Wood Bioenergy: The Rise and Fall of Wood-Based Biofuels, Part II

20 07 2013

This post includes an excerpt of the feature article in the May/June/July edition of Wood Bioenergy US (WBUS) written by Brooks Mendell, Ashley Barfield, and Amanda Lang. It is the second part of a two part series on liquid biofuels.

Investors in wood-based biofuels must keep in mind how ethanol investments have generally lost their luster.  John Eligon and Matthew Wald of The New York Times summarized the struggle of hundreds of corn ethanol plants built throughout the U.S. Corn Belt with government subsidies and mandates (“Days of Promise Fade for Ethanol”, 3/16/13). According to the article, “thousands of barrels of ethanol now sit in storage because there is not enough gasoline in the market to blend it with…”

Regardless of the quality and status of individual technologies and plants in development, analysis of public firms active in the wood biofuels sector confirms how they continue to face extreme economic and market challenges.  First and foremost, ethanol-related production efforts operate in an over-supplied, low-demand market.  The U.S. is flush with excess ethanol production capacity and, thanks to blending walls and other logistic limitations, is holding the bag for a product with few customers.  This is economics 101.  Second, high production costs for wood biofuels, even as firms show progress and improve yields, actually can look worse on a relative basis as the prices for alternative fuels, such as natural gas, decline.  Through no fault of the U.S. biofuels sector, it remains subject to external benchmarks and exogenous forces that erode progress and diminish the attractiveness of wood biofuel investments.  Third, time works against wood biofuel projects in the U.S. when evaluating wood feedstock strategies and alternatives.  With an improving economy, demand for wood raw materials from traditional forest industry users such as building product manufacturers and pulp and paper producers is increasing.  In addition, wood bioenergy projects with existing markets and ready technology, such as wood pellet producers, are increasing production and investment in new capacity.  All of these factors push potential wood biofuels projects to the back of the line for securing woody feedstocks.   As a group, these firms have shrinking relevance to timberland owners and wood raw material competitors.

WBUS Market Update:  As of July 2013, WBUS counts 459 announced and operating wood bioenergy projects in the U.S. with total, potential wood use of 128.6 million tons per year by 2023.  Based on Forisk analysis, 296 projects representing potential wood use of 78.5 million tons per year pass basic viability screening.  To download the free WBUS summary, click here.


Assessing Mill Risk when Analyzing Timber Markets and Wood Baskets

16 06 2013

In evaluating timber markets and wood baskets for forest industry and bioenergy investments, a key concern is the “riskiness”, health and competitiveness of wood-using manufacturing facilities in and near the market.  Timberland investors want to confirm that the mills will remain open for years to come to buy their trees and logs.  Existing wood-using mills have interest in the health of their competitors for wood raw materials.  And new wood-using plants – such as bioenergy projects – want a sense for the potential that existing wood-users may have outlived their usefulness and may slow down or shutter, thereby alleviating competition for desired raw materials.

When analyzing mill risk, consider three categories of analysis:

  1. End markets.  Are the end markets – such as newsprint versus fluff pulp versus linerboard – served by the mill strong or weak?  The answer to this question is observable and can be answered with readily available data.  It provides a powerful, first-cut at the situation for mills in the market.
  2. Firm commitment.  Ultimately, are the corporate parent and owners demonstrating high or low commitment to the continued operations of the mill?  We maintain a checklist of items that, for the most part, are answerable with publicly-available information.  Questions on this list include, for example, employment levels and hiring activity, signs of community involvement, and capital allocation as disclosed in press releases or public filings.
  3. Facility health.  Is this facility, in its structure and equipment, old or new?  Does it employ cutting edge technology?  What is the “ability to pay” for raw material?  How efficient is the plant relative to others in its industry and market?  While this is the most difficult of the three categories to assess, strong conclusions on “end markets” and “firm commitment” usually correspond with conclusions associated with facility health.  In this way, each of the categories serves, at some level, as a proxy for the others.

