According to United Nations trade data, in 2015, 4.5 million tons of wood pellets were exported from the U.S., while Canada exported 1.6 million tons. In the same year, the U.S. exported nearly 73 million tons of coal, while Canada exported over 30 million. Collectively, coal exports from North America outstrip pellet exports by a factor of 17. While not surprising, this disparity helps shed some light on the inherent differences and challenges the wood pellet industry faces as it works to mature and drive the kind of trade efficiencies commonly enjoyed by larger commodities, such as coal, into its own marketplace.

By the simplest of definitions, a commodity is a fungible good. Put even more simply, one unit of a given commodity can be exchanged for another unit of the same commodity. This concept underpins and supports the movement of commodities of all types around the world, including corn, wheat, wood pulp, coal, oil, natural gas, cotton and a multitude of other goods vital to the global economy. Buyers requiring these commodities can be assured that when they need them, ample supply will be available, provided they are willing to pay the market price. And producers, whether they be growers, miners or manufacturers, can invest capital and deploy resources with confidence that their materials and goods will find a waiting market. Whether or not wood pellets have achieved commodity status is a matter of ongoing debate, as are the characteristics that analysts point to when making that determination. Additionally, industry experts differ on the necessity of the marketplace practices commonly associated with larger commodities, including brokerage houses and traders, or financial instruments like futures contracts.

“When people are talk about the commoditization of wood pellets, their intent is clearly to make the market more liquid so that pellets may be traded more freely,” says Gordon Murray, executive director of the Wood Pellet Association of Canada. “I think that is the ultimate objective.”

This liquidity, from Murray’s perspective, is hampered by the existence of varying grades of wood pellets commonly manufactured. “For something to be a commodity, you need to be able to substitute one batch for another, and they should be indistinguishable, provided they meet some basic requirements,” he says. Murray points to industrial and residential wood pellets, and even the varying grades and classes within those two categories.

For Todd Bush, a partner at CM Biomass, a pellet trading firm, this distinction is too simplistic. “Wood pellets are fungible,” he says. “They are fungible just like oil is. There are different grades of oil that are traded. In fact, there are even different grades of light, crude oil traded.  Some refineries might not be able to take one subgrade of light sweet crude, but they may be able to take another.”

Bush says commodities of all types have this kind of quality stratification inherent in their product class. “No commodity market is purely and completely 100 percent fungible,” he says. “That doesn’t mean you can’t exchange one unit for another with discounts driven by certain parameters.”

The Argument for Commodity Status
The seasonality of pellet markets have always challenged the industry, certainly for producers playing in the residential heat market, the sector that gave rise to the industry in the first place. In the heating market, consumers only need pellets during the fall and winter months, and as a result, buying activity peaks in the months leading up to the heating season, plateaus during the season—unless there is an unexpected and prolonged cold snap—and in the months immediately following, it shuts down altogether. On-again, off-again markets bring with them on-again, off-again cash flow realities that challenge producers. Without steady cash flows, producers struggle to run plants efficiently, staff their operations and secure financing for plant improvements and expansion. Further, for the industry to meet demand once the heating market does ramp up, they must find a way to sustain operations for year-round production.

Commodity traders, Bush says, go a long way in eliminating these challenges. “You can’t have the handful of consumers out there buying up all of the summer product and storing it until they need it,” he says. “They can’t afford that kind of storage.” Instead, traders like CM Biomass become a proxy of sorts, buying volumes from producers when others won’t, and then reselling those volumes when retailers and distributors need them. Whether or not those traders make a profit hinges on their ability to earn enough of a mark-up to cover their storage, capital and overhead costs. Therefore, generating a profit is not a guarantee. Traders, unlike brokers, actually take physical and financial possession of the products they trade, whereas brokers serve only as intermediaries. This distinction requires traders to have a very strong cash position, and significantly increases their overall risk. Traders introduce year-round demand into the market when, if end user demand were the only demand in the marketplace, it simply wouldn’t exist. This liquidity serves both buyers and sellers in that it enables producers to more efficiently build supply, and allows buyers to more accurately predict available supplies. In most cases, liquidity contributes to more stable, predictable commodity prices.

Difference and Challenges
There are aspects of the wood pellet market that contribute to making true commodity status elusive. Many inside the industry point to the ongoing struggle to unify and harmonize the sustainability requirements to which pellet producers must comply as the largest impediment to greater marketplace efficiency. In nearly all instances, the buyers of industrial-grade wood pellets are doing so as a means of complying with a renewable energy or low-carbon mandate, and the regulators and citizens they report to want assurances that users of the funds being used to subsidize use of pellets are accomplishing sustainability goals. The result is a patchwork of certification schemes that have fragmented the global market into a number of much smaller markets, and created a situation in which a shipload of pellets cannot be traded freely between buyers. “There are such varying requirements globally, even in Europe, and until there is some consensus there, this will continue to be a barrier for the efficient trading of wood pellets,” says Murray.  “This is what the Sustainable Biomass Partnership was set up for, but so far the European regulators have been slow to come on board.”

