March 25, 2016
BY Katie Fletcher
People across the U.S. have enjoyed the perks associated with cheap fuel oil and mild winter weather in recent months. Yet, for those whose livelihood depends on producing a product that must not only compete with fuel oil, but also attains its value with cold temperatures, those perks come at a price. Mid-February, over 50 percent of pellet producers reported running their plants at 75 percent or less of its capacity, and by the time you read this story, more producers will likely have ratcheted back production to a trickle or, in some cases, stopped altogether. Well over half of pellet manufacturers decreased their production hours this year compared to their long-term average, and nearly 40 percent decreased overall plant staffing. These disappointing figures come from the producers themselves. A sampling of 50 North American pellet producers responded to an online survey Pellet Mill Magazine distributed in February. The data derived from the 12-question survey surmises how current market conditions are impacting individual pellet operations and, when taken in aggregate, provides a reflection of the overall health of the pellet industry. The 50 survey respondents are representative of the industry as a whole, but the data was self-reported and gathered without random sampling techniques. Respondents represent a variety of plant sizes across every region of North America: 13 North Central U.S., 10 Northeastern U.S., eight Southeastern U.S., five Northwestern U.S., five Southwestern U.S., four eastern Canada, and four western Canada.
Producer Confessions
Patrick Curran owns and operates Curran Renewable Energy LLC’s 120,000-short-ton-capacity pellet plant, which utilizes feedstock from nearby sister company Seaway Timber Harvesting located in northern New York along the U.S., Canadian border. “Factors affecting our pellet production today include oil prices, the effects of a strong El Niño and a Canadian/U.S. dollar exchange rate, leading to a perfect storm in the pellet world," Curran says. "Fossil fuel prices fell quickly and to a near record low. Couple this with record warm temperatures and an unfavorable exchange rate between the U.S. and Canadian dollar to complicate an already challenging market.”
This isn’t the first time producers have had to weather through a perfect storm of conditions. “We’ve been through this before—this happened at the end of 2009 and all through 2010,” says Northeast producer Mark Wilson, CEO at New England Wood Pellet LLC. “The cliff the industry just hit here in the Northeast—everyone shut down or is hardly running at all.”
The four NEWP plants collectively have a capacity over 300,000 tons annually. NEWP’s financial position has allowed production to continue for the time being, but it has slowed down some. Wilson anticipates ramping up production again late this summer. “I think the market is going to be significantly reduced this year,” Wilson says. “There will be some inventory carryover because consumers did not burn anything in November and December for heat, and oil prices will play a factor in 2016.” Still, Wilson sees value in being prepared with available inventory, “because even if the market is half of where it should be, there is still going to be one,” he says.
Further south resides Turman Hardwood Pellets 28,000-short-ton-capacity plant in Galax, Virginia. “It was a record-breaking spring for us, everything went wide open continually until around the first week in December and then everything slowed down,” says Ruth Elliott, sales manager with Turman. “From what I hear from our dealers, the consumers were buying early, preparing, stocking up, so they wouldn’t be caught without, and then winter just didn’t show up. Retailers stocked their stores, but no one needed the pellets very much, once December arrived.”
Not only producers in the East are having to scale back production. Out West, Chris Sharron with West Oregon Wood Products joins a number of producers who are biting the bullet. The company’s two pellet production plants in Banks (30,000-short-ton-capacity) and Columbia City (50,000-short-ton-capacity), Oregon, were running half throttle since the beginning of December, and have since wound down to a standstill. “We’ve seen it time and time again,” Sharron says. “There is a soft season for whatever reason—weather is usually the big culprit—so during the cycles, you always have this lag time of wondering what happens from here on out.”
The West has experienced mild weather in recent years, but not to quite the extent as those in the East this past winter. “Where we’ve had two very mild winters the past two winters and basically a normal to slightly colder winter on the West Coast this year, the majority of the producers out East had a dreadfully warm winter this year,” says Stan Elliot, vice president of Pacific Coast Pellets.
