Canadian Biomass • Spring 2020 • Pandemic pellets

The COVID-19 pandemic is likely to cause a global economic depression. The magnitude and reach of this crisis are huge and will inevitably impact the industrial wood pellet industry.

The two primary pathways for the evolution of this pandemic are: (1) The pandemic accelerates uncontrollably and millions of people die; or (2) The pandemic is attenuated by policies and rules restricting contact with other people that limits the spread of the disease and greatly reduces the number of deaths. Both pathways will shock national economies. If policies are aggressive and people are compliant, and if the rules are enforced, pathway 2 will limit the medical consequences. But there is no avoiding the economic consequences.

However, the demand for industrial wood pellets is somewhat independent of drops in economic activity. Power demand will decline in a major economic slowdown, but the power generated by wood pellets in the key European, UK, and Japanese importing markets will have a place in the grid even if other sources such as natural gas have to turn down to meet lower aggregate electricity demand. The potential exception is South Korea (more below on South Korea).

Backed by long-term offtake agreements, it is unlikely that fundamental demand for industrial wood pellets will decline significantly in the markets supplied by North American and European pellet producers as a result of the COVID-19 pandemic. However, as noted below, policy changes could impact demand.

On the supply side, many highly automated wood processing plants such as sawmills and pellet mills should be able to operate without compromising worker safety or the safety of their families and their communities. FutureMetrics has spoken with several sawmills and pellet mills that have implemented protocols that allow operations to continue with no close personal contact and with comprehensive and continuous attention to working with and sanitizing at-risk surfaces.

Lumber and wood pellet operations should be able to adapt to the current health guidelines and requirements with little impact on output and only a marginal increase in operational costs.

The wood supply chain is dominated by machinery operated by single individuals. Sawmills and wood pellet plants are highly automated. For the operations and maintenance staff, social distancing and frequent hand sanitizing will be the new normal until the pandemic is quashed. Office staff may have to work remotely.

In all cases, normal routines that include close social interaction will have to be changed. But it is likely that production of pellet fuel for export can continue.

While the in-woods and transport logging operations should be able to continue to meet demand, many sawmilling operations will likely slow as lumber demand falls. Some pellet factories dependent on sawmill residuals will experience higher costs for alternative feedstocks or will have to move to lower production rates (or both). B.C. pellet mills are already using an increased proportion of forest residues due to unrelated changes in the sawmilling industry there.

A drop in lumber demand will also impact the demand for sawlogs. Some of the roundwood on the upper part of the tree harvested for sawlogs is not suitable for conversion to lumber and typically goes to pulp and paper mills or pellet mills. A drop in sawlog demand will likely change the dynamics of supply and the cost of feedstock for pellet mills that depend on roundwood byproducts. The drop in sawlog demand may also impact the supply of forest residuals. A worst- case scenario is that no sawlog harvesting results in no pellet feedstock grade wood fibre. The cost of buying sawlog-quality wood for making pellets would be punishing to the profit margins.

Most North American port operations for bulk cargo shipping are likely to continue operating. Given the automation of the systems, close contact between people is not necessary. Imports and exports of all types of bulk goods and commodities are fundamental to social stability and for the support of those manufacturing sectors that remain active. Container and breakbulk shipping may be impacted. Some container and breakbulk cargos will be quarantined and possibly subject to decontamination procedures to prevent the spread of the virus. But wood pellets in bulk ship holds should not be impacted.

Unless recommended workplace procedures and protocols change with new information on the transmission of the virus, the supply side of the industrial wood pellet industry should weather the pandemic without putting workers and their communities at risk.

For pellets shipped in containers (mostly to South Korea from Vietnam), there will be disruptions due to evolving changes in the flow of shipping containers. Some ports do not have the typical inventory of empty containers anymore.

The cost of shipping via container from Vietnam to South Korea, which has traditionally been very low due to surplus empties in Vietnam, is therefore likely to increase. The South Korean pellet market exhibits a very high risk for unstable pellet demand even without the impacts of a pandemic. Almost all pellet imports to South Korea are not based on long-term offtake contracts. If the delivered cost of pellets rises significantly due to shipping cost increases and South Korea does not intervene in the Renewable Energy Certificate (REC) markets, South Korean demand will fall and heavily impact Southeast Asian pellet producers.

What is most difficult to forecast is the impact of policies. Many jurisdictions have mandated that all non-essential businesses close. In Malaysia, for example, that included pellet plants. Policy can impact the industrial pellet sector in two distinct ways.

The first is due to policies and rules that impact business activities, and how a business is determined to be allowed to operate or not. It is possible that government policy could designate elements of the wood processing sector non-essential and mandate shutdown. Government rules for business closures are already in place for many serviceoriented businesses. Many automated manufacturing and logistics operations can function without close personal interactions and with enforceable rules for preventing spread by contact. Even so, some governments may invoke the precautionary principle and opt for policies that would impact the production and transport of pellets.

The second way that policy can impact the industrial wood pellet industry is from government decisions about renewable energy policies in major importing countries such as the UK. Power generated from pellets is costlier than power from fossil fuels. It is possible that, as part of fiscal stimulus packages, temporary reductions are put in place on higher cost generation sources to, ostensibly, lower the cost of electricity. FutureMetrics thinks this is highly unlikely for two reasons.

First, the proportion of power from pellets on average is about eight per cent in the UK and less in other countries. Stopping pellet baseload generated power would have a very small impact on the overall average cost of generation. Fiscal stimulus packages are very large. The impact of the cost of pellet fuel versus fossil fuel is relatively tiny.

Second, the consequences of that demand dropping out would be far reaching and harmful to many stakeholders. The ripple-effect economic consequences to rail, ports, shipping, producers, and producer supply chains associated with curtailing pellet use, combined with the multiplier effects of the loss of jobs, are far larger than the marginal cost of making electricity with pellet fuel. Much of those negative economic and jobs effects would be in countries using pellet fuel for power generation.

Furthermore, the entire supply chain is based on long-term offtake agreements that provide legal protection to the flow of the pellets and payments for the pellets.

Overall, the tonnages of wood pellets flowing under long-term offtake agreements should not be significantly affected by the COVID-19 pandemic. That conclusion assumes that the mitigation measures to limit the number of infections and deaths are successful, and that the procedures and protocols for controlling the virus and assuring the safety of workers and everyone they contact, are similar to what they are as of April 11, 2020.

While production volumes for most North American and European pellet producers are likely to be sufficient to fulfill their offtake agreements, the cost of production is expected to increase during the crisis. Profit margins for some producers may be seriously challenged. However, losing a few dollars per tonne may be better than the alternative of not delivering on an offtake agreement. While “force majeure” may be possible for those producers whose feedstock costs are punishing, usually an event that impacts profitability but not the ability to produce does not qualify. (FutureMetrics is not qualified to make legal opinions.)

For Southeast Asian producers, demand from South Korea will likely fall if container freight rates increase significantly.

Spot markets are difficult to predict. The summer months typically bring a drop in monthly demand and spot prices drop. However, if producers are reticent to make pellets due to poor (or negative) margins then there will be no excess production beyond what is contractually obligated. That would push up spot prices.

Some future pellet demand in Japan will likely be delayed. Construction activities on FiT (feed-in tariffs)-approved power plants have, for the most part, stopped in Japan for the duration of crisis.

Let us all work together to get COVID-19 to peak and pass sooner rather than later. That means we all have to be careful and be considerate of the possibility of contagion almost all the time. We have to protect ourselves to protect our communities and countries. With that as a foundational condition, it is still rational and responsible to keep making and moving pellet fuel to power stations to help keep the lights on. •