The Wood and Fiber Supply Chain Experts
The Future of Wood Fiber Supply Agreements
From the August 2009 Forest2Mill newsletter.
Globally, securing a steady and affordable supply of feedstock has
become critical path for wood bioenergy companies. As plant completion dates draw nearer, many
energy producers are in discussions with wood suppliers as part of the process of understanding
their wood basins (what energy producers call
supply sheds), identifying suppliers and determining the characteristics of mutually
beneficial supply agreements. As this process gears up, it is almost certain to ripple into the
supply agreements of competing users of wood fiber.
One of the obstacles in this process is that energy producers and wood suppliers
have differing expectations about 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 for coal. 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 refers 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 also 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 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 operating in
contracting industries. 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.fs.fed.us.