Pacific Coast Pellets 50,000-short-ton-capacity operation in Shelton, Washington, emerged as an anomaly in some areas addressed with the survey. “We are fairly unique in that our owner was in the right place at the right time when we purchased our business, so we don’t have the debt load that many of our competitors have,” Elliot says. “I’m certainly aware that not only are there people stressed, there is actually a fairly significant pellet manufacturer out here who has his plants up for sale because of his financial situation.”
Plant size, in some cases, factored into a plant’s stamina against current market constraints. Midwest producer Gene Merkley’s Southern Indiana Hardwood pellet plant produces around 11,000 to 12,000 tons of pellets on an annual basis, which is then distributed, for the most part, through big box retailers. “We’re just a small company, we’re not one of the bigger players out there,” he says. “Our market hasn’t changed in the past two to three years because we deal with steady customers, and really there is very little variation on our markets that we have.”
A number of factors play into the robustness of a pellet operation, and when it comes to market conditions, their influence can vary by region. Regardless of the pellet business and locational dynamics, when taken as a whole, there are few industry stakeholders with product in North American heating markets who will dodge this storm.
Market Manipulators
Weather comes to the forefront as the reason for the domestic heating market’s current state. Information collected from the industry survey revealed that 64 percent of producers attributed unseasonably warm winter temperatures to the reason for price changes this heating season.
Virginia-based producer Ruth Elliott of Turman Hardwood Pellets says that, first and foremost, unseasonably warm temperatures factored into the decline this heating season. “The consumers were buying from our dealers at a fast, steady rate throughput in spring, summer and even early fall,” she says. “Although the oil prices were down even then, they still continued to sell.”
As a pellet boiler owner himself, Northeast producer Curran says, “It is likely that wood pellet consumers, who heat with pellet stoves or furnaces, were not firing them up this winter due to the warmer than normal temperatures, at least in the Northeast, and reduced oil prices did not necessarily promote anything otherwise.”
Although weather is ascribed as the main offender to the slowdown this heating season, the downward price trend in petroleum products may very well threaten pellet producers’ operations if it continues. In early March, a barrel of crude oil hovered around the mid-$30 range, and those filling their tanks paid an average of $1.72 per gallon for gasoline. This year, residential heating oil dropped to its lowest price per gallon since 2005. U.S. Energy Information Administration data from Feb. 29 showed residential heating oil averaging just under $2.09 per gallon, a drop of $1.20 per gallon compared to last year’s price. Residential propane prices averaged nearly $2.03 per gallon on Feb. 29, 34 cents lower than one year ago.
The drop in fuel oil is having more of an impact in regions where pellets more commonly compete with it. “I would say less than 1 percent of the homes in the Pacific Northwest have heating oil as even an option, unlike the Northeast, they have several million people who heat with heating oil,” Stan Elliot says. “We’re a natural gas, electric or wood heating market so what happens to heating oil has almost no impact on us good or bad.”
One of the questions the survey prompts producers to answer is to what degree low fuel oil prices impacted production decisions when planning volumes for the 2015-‘16 heating season. Of the 46 producers who responded to the question, 36, or 78 percent, indicated fuel oil prices impacted their decision only a little or not at all and 10 replied quite a bit or greatly. Although competitive fuel oil held little weight this heating season, based on conversations with producers, the sentiment that if low oil prices continue, 2016-‘17’s heating season will tell a different story. “I didn’t factor in oil prices at all into my production decision for 2015-‘16, because, in my opinion, it takes the pellet consumer a year of really consistent low oil prices to have an impact on the pellet market,” Wilson says. “I believe that the reason why November, December and January sales were almost nonexistent is that we didn’t have winter in November and December, and it was purely weather, with little impact if any from oil prices. I thought oil would play a role in February and March when consumers, instead of buying their extra tonnage, will just turn up their thermostat.”
Wilson adds that he thinks oil prices will affect how much people buy in the spring and summer, and they’re waiting to see what happens in the fall. Recent prices are not only beginning to cause strain in domestic heating markets. “We’ve often sent a pretty good tonnage into the export market, but that’s been very soft the past year or so since fossil fuel pricing has come down significantly,” Sharron says. “Prices have come way down with the strength of the dollar—the competition for $40-per-barrel oil just made that business go away.” Sharron thinks some opportunity may arise in the Asian pellet export market again for them, but right now, the company is still very dependent on the domestic thermal market in the West, and for the most part residential.
