Building Liquid Markets for Solid Biofuels

Driven by EU renewables targets, demand for biomass wood pellets is set to soar over the next decade as utilities displace coal-fired generation. How can the industry reconcile the primary criteria of a viable biomass supply chain: quantity and sustainability?

Once you realise that even sludge given away free by sewage farms can be a more expensive feedstock for power generation than coal, it is clear the power industry faces an uphill struggle to source enough sustainable biomass to supply a surge in co-firing and dedicated burning.
While utilities can and do burn hundreds of different types of biomass, literally almost any old rubbish such as chicken litter, peanut husks and olive stones, the most cost-effective biomass to displace coal in co-firing and conversion plants at serious volume is wood pellets. Although more than twice the cost of wood chips, pellets have 3.5 times the energy density by volume. Furthermore, pellets are usually made from compressing sawdust in pelletization plants, offering a standardised, industrialized product in large, easily transportable quantities.

So far, so good. At present, the global trade of wood pellets is a manageable 10-12 million tons per year. However, the use of pellets is rising extremely quickly, driven by EU targets. Around half of the EU’s target for providing 20 per cent of energy from renewable sources by 2020 will be made up by biomass, according to Member States’ National Action Plans. The European Pellet Council estimates that pellet imports to the EU increased 50 per cent in a single year, 2009-2010, to 2,523,000 tons, while trade within the EU rose 60 per cent to 3,445,000 tons. Overall, global trade could hit 60 million tons by 2020, it says. To meet this demand the industry will require large investment both in processing and in wood pellet feedstocks, while at the same time it needs to ensure supplies are sustainable.

Sourcing wood pellets

Power utilities are used to purchasing commodities towards the end of the supply chain – at the port of loading or discharge – on a long-term basis. At present for biomass this is simply not possible on a viable scale. Securing biomass is very difficult because there is no tradition of commitment to long-term contracts with suppliers, at least not of the kind to which the energy business is accustomed.

Some utilities have recognized the upstream risks by building and operating their own pelletization plants. RWE Innogy, for example, runs a 750,000 tons-per-year plant in Waycross, Georgia, U.S. Yet exposure to fiber market risks means power firms cannot secure the long-term price and volume of biomass, says Diekumo Anthony, biomass fuel developer at E.ON Climate & Renewables.

“The primary feedstocks of pelletization plants are sawmill residue and forestry residues like bark,” he says. “They are by-products of another market altogether. The entire biomass fuel supply chain on the power side is reliant on subsidies, while upstream the feedstock is led by the demand for timber from the U.S. construction industry. So the entire supply chain is floating in the middle of two uncertainties.

“The key players, the people who have control of the factors which create these risks, are not utilities or the biggest users of the product. Therefore, the price and volume of the feedstock for wood pellets is completely dependent on other markets. That presents huge risks in developing a secure biomass supply chain.”

The bulk of feedstock for wood pellets in North America, which accounts for two thirds of EU imports, comes from small landowners, with the rest coming from a handful of large forestry product companies traditionally supplying pulp, paper or other wood-based products. Anthony suggests the only way to manage these market risks is to take control of the supply chain as far upstream as possible, and to partner with forestry product suppliers owning vast tracts of forest.

Big role for forestry product companies

One such company is Weyerhaeuser. The Washington state-based company is the world’s largest private sector owner of softwood timberland, managing more than 8 million hectares of forest in the U.S. and Canada, as well as one of the world’s largest pulp and paper companies. James Leitheiser, director of global business services for Weyerhaeuser Solutions, believes the power industry is needlessly reinventing the wheel by manufacturing a product it does not truly understand.

“Forty or fifty years ago North America saw the same thing in the paper industry,” he says. “Paper companies owned forestry assets for security, but once the industry matured the supply and demand flow of raw materials changed. The paper supply chain does not exist in a vacuum; it is integrated with traditional forestry products. The economics of the supply chain mean that biomass has to be integrated into these products as well. The paper industry has already learned these lessons.”

In other words, utilities should leave wood pellet manufacture to forestry product companies that can harness their expertise and natural economies of scale to offer long-term security of supply, says Leitheiser. Weyerhaeuser is pushing a “Resource Forward” model, which it claims can reduce project risk and commercial risk for investors. Under this model, a large timberland owner with strategically located resources would bring the supply chain forward via an institutional investor to provide stable, relatively low-cost capital to build a pelletization plant in conjunction with an offtake partner. The offtake partner could be a utility or a biomass supply intermediary, such as a commodity trader, an energy company or an agribusiness, delivering wood pellets to European ports.

This “Biomass, Inc.” model is proving very attractive to investors. Biomass is on the cusp of a huge change, says Dr. Chris Rowland, senior research analyst at Ecofin, an investment management company specialising in energy.

“Many companies are eyeing investment in the biomass feedstock supply chain. We see potential in investing in assets along the entire chain, owning forestry, pelletization plants, as well as storage facilities at European ports.”

In the U.S., at least eight pelletization plants with capacities of 500,000 tons per year or more are now in the design stage, potentially giving a huge boost to current annual capacity of 2 million tons, says Leitheiser. “All this must be done to scale in order to be successful,” he says. “If you build half a dozen of these plants you start to get significant volumes to market and economies of scale.”

Utilities want to take more price risk

Not all market players wish to tie up their supply of wood pellets in long-term contracts. Jorrit Hachmer, vice president of Biofuel Trading & Development at RWE, sees a need for floating price contracts that allow end users to reduce credit risk by trading price risk, separating it from the physical commodity, as happens with coal and other energy commodities.