Forisk will discuss risk analysis of wood-using mills  during “Timber Market Analysis” on August 12th in Atlanta, a one-day course for anyone who wants a step-by-step process to understand, track, and analyze the price, demand, supply, and competitive dynamics of timber markets and wood baskets. For more information, click here

How Reporters Miss the Forest and the Trees When Covering Wood Bioenergy Markets

3 06 2013

While the general public’s understanding of wood bioenergy remains incomplete, recent reporting on the issue fails to meaningfully inform readers on the status of woody biomass supplies and the actual development of wood bioenergy markets in the U.S.  In fact, several articles suffered from three common errors we observe in major media coverage:

  1. Failure to provide context.
  2. Improperly assigning “causal” relationships.
  3. Errors of fact.

For example, Roger Harrabin of the BBC, in a March 5, 2013 article “Biofuels: MPs to Consider Subsidies for Power Stations” about potential subsidies for using wood at power stations in the UK, reported that power producer Drax plans to convert approximately half of the boilers at its coal-fired power station in Yorkshire to wood pellets.  Harrabin notes that this would “burn more wood than the entire output from the UK’s timber industry.” And how much wood would that be?

This took four minutes to track down and summarize using the online “ForesSTAT” database from the United Nations. The UK produced one-half of one percent of the world’s industrial timber in 2011.  The U.S. timber industry is 32 times bigger.  EU timber production is over 38 times bigger.  This failure to provide context for UK’s timber industry is like reporting on hamburger sales in India or breweries built by BYU graduates.  While these could prove interesting, the numbers may prove trivial.

A more recent May 28, 2013 report by Mr. Harrabin, “Renewable Energy: Burning US Trees in UK Power Stations”, further addresses the growing trade of wood pellets from the U.S. to the UK.  While the story gives ink to all sides, it lacks the context to illuminate the scale or likelihood of operational impacts on U.S. forests from UK pellet demand.  In fact, bioenergy is a relatively small business in the U.S. and will remain that way for the foreseeable future.  Readily available research and studies conducted by private firms and conservation groups, while sometimes diverging on potential implications, generally align with the facts on the current state of affairs.  One study is “Biomass Supply and Carbon Accounting for Southeastern Forests” conducted for the National Wildlife Federation and the Southern Environmental Law Center (with whom Mr. Harrabin produced an interview).  The study incorporates academic and private studies, and provides necessary context relative to potential policy outcomes.

In “Limits to Growth: Wood Pellet Production in the U.S.”, Forisk addresses the issue by quantifying how the actual growth of bioenergy relative to available resources in the U.S. can be understood.  In “Three Realities of Wood Bioenergy and Forest Owners”, Forisk specifies areas of direct relevance to timberland owners and legislators that forest analysts understand well and can address with authority and data: bioenergy project failure rates, forest landowner behaviors that increase long-term supplies, and wood supplier adaptability.  New wood markets do not create a frenzy of forest harvesting.  Forest owners and wood suppliers adapt through improved forest management, incremental growth of logging operations and utilization of previously underutilized wood raw materials.

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On Tuesday May 28, 2013, the Wall Street Journal published a front page story related to wood bioenergy markets that managed to score the trifecta and feature all three common errors appearing in media reports related to wood and timber industries.  Posted online on May 27th, the article, “Europe’s Green-Fuel Search Turns to American’s Forests” by Justin Scheck and Ianthe Jeanne Dugan contains factual errors, fails to provide context or measures of scale, and improperly implies causal relationships.  Ugh.  A few examples include:

  • The article does not scale UK demand to the U.S. forest industry.  During normal economic conditions, the U.S. forest industry consumes ~500 million tons of wood per year.  Currently, the U.S. is exporting on the order of 2 million tons of pellets per year.
  • “….Europe doesn’t have enough forest to chop for fuel…”  Not true.  Europe has 25% of the world’s forests.  While the article notes that “many restrictions apply” to Europe’s forests, it does not question the quality, usefulness or soundness of these restrictions.  The bottom line is that Europe may actually have enough wood, but chooses not to use it.
  • Many of the pellet-making plants springing up in the U.S….are near pine plantations established long ago partly to serve the now-slumping wood-pulp market.”  The reference to the “slumping” pulp market is factually incorrect and easily knowable.  This is a critical miss because the U.S. pulp and paper mills dominate the market for the low valued wood raw materials of interest to wood pellet producers.