Pellets aren’t the only product with near stagnant sales. “New stove sales have been flat for many years,” Sharron says. “In New England, you’re seeing flat stove sales more recently since oil took a dive from $140 per barrel down to $40 per barrel. There is just no incentive for people to put in pellet stoves at this time, and with the weather being a lot milder this year, that’s another nonmotivator for people to move to alternatives. No matter what they’re heating with, they just don’t need that much heat this year. I’m sure the cycle will change again at some point.”
While low fuel oil and unseasonably warm weather take center stage this heating season, other contributing factors like the value of the dollar and primary timber product demand and supply play a role in the perfect storm. On the survey, producers also attributed pellet price changes to lower in-woods operating costs due to decreased fuel price, a higher level of supply and the expansion of pellet plants globally.
Plant Operations
It’s no surprise considering the market climate that a majority of producers reported a decline in this year’s heating season sales compared to last year. The survey found 65 percent of producers, or 30 of the 46 who responded to the question, are experiencing a moderate to significant decline in sales—5 to 20 percent or more. Across all regions of the U.S. and Canada, some sort of downward trend was reported. In the Northeast, 70 percent of producers described this heating season’s sales as down moderately to significantly, with all but 10 percent indicating they are down greater than 20 percent. Other areas of North America with a decline in sales include 58 percent of producers in North Central U.S., 60 percent in the Northwest, 67 percent of western Canadian producers, 100 percent of Southeastern producers who responded to the survey and 60 percent in the Southwest.
Raw material drives pellet prices, and in certain regions of North America, producers have adjusted the price they pay for inbound feedstock in the past six months. In fact, seven of the 10 producers who responded to the survey from the Northeast reported they have had to adjust their price, and six out of those seven producers decreased the price they pay between 5 to 10 percent. Similar data was reported from the North Central U.S., where nine of the 12 responding producers have adjusted the price they pay for feedstock, with five of those nine decreasing their price 5 to 10 percent or more. In all other regions, the majority of producers have not adjusted the price paid.
T.J. Morice with Wisconsin-based Marth Companies estimates there will be a decrease in raw material value in his area. “We, and the pellet industry as a whole, have been instrumental in the Great Lakes Region of increasing the value of residuals over the past two decades. Unfortunately, that increase in value has exponentially gone beyond what that material was probably reasonably worth because of what happened to fuel prices,” Morice says. “You had fuel prices that were heading up in ‘07, ‘08, ‘09, which was when all the capacity came on. In our region, in particular, we have an overcapacity.”
There is a market correction occurring in residual raw material values, Morice says, and this year will be significant due to low fossil fuel prices and higher than normal temperatures. “The raw material values have been higher than they should’ve been the past few years, but with energy down, those raw material values have to come down and quick,” he says.
Out West, Sharron shares a similar perspective, “Prior to ‘07, ‘08, ‘09, ‘10—throughout that time period—we were paying on average about $20 per bone dry ton (BDT) for fiber delivered into our plant, and it shot up as high as $65 per BDT at the start of the recession.
Unfortunately, Sharron adds, “that’s the same time that some new pellet production came into the West, so we were getting squeezed on both ends. We were having to bring our sell price of pellets down to stay competitive, yet our cost went up significantly.” Sharron says as the housing market started to improve in 2012 and 2013 the pricing also improved, and for the past two or three years the company’s average price has come down from in the $60-BDT range to around $40 per BDT.
“I think T.J. is right, the overall trend would suggest those prices should be softening a little bit as the Chinese take more and more of that pulp and paper market,” Stan Elliot shares. He adds, when it comes to feedstock, variations are regional, and the survey reflects that. “It could be very beneficial for some folks and maybe not so much for others.” Through conversations he’s had with fellow producers in the Midwest and Northeast, Elliot says they agree that warm weather in the early winter caused the demand for raw materials to crash because not as many pellets were being produced. “There became not only an abundance of pellets, but also an abundance of raw materials, so those raw material suppliers had to drop their price for those same pellet mills to want to buy their materials from them,” he explains. “I think it’s just the classic supply and demand curve. The raw material suppliers are suffering just as pellet producers are.”
