of the power plants that have begun operating thus far have been designed to utilize any heat, and electric-only plants typically operated at an electric efficiency of 20 to 40 percent, while CHP plants are near 80 percent, according to Aikawa. Profitability would improve if the plants sold heat—for example, as district heating—but as the FIT stands now, there is a reliance on the high rates, and the FIT applies only to electricity production.

While the FIT isn’t perfect, it is still in early, evolving stages, and will undoubtedly be a major catalyst in achieving Japan’s long-term energy strategy. In the meantime, for biomass use, the biggest question that remains is what kind of sustainability requirements the government will enforce, and how carbon footprints will be measured. “That’s still sort of a work in progress right now,” Strauss reiterates. “The FIT says you must have sustainably sourced fuel, but the definition of what that means has to be fully fleshed out. We’ll just have to wait and see where Japan goes with that.”

Author: Anna Simet
Managing Editor, Pellet Mill Magazine
[email protected]


Japan’s Port Bottleneck
By Tim Portz

With industrial pellet producers in both Canada and the U.S. counting on Japanese demand to deliver the annual volumes being forecast by many marketplace observers, the differences between this new demand center, and the industry’s first—the United Kingdom—are becoming more and more evident. In many ways, the industrial wood pellet industry couldn’t have asked for a better platform upon which to build than the Drax Power Station. The conversions at Drax created demand for millions of tons of wood pellets, all at the same location underwritten by the U.K.’s Contracts for Difference (CfD) scheme. The demand at Drax gave investors in the U.S. confidence to build not only production assets, but also vital port infrastructure. Similarly, ports in the U.K. were more than happy to invest in wood pellet handling and storage capabilities, particularly in the face of withering coal business. The Drax Power Station, almost by itself, enabled the industrial wood pellet sector to get off the ground in North America.

The opportunity in Japan promises to be the sector’s much-anticipated sequel, but the situation there lies in stark contrast to the opportunity presented to the sector by Drax. Brodie Govan, a biomass broker at Voyage Power, is arguably the most active wood pellet broker in the Japanese market, helping to arrange the first long-term wood pellet offtake agreement in Japan. From Govan’s perspective, one of the biggest challenges in the Japanese market right now is understanding which of the many projects being discussed and planned will ultimately be built. This reality is having the biggest impact on investment in port infrastructure. “There is such a lengthy list of projects in the pipeline that I’m not sure the ports know which ones to take note of,” he says. “They are inundated with potential projects, and I think it’s difficult to see which ones will come to fruition in the end.”

Being able to efficiently discharge pellets, handle and store pellets from a vessel is no small thing. At this year’s Exporting Pellets conference, hosted by the U.S. Industrial Pellet Association, the challenge of limited port infrastructure was a frequent topic of conversation. “It comes down to the cost of the vessel per day,” Govan says. “Each port has a different discharge rate that they can take those pellets from the ship into the port. In Europe, it’s probably around 10,000 tons per day. Then, a handy-sized vessel will come in, and be gone again in a few days. In Japan, if you are bringing in a larger vessel with 45,000-50,000 tons—which is pretty much what you have to do make it work pricewise, from shipments from the U.S. East Coast—and you’ve got a discharge rate of maybe 3,000 to 4,000 tons per day, a vessel is sitting at a port for maybe 10 days, and the cost of that is just prohibitive.”

There are additional factors are contributing to slower rate of investment at Japan’s ports. Coal volumes in Japanese ports have remained stable recently, while volumes in the U.K. have not. “Some of these ports in the U.K. that Drax is using for inbound wood pellets had really lost quite a bit of coal business,” Govan says. “They didn’t really have a choice. They had to convert to biomass to bring in new business. I’m guessing a lot of these ports in Japan don’t have that problem.” Govan’s observation is supported by trade data—since 2012, Japan’s coal imports have been stable with inbound coal volumes hovering around 180 million tons each year, the vast majority of those tons being bituminous coal. The U.K.’s coal volumes, while paling in comparison to Japan’s, nevertheless show a steep decline beginning in 2015, when imported volumes fell from 25 million to 15 million, and again to 6 million in 2016, just 20 percent of the volume the country brought in 2012. These falling volumes hit ports hard, and their willingness to invest in wood pellet infrastructure is easy to understand.

For now, Japan’s port infrastructure is stuck in a bit of a chicken-and-egg situation. Without a certain, bankable project, the motivation for a Japanese port to invest in wood pellet infrastructure just isn’t there, and without necessary infrastructure with which to receive wood pellets, projects needing significant volumes find themselves answering difficult questions about certainty of supply. Ultimately, Govan sees this situation working itself out, when one or more of Japan’s very large diversified trading companies, like Mitsui or Mitsubishi enter the marketplace. “Some of these large trading houses already own ports,” he says. “If they don’t own ports, they have very good relationships with the ports, a stake in them, or they will make the necessary investments at a port to handle these volumes.”

Govan says that, for now, this may leave some of the smaller projects and independent power producers on the sidelines, waiting on larger players to fund the infrastructure they’ll need for their inbound feedstocks.