Pellet Hoarding, Market Distortions and Oil Prices

In the wake of what happened last year, pellet producers, trade
organizations and industry stakeholders rallied to convey the message to
consumers that it is important to buy pellets early this season, and to
be prepared.  And it looks like consumers have done so, because the
Northeast is seeing record demand this season, says the Pellet Fuels
Institute and Biomass Thermal Energy Council.

Those of us in the industry understand why it was important for
consumers not to wait to buy pellets until it was/is cold enough to need
them, so I won’t go into that. But as I was thinking about the
situation, I began to wonder how I would react as a newer pellet user
who wasn’t able to get pellets when I needed them last season, polar
vortex and all.

Would I buy early? You bet. Would I buy a lot more than I would likely need? A strong possibility.

So what if a large number of consumers buy quite a bit more than they
need?  My friend Bill Strauss recently touched on this in a new paper he wrote on falling oil prices and potential effects on the pellet industry, so I called him up to see what he thought.

As I suspected, he agreed that if—and it is IF, because I certainly
don’t know that this is the case—consumers are overbuying, it could
facilitate additional shortage problems this winter, and it could also
distort demand next season and make it difficult for producers and
retailers to gauge what the market looks like.  A warmer winter, which
has recently been predicted, could further exacerbate the issue.

“It’s an interesting problem—a bit of a balancing act,” he said,
mentioning that the last time there was a situation similar to what
happened last year, he knew somebody who typically burned 3-4 tons of
pellets per year and wasn’t able to get them when he needed them, so the
following season he purchased 15 tons of pellets and kept them stored
in his garage. “He wasn’t going to get caught short again,” Bill said.

If there are a lot of pellet hoarders out there, it might look like
demand has gone way up, but it just may be that people are overbuying
and will continue to use their stash next season, and, again, that could
throw a wrench into determining market demand.

He was quick to remind me this isn’t the case for the bulk market,
which is pretty straight forward. Fuel is guaranteed and set aside for
customers. It is delivered from a truck. Consumers don’t have to worry.

“You don’t see these crazy fluctuations in Austria or elsewhere,
where bulk pellets are predominant, and bagged pellets are unusual,”
Bill said. “That’s not what we have here in the Northeast.”

The above is all speculation. The industry has done a wonderful job
of getting their message out, and it will likely just take some time,
trial (and maybe a little error) before kinks like these in this rapidly
growing industry are worked out.

So while we’re on the topic of pellets and the Northeast, I asked
Bill a little more about the paper I previously mentioned. In it, he
explores a couple of different scenarios that might result from oil
prices falling, if they came close to the same cost per MMBtu as
pellets, or lower.

Is that a possibility? “Last time oil prices tanked, heating oil did
go below pellets for a brief period of time,” Bill said. Whether it’s
likely is a different question…crude has to go down to around $50 per
barrel for heating oil to be around same price as pellets. Most
countries can’t make money in the oil markets at $50 per barrel, only a
few can…in fact, most countries can’t afford even $80 per barrel oil,
where it recently was.”

Bill admitted that the scenario isn’t very likely, but that it is
something for stakeholders to think about. “You can’t bury your head in
the sand about the impact of cheap oil prices on the pellet business;
it’s something to be aware of…even $80 per barrel makes the differential
between heating oil and pellets less compelling than it was just a few
months ago. It also impacts sales of appliances, particularly higher
cost pellet stoves and pellet boilers where payback is measured by how
many years it takes you to get your money back.”

However, falling oil prices do have a bright side, Bill pointed out.

But for who?

“Heating oil and diesel fuel are almost the same thing, so price
movements pretty much go in lock-step—they’re highly correlated,” Bill
said. “Cheap crude oil means cheap diesel fuel.”

Bill explained the following scenario:

If a landowner gets $8-12 per ton of pulp-grade wood, by the time it
gets to the pellet mill, the cost is in the upper $20s or even upper
$30s per ton of wood. More than half of that price is the price of
diesel fuel to get the wood to its final destination. So if the
beginning cost is $10 per ton and the pellet mill is paying $35 per ton,
at least half of that $25 differential is going to pay for fuel. If the
distance is longer, it could be up to 65 percent.

Now if diesel prices go down, the price of wood delivered to the mill
should go down as well—it will cost less to get it there. That theory
makes perfect sense.

But who benefits from that? Do the trucking or logging guys simply
experience increased margins, or do the buyers benefit as well, and
negotiate a cheaper price? Furthermore, is that passed even further
along to the consumer, resulting in lower-priced pellets?

“That I don’t know,” Bill said. “Producers margins may improve as
well. The cost of transportation will go down, but who benefits from it?
Will it get passed along through the supply chain? It all depends on
who you’re doing business with.”

Food for thought.

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