Curran says, “Looking at our operation in general, I think there is going to be a glut of fiber all over the Northeast, and who knows how feedstock prices will be impacted going forward.”
Most producers indicated on the survey that their pellet prices were slightly higher or slightly lower (less than 5 percent) this year compared to the previous year. “We have dropped our prices to most stove shops and box stores,” Curran says. “They currently have inventory that was bought with a growing demand in the market, and I’ve already seen cuts to their prices to liquidate this inventory.”
When in a cycle of oversupply or plenty of supply, Sharron stresses the sensitivity of pricing. “You have to be really careful that you’re staying competitive,” he says. “I don’t think anybody is really in the position to increase prices. We might be forced to lower our pricing a bit because whether or not we can gain market share is one thing, but I certainly can’t afford to lose any more market share.”
Of producers, like Sharron, located in the Northwest, 60 percent reported this year’s prices as slightly lower. However, of the 45 who responded to the survey question about the price they were able to charge for pellets, 24 indicated this year’s prices are slightly to moderately higher (5 to 15 percent), and 21 producers’ prices were slightly to significantly lower (5 to 15 percent or greater).
Survival of the Fittest
All components of the supply chain get impacted when unfavorable market conditions prolong, and even if conditions improve, it may be hard for the industry to respond. There is currently an excess of inventory in the supply chain, but Sharron says if there is an early winter and the inventory bleeds back down to the producer needing to produce again, how high or low the demand is will dictate the rate it will travel through the supply chain. “Oftentimes, it happens so fast that the reaction time might not be quick enough, depending on the extent of the shutdown of a manufacturing plant,” Sharron says. “We’ve already started laying off some people, and when you’re ready to start ramping up again, can you get those people back? Can you get your raw material supply back? Sometimes you’re not able to react quickly enough to those market conditions.”
Sharron isn’t the only one whose curtailed production has led to layoffs. According to the survey, 38 percent of producers have decreased overall plant staffing at their facility in the past six months. This lends itself to the fact that 27 of 46 producers, or 59 percent, required a decrease in production hours when compared to their long-term average. Only two producers increased production hours and four increased plant staffing.
Producers can only project where industry will go from here. “I firmly believe 2016 is going to be a very challenging year, maybe not for all pellet producers, but I think a lot of us are going to see slow change at the front side of this,” Curran says. “If there isn’t a market, no matter the price, you can’t sell them. I don’t see any reason to be building inventory at a time when the market is not stable.” Curran adds that he’ll have a better sense of where the market is going toward July, but for now, “when the sales stop so dramatically in January and February and you travel around the countryside and see inventories built up at different stove shops and box stores, I think we all have to wonder where we’re going to be in 2016 as a biomass/pellet industry.”
Some producers predict the more financially stable may take a gamble and produce volume to take advantage of the market if and when it arrives. “2016-‘17 season will be interesting, as the pellet industry competes with low oil prices as well as more stock in the pellet pipeline coming into spring,” Ruth Elliott says. “It will, more than likely, be a lean year for this industry. We must work together”
She adds that it will be important for the pellet industry to not regress in the progress that has been made over the past few years. “We must dig in, hold on tight, and look for new ways to continue to grow this industry,” Elliott says. “Sometimes our most creative thoughts and ideas, form in the hard times. Now is the time to remain focused, and continue the course that is set before us.”
Producers who have been in the industry long enough know all too well the volatility of the domestic heating market, and more than likely have weathered the storm before. “It’s a gut punch,” Stan Elliot says. “Whether the gut punch is a one-year thing or lasts a couple of years, if nothing else, the expansion in some markets will probably slow down to a trickle, if not a little regression, as people struggle to figure out how they sell the extra tonnage we have after a year like this. It’s a tough spot, but as Darwin says, the strong will survive and probably come out the other end stronger. Unfortunately, we may lose a few folks along the way.”
Author: Katie Fletcher
Associate Editor, Pellet Mill Magazine
701-738-4920
kfletcher@bbiinternational.com
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