Roadmap to an organized global commodity market of bioenergy

While there is broad consensus on the need to ensure sustainable practices in the bioenergy supply chain, the economics of this industry is still frail and depends still heavily on feedstock logistics’ risks. Traded volumes in the market are not yet enough for a full take off and the bioenergy industry is lagging behind its expected targets. SQ Consult calls for an effective evolution of the market structure is made in this article.

In our newsletter from summer 2010 “A new era of the Bioenergy Industry: Sustainability criteria shaping the market” discussed the growing value of bioenergy to the world’s energy matrix, and the need to ensure sustainability principles to guide the development of this potentially large industry in meeting future energy needs. Managing the economics of sustainable production and its verifiable certification is a key need of this emerging sector. Pike Research forecasted last December that worldwide capital investment in biomass infrastructure will maintain its steady growth in the next five years, rising from $28.2 billion annually in 2010 to $33.7 billion by 2016. Bioenergy suppliers able to fully embed sustainability principles will stay in the market, while others will most likely disappear in the face of sustainability regulations in markets where bioenergy is in demand.

While these issues are still very much valid, the current global economic crisis has imposed even more urgent challenges on the bioenergy industry, namely:

1. Developing the commercial strength to exist without long-term government incentives, even as demand falters, and
2. Constant and sufficient provision of sustainable feedstock in a capital-constrained and very risky global marketplace.

These challenges require a more robust bioenergy market structure than we have today; a market where volume tempers future price volatility and secures the availability of certified feedstock without creating an unmanageable administrative burden on the industry. It requires an organized commodity market similar to the conventional fuels market, or similar to the market of major agricultural crops, and with an effective integration of certification of sustainability obligations, as with existing quality and sanitary requirements for other products.

 International markets for bioenergy carriers are young and have developed at different speeds. Ethanol is the only bioproduct traded as a real commodity on a market exchange

Comparison exchange markets for major bioenergy carriers

(*) Currently there are various schemes in development that are used to prove different sustainability criteria for industrial pellets production. Examples are ENplus, FSC, PEFC or company labels as Drax (UK) or Green Gold Label (Essent/RWE) in the Netherlands.

Companies and countries in Europe are currently establishing their own sustainability requirements based on what the European Renewable Energy Directive has established obligatory for biofuels and non-obligatory for biomass for heat and electricity. An effective organized market is viable not only when volume traded and stability is reached, but also when product specifications (including sustainability requirements) are unequivocal, unique and useful for the buyer. This market is very much possible to build and it would be key to revolution the growing bio-based economy in the world.

We discussed current obstacles to setting up effective organized markets is discussed in this article along with our call to move towards a market transition.

The subsidy trap

Pellets and biofuels global markets have grown vigorously in the past 5 years. From 2004 to 2008, world yearly production of ethanol doubled to 53 million tons, biodiesel got six times higher to almost 11 million tons, and wood pellets from little to about 12 million tons. However they live trapped in the vicious loop of subsidies and incentives, and an excess of production capacity with little production. On one hand, heavily imported subsidized biofuels destroy any competitive industry and inhibit its healthy growth. On the other hand, subsidies are still needed to overcome the economic costs from logistical, distribution and trade barriers while achieving at the same time both mandated production and blend.

As an example, the recently renewed US government support to corn ethanol (VEETC- Volumetric Ethanol Excise Tax Credit) subsidized US ethanol with $4 billion in 2008 and $7,7 billion in 2009 ($.45 tax credit per gallon, plus a bonus for small producers) to only replace a miniscule 2% of U.S. gasoline supplies. These tax credits do not only blocked imports, but have turned the United States ironically into a net exporter of ethanol despite their 12 billion gallon national target in fuel supply, which is not reached due to internal logistic and trade barriers. US ethanol exports are expected to run a record 315 million gallons for 2010, more than double the 2009 figure. True exports might be 50% larger according to F.O. Lichts Hamburg if ethanol blended with exported gasoline is included. Main receptors of this subsidized ethanol were Canada (30%), continental Europe via the Netherlands (23%) and UK (4%). This subsidy echoes the earlier “splash-and-dash” EU-US dispute over biodiesel. EU countries also promote domestic ethanol production through tax reduction of as much as € 0.65 per litre in Germany and € 0.525 per litre in Sweden. EU countries have supported domestic production of ethanol in 2009 with $2.1 billion.

Addressing domestic and international barriers for achieving larger consumption is far more important than subsidies if we want to develop a strong and larger market. What truly disrupts global trade are unpredictable subsidies led by short-sighted trade policies that are irregularly adjusted based solely on the economic health of the domestic industry at the very moment. A long term, stable political environment is needed for a market to develop. As an example, former US Vice President Al Gore recently stated that it was a mistake supporting corn ethanol. The process of converting corn into ethanol is highly energy intensive and also requires using a food crop for fuel. Al Gore contends corn ethanol is negatively impacting food prices, and that there are better biofuel solutions to be developed and supported: "I think second and third generation [biofuels] that don't compete with food prices will play an increasing role certainly with aviation fuels."

As a consequence of the subsidies trap, markets are flooded with subsidized products and the more competitive bioenergy industry does not flourish enough further hampered by the heavy support on fossil fuels, which limits an even level-playing field of our energy resources; this prevents markets from reaching global volume targets.