The Sustainable Biomass Partnership, formed by seven large heat and power utilities in Europe, was established in an effort to drive out the inefficiencies that multiple and disparate country-specific sustainability requirements introduce into the market. European utilities that are planning on, or already engaged in the cofiring of wood pellets, recognized that multiple sustainability programs would introduce added expenses for producers, as well as limit available supplies, ultimately leading to constrained supply, supply interruptions and highly variable prices. The SBP was developed to mitigate each of these, while also providing utilities a means of demonstrating that the widespread replacement of coal inputs with wood pellets delivered the environmental benefits for which it was intended. 

In a recent Biomass Magazine webinar about the SBP and process by which producers become SBP certified, Simon Armstrong, technical director at the SBP said, “Another objective of the SBP is to make wood pellets more fungible to ease the trade of pellets between market players, particularly when the ultimate end user is not known.”  The success of the SBP and the promises of increased marketplace efficiencies all hinges on the regulatory bodies in pellet countries recognizing SBP certification and aligning their requirements with the program. If this is accomplished, producers and traders will be able to more freely capture opportunities in the spot market.

 Also during the webinar, Armstrong reported progress on recognition of the SBP program in key pellet-buying markets in Europe. In early 2015, Denmark recognized the SBP in their energy agreement, and later in the year, the United Kingdom found that SBP approved pellets complied with U.K. legislation.
 For other major pellet destinations in Europe, there is work left to do. “We are working with the Belgian regulators to make sure the SBP meets their requirements and are now piloting SBP with the Belgians to give them confidence in the program,” Armstrong said, continuing by touching on progress with the Dutch government, a market producers throughout the world are eager to see reemerge, including Murray. “The Netherlands is just a mess right now,” Murray says. “The previous subsidy system and the contracts associated with that expired over about a three-year period and for now, cofiring in the Netherlands is all but dead. I don’t think there was even one pellet cofired in the past two years.”

Most analysts agree that once the Dutch can agree on the sustainability requirements, they’ll generate 3.5 million tons of new demand. That said, producers will have to engage in an altogether new certification program to sell into this market, and more stratification will occur within the supply chain. Conversely, if the Dutch and the Belgians both agree to recognize the SBP certification process, pellets that are SBP certified can then move freely between each of those countries, increasing overall market liquidity.

While Bush shares Murray’s and the industry’s concerns about the number of certification schemes out there, he differs with their conclusions, and suggests that while they do introduce challenges, and that measures should be taken to harmonize them when possible, the number of programs is less problematic than the overall volumes and number of buyers looking for pellets certified inside of each of these programs. “I still say that underlying all of these challenges is the volume,” Bush says. “If the market were 10 times larger, you’d have 10 times more volume in each category. But right now, it is still a fragmented market, mostly because there are so many specifications and certifications out there that each end user requires. It’s really just a volume issue; a volume of trades issue, not volume in tonnage.”

For now, the vast majority of pellets made by Murray’s producers never even enter the spot market. Murray tells Biomass Magazine that it’s probable 90 percent of the volume that Canada exports is sold under long-term contracts. Pellet volumes produced in the American Southeast are also largely sold to customers under long-term contracts, and while the value of the U.S. dollar and two consecutive warm winters in Europe has all but eliminated opportunities for U.S. producers within the sport market, those looking to move some discretionary volume are hungry for greater liquidity. 

While opinions on the way to get there vary, all participants in the wood pellet market, in any market, want the same thing: options. Options offer all parties leverage. More buyers and the freedom to sell product to those buyers, unencumbered by varying sustainability requirements, gives producers options. In the same way, a healthy marketplace with adequate, uniform supply allows buyers to distribute their inbound purchases across many different suppliers, and hedge against price fluctuations or supply interruptions caused by an unforeseen production outage at a single manufacturer, or weather interruptions.

For the world’s biggest commodities, these conditions are taken for granted. A buyer suddenly in need of a 25,000 tons of corn would have no trouble securing it, and without question, would entertain offers from innumerable sellers. In some ways, this is a function of the size of the global market, but pellets must also answer questions different than those of corn customers. For this reason, there are additional layers of complexity introduced to the equation. The work to streamline these challenges is well underway, but for now, producers find themselves managing a fragmented market, and traders like Bush work to smooth out the rough edges.

For Bush, the end game is clear. “Our perfect pellet,” he adds, “is one that we can buy and then sell into any market.”

Author: Tim Portz
Executive Editor, Biomass Magazine
tportz@bbiinternational.com
701-738-4969