The Wall Street Journal also dwells on the topic of swamp logging in North Carolina.  Few people would look to swamp logging as inherently desirable or preferable for a host of reasons.  However, it represents between 1% and 4% of related forestry activities, and the article skirts the primary economic drivers and realities for U.S. forest management.  Regardless wood pellet demand in the UK, forest owners in the U.S. will not overhaul their long-term forest management strategies or harvest practices for pellet markets.  The economics don’t make sense.  The U.S. remains a “sawtimber” market where landowners grow trees for lumber production.

In forestry, a natural tension exists between the unfettered exercise of private property rights and the biodiversity preferences of third-party conservation groups.  This “tension” is important.  Market incentives help ensure that private forests remain productive and forested, while spotlights on best management practices that protect soil integrity, water quality and wildlife habitat support long-term forest health.  This tension, like a tug of war, puts someone in the mud once in a while.  Sometimes a landowner cuts trees you might not cut, and sometimes states or groups seek a rule that restricts private property owners in an unreasonable way.  That is part of the back-and-forth.

Wood bioenergy in the U.S. faces limits to growth.  No one will be vacuuming U.S. forests to feed UK power plants.  The economics, logistics and sustainability of such strategies fail on multiple levels.  This is why markets in other regions such as South America, Russia and Canada continue to scale up capacity.  The facts, context and market relationships highlight a stuttered, evolving wood bioenergy market in the U.S. that continues to feel its way forward as part of the large, established wood-using forest industry.

Forisk will cover wood bioenergy market analysis during “Timber Market Analysis” on August 12th in Atlanta, a one-day course for anyone who wants a step-by-step process to understand, track, and analyze the price, demand, supply, and competitive dynamics of timber markets and wood baskets. For more information, click here

Wood Supply Agreements, Part II: Basic Principles for Transfer Price Calculations

12 05 2013

This is the second in a two-part series related to wood supply agreements and their relevance to analyzing timber markets.

Part I of this series on wood supply agreements introduced basic pricing mechanisms often used in supply agreements and associated concerns raised by parties to these agreements.  Bioenergy firms new to local wood markets, in particular, focus on potential conflicts of interest associated with price indices or pricing mechanisms implemented by the same firm that collects and reports the underlying price data.  They ask “how reliable and independent are these data sources and indices?”

As a general rule, we find it helpful to avoid swimming in the toilet or peeing in the pool.  Clear, verifiable methodologies for collecting data and reporting changes over time facilitate strong wood supply relationships.  In specifying these methods, parties in a long-term wood supply agreement may rely on a set of working principles.

We believe the following three criteria for establishing an independent pricing mechanism include the proper principles while maintaining the practical necessities of an operational transfer price in a real world forest products or bioenergy supply agreement:

  • Reflects market prices: The log or wood transfer price should approximate an “arms-length”, market based price. While the transfer price may deviate from the market price for a given month, the prices paid by the mill or bioenergy plant for raw matieral over time should minimize the perceived and actual missed opportunities of bypassing other customers and markets.  This criterion passes the fairness test and retains the benefits of operating in a market environment.
  • Easy to implement and to use: The model should be easy to understand, easy to explain, and easy to use.  Complex transfer pricing methods do not create value for business owners; simple transfer pricing models allow managers to focus time and resources on operating the business.
  • Retains flexibility:  At times, the two parties may feel the transfer price requires an adjustment.  Rather than disregard the model to make an adjustment, an approach should be determined in advance for adjusting the model or revising the price. As such, the option would exist for both parties to agree to periodically review and revise, if necessary, the transfer price based on new information or on a region-wide log price index.