The risk of controlling the upstream business

Most players in the large biomass co-firing and advanced biofuel industries are generally advised to quickly secure dedicated parcels of land to provide them with sustainable and low-cost feedstock. Utilities with large co-firing coal-based power plants are pushed to enter into a different business. They divert their attention from what they do best – production, distribution and commercialization of electricity, heat or biofuels - to forestry and agriculture businesses, which many times are located in distant lands from their core operations. Large European utilities are forced to invest in pellets facilities in other continents to have control of the full value chain to keep their business successful. RWE AG started in March of 2010 with the construction of the world biggest plant for wood pellets in the U.S. state of Georgia. The annual capacity of the plant is 750.000 tons with a needed input of 1,5 million tons of fresh wood from Georgia forests. RWE is also investing in port facilities.  The first pellets will be produced in the third quarter of 2011 and will supply a RWE 1.245-MW Amercentrale station in the Netherlands. Future production is intended to supply other RWE stations in the Netherlands, Germany, Italy and the UK.

Other energy companies like Essent/RWE have their own trading unit within their company carefully examining origins of biomass and testing pellets for large scale co-firing. These activities could be avoided with clear product specifications in a market exchange same as with rest of fuels. The truth is that by going upstream, energy companies also assume the risks of dedicated biomass suppliers: flooding, plagues, fires, etc. In an organized exchange market, the figure of trader takes over all these upstream risks; energy companies deal therefore only directly with a trader and have access to a constant supply of pellets without so many complications and with better security of price.

The certification issue

US and EU sustainability regulations for the biofuel industry challenge companies to develop entirely new information pathways to trace feedstock provenance from the farm or forest to the fuel blender. In the case of the EU, there is ongoing uncertainty over how the Renewable Energy Directive (EC-RED) will be introduced into national legislation in all 27 EU countries. Some EU countries are developing their own national certification systems. The current non-homogeneity of national and voluntary systems has an impact in the organized market. Uncertainty over implementation of the EC-RED is hindering liquidity in the ethanol market, as market participants are cautious of taking large positions or are withdrawing from the market completely. In a worldwide international trading market, "Market participants are not certain which sustainability clause they have to fulfill and don't want to expose them" a trading source recently said in an interview with energy market information company Platts. "It is not clear yet which product you can supply to different countries, and you don't want to be stuck with non-compliant product" the trader added.

The European Commission still has work to do to ensure that the implementation of sustainability criteria certification is done correctly among EU countries, otherwise it will become a serious trade barrier which will threaten reaching the ambitious targets for sustainable biofuels use. The European Commission has just opened a public consultation, running from February 1 to March 29, concerning the need of EU sustainability obligations for biomass other than biofuels and bioliquids, solid biomass and pellets by instance.

The certification process is complex but a necessary reality of ensuring sustainability. Industry tends to perceive the certifications procedures as an administrative burden jeopardizing their survival in a difficult and still nascent market. The industry needs to understand that certification is the only way to separate sustainable products from non-sustainable ones; at the same time, industry’s objections should be taken seriously by aiming for a cost-efficient, effective approach.

The understanding in the market to use certification as a way to distinguish itself as sustainable company is taken up voluntarily by various large energy companies combusting or co-firing biomass by developing their own sustainability certification labels: Essent/RWE (Green Gold Label), Electrabel (Laborelec) and Drax. Other large international utilities may follow the same route, as they all understand that proof of the use of sustainable biomass will be a requisite either by future regulation or by customer exigency.

Certification under EC-RED sustainability requirements includes audits on different operations and locations in the feedstock chain: the first gathering point, processing unit, farm and transport. The audit’s success is dependent on the available information. An audit consists predominantly of verification of documents, registrations, minutes, measurements, etc.  When shortage of information is notified during the audit, the audited entity must produce the necessary data before the certificate can be provided. The average time between the audit and the release of the certificate is a few months.  The certification company judges both the work of the auditor and proffered solutions to information shortages, and may demand a re-audit if the information provided is still lacking.

In a full organized bioenergy carriers market, the inputs for production are also traded in the Futures market; therefore the obligation of providing all needed certification is passed on mostly to the feedstock traders who can take on them as sanitary or quality certifications. Information pathways to be developed in the biofuel companies are no longer complicated and they can concentrate on the core of their business.

Beside the case of biofuel companies, large energy companies combusting or co-firing biomass are also developing voluntarily their own sustainability certification labels: Essent/RWE (Green Gold Label), Electrabel (Laborelec) and Drax. Other large international utilities may follow the same route, as they all understand that proof of the use of sustainable biomass will be a requisite either by future regulation or by customer exigency.

The burden of sustainability certification strains the existing model of bioenergy production, with its excessive vertical integration of production processes and lack of market transparency. An organized exchange market offers superior characteristics for handling the costs of certification.

Current volumes traded for pellets and biofuels are not yet sufficient for fully developing an organized market; however it is a market that will keep growing to several billions of euros in the following years. We are in the right time for market future exchanges, brokers, traders and key users to come together and make the first steps in organizing the rules for such market and infrastructure, and for putting the needed pressure on the demand side to accelerate the transition.

This newsletter is based on recent work conducted by SQ Consult; more information on these studies is available at request. The author thanks Ivan Rodríguez, Jinke van Dam and Adam L. Reed for their valuable contribution to writing this article.