Will Bioenergy Demand Have an Effect on Wood Fiber Supply Agreements?

From the August 2009 Forest2Fuel newsletter.

Globally, securing a steady and affordable supply of feedstock has become critical path for the wood bioenergy industry. As plant completion dates draw nearer, many energy producers are in discussions with wood suppliers as part of the process of understanding their supply sheds (what forestry professionals call wood basins), identifying suppliers and determining the characteristics of mutually beneficial supply agreements.

One of the largest gaps between energy producers and wood suppliers can be found in their differing perspectives on the length of supply agreements.

In the energy sector, it is a long standing practice for producers and suppliers to enter into long-term supply agreements. For coal, it is not uncommon for supply agreements to run from 15-20 years. In March of this year, for instance, Peabody Energy entered into a 17-year supply agreement. In April, Royal Dutch/Shell signed a supply agreement for liquid natural gas; the length of the contract was 20 years. A recent news report about supply agreements in the energy sector from around the world refer to 7-year agreements as medium term.

Renewable energy sources, to date, have followed this same pattern. For instance, Excel Energy, an electricity and natural gas company with operations in 8 states in the West and Midwest, announced in April that it signed a 10-year deal for renewable natural gas with Microgy, which uses an anaerobic digestion process to break down animal waste from local dairy farms. The deal comes with an option to renew for an additional 10 years.

These longer term supply agreements are preferred by wood bioenergy companies as well. Outside of being standard practice in the energy sector, these companies have to face steep uphill battles for financing. Investors and bankers look closely at the stability of fuel supply, as the cost of fuel generally represents approximately half of a company’s operating expenses. To get financing, these companies are faced with having anywhere from 50 to 80 percent of their supply agreements in place.

In a recent survey conducted by the Empire State Forest Products Association, one banker indicated that “for other energy projects, there are investment-grade suppliers who are able to sign long-term contracts. This is typically not the case with biomass a[s] local markets, transport costs and overall costs are volatile. Without long-term contracts, you are at risk of indeterminable feedstock costs.” As a result, “fuel supply certainty” (including long-term contracts and supplier creditworthiness) is one of the most important project investment criteria.

Given the very real prospect that the emerging wood bioenergy industry will not get off the ground without long-term supply agreements, it’s understandable that bioenergy companies are seeking longer term contracts. The issue, of course, is in the meaning of long term. In the forest products industry, one year is considered long term. While there are occasional longer term agreements—such as those integrated forest products companies made to secure their supply when they were divesting themselves of timberlands—agreements lasting six months to two years are more the norm in the industry.

In the current business environment, landowners are faced with customers from industries that are contracting. The pulp and paper industry is flat to decreasing. It is uncertain when and where the housing market (and demand for building products) will find a new and diminished normal. As the one expanding segment of the wood fiber customer base, the energy sector will account for a growing percentage of demand. For timberland owners, the new markets for both domestic and international energy sources will represent opportunities for diversifying their business. In order to take advantage of these new markets, timberland owners looking toward the future may want to adjust their business models, including the length of supply agreements, to meet the requirements of the energy sector.

As more wood bioenergy production comes on line and landowners make this transition, the definition of long term will migrate. While it isn’t likely to extend to the energy sector’s 15 to 20 years, terms of 5 to 7 years may be on the horizon.

Source:
The results of the Empire State Forest Products Association surveys, “Establishing Long-Term Supply Agreements for Wood Energy Facilities,” can be found at www.na.fw.fed.us.

To register and read more about the Forest2Fuel e-Newsletter, click here.