Situations exist when both parties want to revisit prices and how they were calculated, and accounting for this in advance based on clear principles can minimize unnecessary costs, friction and arbitration.

For investors and analysts evaluating wood and timber markets, Forisk offers “Timber Market Analysis” on August 12th in Atlanta, a one-day course for anyone who wants a step-by-step process to understand, track, and analyze the price, demand, supply, and competitive dynamics of timber markets and wood baskets. For more information, click here

Wood Supply Agreements, Part I: Pricing Mechanisms and Market Analyses

9 05 2013

This is the first in a two-part series related to wood supply agreements and their relevance to analyzing timber markets.

In his 1989 book Liar’s Poker, Michael Lewis wrote, “Risk, I learned, was a commodity.  Risk could be canned and sold like tomatoes.”  This represented a prevailing view among the sophisticates of Wall Street prior to the mortgage bubble and collapse of AIG.  Though the view of risk “as a commodity” varies over time, it remains critically important to managers and investors exposed to timberlands and wood-using assets.  One tool employed to mitigate risk in timber-related industries is a wood supply agreement.

Forest industry managers and bioenergy project developers sometimes use wood supply agreements to manage the costs and flows of logs and other woody raw materials to manufacturing facilities and bioenergy plants.  Integrated forest products firms also used them to work through the operational impacts of timberland divestitures.  A typical agreement comprises a contractual obligation by a supplier to provide agreed-to volumes of wood to a buyer, who commits to purchase this raw material at the contract price.

Most agreements reflect a tradeoff between security and flexibility.  In guaranteeing volumes, the supply agreement secures supply for the mill and a market for the timberland manager.  The aspects subject to negotiation include product, volume, timing, and price.  Product specifies the species and “specs” of the product to be delivered.  Pine pulpwood or hardwood logs?  Volume specifies the amount of wood covered under the agreement, whether it is fixed or a range.  Timing specifies the timeframe covered, and the time periods for actually delivering the wood.  Price specifies the method and manner for pricing the wood delivered, and the process of updating and communicating this price.

The “pricing mechanisms” built into wood supply agreements are of central importance.  They have influenced many a bonus, ulcer and sleepless night.  How can fair prices be calculated over time that account for actual market activity while minimizing the “penalties” for being locked into a set marketing arrangement?  Existing supply agreements attempt to balance two competing aspects of pricing wood based on available data.  The first asks the question, “How does the market price this wood?”  The second asks, “What is the value of this wood in the market?”  The first is the question of the wood buyer, and the second is the question of the stumpage seller.

Common approaches include rolling averages, indexing, and blended indexing.  Rolling (moving) averages are used within the forest products industry, and in other heavy industry settings, to calculate transfer prices and for raw material supply agreements. One advantage of a moving average is that it reduces the peaks and valleys associated with changes in log prices.  One disadvantage is that, for any given month, the transfer price lags the actual market price, though this should balance over time.

Recent issues related to supply agreements have focused on reduced confidence in the data underlying a supply agreement and concerns about conflicts of interest associated with pricing mechanisms or indices provided by the same firm that collects and reports the underlying price data.  These issues become relevant when conducting due diligence on timber markets or wood baskets as they can affect the ranking and risk assessments associated with potential or existing wood procurement strategies.

For investors and analysts evaluating wood and timber markets, Forisk offers “Timber Market Analysis” on August 12th in Atlanta, a one-day course for anyone who wants a step-by-step process to understand, track, and analyze the price, demand, supply, and competitive dynamics of timber markets and wood baskets. For more information, click here

The Rise and Fall of Wood-Based Biofuels, Part I

16 04 2013

This post includes an excerpt of the research in the February/March/April edition of Wood Bioenergy US (WBUS) and is the first part of a two part series on liquid biofuels.