“We’re pretty comfortable with buying short. This hasn’t been the problem so far. A floating wood pellet price element within supply contracts would allow us to trade derivatives with banks and other investors,” he says. “The only alternative is to continue with the status quo, where the buyer has to calculate risk premiums, which in the end makes the product more expensive. Credit is a big challenge and we’ll need a lot of it to build these pelletization plants. If we want to maintain cost leadership of renewable energy, it’s important that we use credit in the right way so that biomass is not overpriced.”

Weyerhaeuser’s Leitheiser says its Resource Forward model incorporates an element of floating prices so that trading companies can partake in price risk. “It’s almost always cost-effective to source some supplies on a short-term, spot basis from third parties, but having a long-term anchor supplier offers a great deal of security to end-use customers and investors,” he says.

Trading biomass

As utilities tend to produce pellets themselves, pricing biomass can be a challenge. In November 2011, Amsterdam-based energy exchange APX-ENDEX launched the world’s first biomass exchange. In phase one, the exchange started with non-cleared wood pellets, meaning the physical settlement is arranged bilaterally between the counterparties after trade has been concluded.

Phase two, scheduled for later this year, will include implementing clearing services for wood pellet contracts with a contribution from the Port of Rotterdam’s “BioPort” in shipping, storage and distribution. These contracts enable end users and institutional investors to hedge themselves against price movements, while producers will be able to sell biomass on a longer-term basis in order to access working capital, says APX-ENDEX’s futures manager Paul Groes.

As yet there have been no trades on the exchange, says Groes, but several banks, hedge funds and other institutions have expressed an interest in trading cleared contracts. “We are now developing the concept of clearing in conjunction with European Commodity Clearing,” says Groes. “We have three or four concepts on paper and we will make a decision in due course.”

A key challenge for APX-ENDEX and other commodity exchanges seeking to offer biomass trading is the lack of international standardization of wood pellets. APX-ENDEX’s current product specification criteria are based on input from its pricing panel, which includes E.ON, RWE, Eneco, Dong and Electrabel and suppliers like Enviva, but the exchange will adjust to any moves by the industry to introduce standardization, says Groes.

Peter Rechberger, general manager of the European Pellet Council, says wood pellets must become a clearly defined commodity to compete against fossil fuels. “There is no EN (European Standard) for industrial pellets yet, although the power sector has virtually defined its own industrial pellet qualities: I1, I2, I3,” he says. “We are working with IWPB 1 (Initiative for Wood Pellet Buyers) to include industrial grade certification as part of PellCert, which aims to develop an ENplus2-compatible certification scheme for industrial wood pellets that also incorporates sustainability.”
Sustainability, sustainability, sustainability

Sustainability is critical to the biomass industry, as utilities are acutely aware. So far, many European utilities have effectively self-certified their biomass as sustainable. For instance, British generator Drax’s “Sustainability Policy” rules out burning any biomass that does not reduce carbon dioxide versus the coal alternative.

But rising demand will increase the amount of fresh wood needed from forests, an area coming under stricter control from the EU. German utility RWE npower, which operates the ill-fated Tilbury coal-to-biomass conversion plant that caught fire on 27 February, 2012, says UK demand alone could hit 11-12 million tons of pellets by 2015, equivalent to 22-23 million tons of fresh wood.

Sawmill residues can only be expected to provide half of the fiber for this volume of wood pellets, says Karine Culerier, senior market analyst, RWE Supply & Trading. “More and more volume from sustainability-certified forests will be needed,” she says.

At the end of 2011 the UK adapted the Renewable Energy Directive for biofuels and bioliquids to block extraction for solid biomass from primary forests, peatlands, wetlands, grasslands and land for nature preservation, she adds. Crucially, forests with a land use change after January 2008 will not qualify for ROC (Renewable Obligation Certificate) support.

As a result, commercial forest thinning is developing, she says.The increasing volume of fresh wood required has also boosted sustainability schemes such as the Green Gold Label, although the proliferation of such schemes – to 67, according to a University of Utrecht study – is slowing the development of the supply chain. RWE’s Hachmer calls for a single, Europe-wide sustainability scheme. “The lack of one is harming the industry,” he says. “We need to convince the public that biomass is sustainable. Without public support, there will be no industry.”

Caroline Season, senior policy adviser for bioenergy at the UK’s Department of Energy and Climate Change, says a European Commission report on requirements for EU-wide sustainability criteria for solid biomass is imminent. “Two years ago they said there was no need to bring in an EU-wide approach but individual Member States could introduce their own criteria. Of course, the Commission could decide to take a different view in the report. They have signalled quite strongly in an earlier report that solid biomass should be consistent with transport biofuels, with a minimum greenhouse gas emissions reduction and some restrictions on sources, such as primary forests or wetlands.”

Hachmer rejects fears that large chunks of Brazilian rainforest will be burned in European power plants. “All the hurdles of sustainability, credit, finance and logistics will show that easier tonnage will be out of North America.” He also considers that stricter sustainability rules will in the long run be “more cost-efficient”, although he warns that they will bring a great deal of administration and companies may struggle “on the paperwork side” to keep up the growth in demand.

Not all European utilities support using biomass in large combustion plants. Dr Bernhard Graeber, director of Renewable Energies & International Climate Projects at another German utility, EnBW, would prefer biomass to be burned at its country of origin.

“It’s wrong for Europe to subsidize power generation which makes it feasible to transport wood from the U.S. and Canada,” he says. “It would actually make more environmental sense for these countries to use this biomass to displace their own coal generation and export more coal to Europe. To have a sustainable development of biomass it has to be home-grown. The German model is based mostly on small, decentralized biomass units fired by energy crops sourced by local farmers. It’s not the intention of Germany to import massively.”

It has yet to be proven whether utilities will be able to source enough biomass on a sustainable basis. Europe is essentially conducting a very large experiment to see if it can.

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