Epsilon Archive for Student Projects

Abstract

A review was made of the current and past use of long-term supply contracts in the forestry, coal, and natural gas industries to assess the applicability of long-term supply contracts in bioenergy and why they are not prevalent. To assess past use, an extensive literature review was undertaken. In determining the current use of long-term supply contracts, professionals throughout woody biomass supply chain were interviewed using a structured questionnaire. Participants represented forest landowners (non-industrial and industrial), pellet and biofuel producers, forestry management consultants, procurement firms, and energy producers (Biomass facilities, investor-owned utilities, and electric cooperatives). Participants were asked about their experiences with long-term supply contracts, willingness to enter into future long-term supply contracts, and factors that impact the decision-making process for decided whether to sell on the spot market or enter a long-term contract.
Current use of long-term supply contracts was mixed, with only a few participants having willingly entered into a long-term supply contract. Several participants, who currently did not utilize long-term supply contracts, believed they had a system that worked and saw no need to change what “wasn’t broken.” At the same time, many of these participants were open to considering long-term supply contracts in the future.
Participants indicated several factors that were important to them when considering long-term supply contracts. Loss of control was particularly important for nonindustrial private timberland owners. Control was also important to other stakeholders in the bioenergy supply chain. These stakeholders believed long-term contracts could help them control the market by minimizing risk. Other important factors mentioned were the scale of operations to back a contract, pricing, use of long-term offtake agreements, building mills in areas with less competition, and the higher costs of bioenergy.
Results from this study suggest the current lack of long-term supply contracts is attributable to a combination of relatively easy availability of wood, consumers not willing to pay a premium for a less efficient energy source as compared to coal, and stakeholders in the bioenergy supply chain being satisfied with their current system to procure/sell fiber. So is the current status quo likely to change? The answer is complicated. Due to the inefficiencies of woody biomass for energy and the efficiencies of using fossil fuels, bioenergy is not likely to gain significant market share without consumers being willing to pay more for energy. In places where it has expanded in use, contracts have usually been backed by subsidies.
In the end, possibly the most important factor is how stakeholders view long-term contracts as a strategy. Buyers in this study mentioned them being financial undesirable due to their higher costs associated with price premiums. Sellers, on the other hand, said they felt long-term contracts would limit their ability to receive maximum value for their timber. Is it possible for them to be both? Well if the contract includes a rolling average pricing mechanism, it’s possible that at times it will be the highest priced/cost timber, and at other times the lowest priced/cost timber. It will however, never reach the market peaks or troughs that parties might experience in the spot market. Thus, if layered appropriately, it’s possible to keep your revenue/expenses relatively flat compared to participating in the spot market. This strategy is utilized by many Utilities and allows them to focus on eliminating inefficiencies elsewhere in their business while guaranteeing a steady supply/price. Thus, if parties looked at long-term contracts as a way to minimize market risk, via lowering market swings, we could see an increased future use of long-term contracts in the bioenergy and forestry industries.