In May 2011, Forisk and the Schiamberg Group evaluated the viability of 36 wood biofuel projects in the United States.  The study emphasized the unlikely and problematic development of the wood biofuels sector while singling out projects with drop-in fuels and specific technology types as having investment potential for investors.  As of April 2013, 13 of the original 36 projects have been cancelled and 12 remain in the planning or construction stages.  Four have been shut down.  Since the 2011 study, ten new wood biofuel projects have been announced.  New projects emphasize feedstock flexibility beyond wood raw materials and focus on multiple, existing end markets including diesel, sugars and industrial chemicals.  Analysis of potential wood use highlights the minimal relevance of the biofuels projects to timberland investors in the U.S. today and over the next ten years (Figure 1).  


Newly announced wood biofuel projects have become increasingly less ambitious and less relevant to forest industry firms and timberland investors.  Analysis comparing projects in 2013 to those from 2011 find that current projects use less wood and scale at smaller production levels.  Meanwhile, the traditional forest products industry is reopening closed plants and building new capacity in response to increasing housing demand.   

In the bioenergy sector, wood pellets provide a ready, realizable market.  The enthusiasm for wood biofuels from a few years ago has been replaced with well-earned skepticism and caution. For timberland investors, potential demand and wood-based revenues from biofuels have been discounted.  For traditional forest industry firms, biofuel worries have been replaced by demands to be treated fairly in legislation or mandates that could affect wood raw material costs.  And for biofuel investors and project developers, the needs to produce product for existing markets that can produce cash today have strengthened business models and modified expectations for potential growth in the next five years. 

WBUS Market Update:  As of April 2013, WBUS counts 456 announced and operating wood bioenergy projects in the U.S. with total, potential wood use of 125.0 million tons per year by 2023.  Based on Forisk analysis, 293 projects representing potential wood use of 75.4 million tons per year pass basic viability screening.  To download the free WBUS summary, click here.

Forisk Forecast: Expanding the Panama Canal

26 02 2013

This is the third in a series related to Forisk’s 2013 forecast of softwood stumpage prices in the United States.

One of the best books I read in 2012 was David McCullough’s The Path Between the Seas about the building of the Panama Canal.  Early in the book, McCullough summarizes the prognosticating efforts of those studying and considering in the 1800s alternatives for slicing a path through the isthmus of Central America at Nicaragua or Panama to connect the seas.  McCullough notes that:

….all the canal projects proposed, every cost estimated, irrespective of the individual or individuals responsible, were hopelessly unrealistic if not preposterous.  Every supposed canal survey made by mid-century was patently flawed by bad assumptions or absurdly inadequate data.  Assertions that the task would be simple were written by fools or by men who either had no appropriate competence or who, if they did, had never laid eyes on a rain forest.

While McCullough falls (just) short of crucifying the analysts and pitchmen of the day, his language quickened my pulse and reminds us all to confirm assumptions on the ground, check data and respect context.  In the end, we must take a position on what’s “doable.”

In December, I visited the Panama Canal.  The largest ships began outgrowing the Canal in the 1980s. In 2007, Panama officially started an expansion project that will add a third lane to the Canal.  Scheduled for completion in 2015, the Panama Canal expansion will allow significantly larger container ships to short-cut the trip from Asia to the East Coast in the U.S. and elsewhere.  A critical limiting issue remains.  Tom Heagle at ASF Logistics highlights how most East Coast ports currently lack the necessary depth and/or maneuvering space and/or suitable cranes and/or docks to handle the enormous ships.

In studying and tracking log and lumber export markets, we model potential implications from the Panama Canal.  In practical terms, 2013 will not be the year the Canal Expansion influences stumpage (or lumber) prices in the United States.  Neither will 2014.  For U.S. stumpage and log forecasts, keys include competitively priced supplies – influenced through imports and exports that may or may not change due to the Expansion – relative to U.S. demand.  The economics of utilizing an expanded Panama Canal fail to qualify as a “no-brainer”; it simply opens a trade-off between total time and total cost.

To learn more about the 2013 Forisk Forecast and its assessment of the economics of the Panama Canal, contact Brooks Mendell at bmendell@forisk.com, 770.725.8447.