When customers are unable to find bags of pellets lining the shelves of their neighborhood big box retail store in a particularly cold heating season, the situation has sometimes been attributed to a capacity shortage. The empty shelves are not a result of limited production capacity, however, but rather the limited capacity producers have to store product. The pellet fuel shortages have been limited, in fact, to select regions of the U.S. during certain times of the year, and have not impacted all producers––tightness in the marketplace has been experienced predominantly where the most dynamic market share is sold, the Northeast.
A tight supply of pellets in a particular region has often been countered with softer markets for pellets elsewhere, creating not a problem of capacity, but of logistics. Further, storing enough product to meet demand is often a substantial commitment not only in dollars, but infrastructure. Even if producers have the capability to store adequate product on-site, they may not have the capital needed to keep the plant running during the off-season when consumer demand is low. Driving just the right amount of throttle into a plant to produce product with demand contingent on uncontrollable factors, like volatile weather patterns and other competitive fuels, is a challenging balancing act, and it isn’t uncommon for a producer to lose their steadiness.
Pellet Mill Magazine distributed a survey to North American pellet producers, compiling information about their infrastructure capabilities and distribution patterns as a means to share some collective data about the industry. In August, 52 producers responded to the online survey. The number of respondents is representative of the industry as a whole, but the data was self-reported and gathered without random sampling techniques. Respondents represent a variety of plant sizes across different regions of the U.S. The straightforward, 12-question survey sheds light on a range of questions from the amount of annual production producers are able to store on-site to how much of their production they distribute through big box retailers.
Capacity and Capital
Amongst the survey respondents, about 76 percent of producers have experienced increasing annual production trends—43 percent increasing by less than 20 percent and 33 percent increasing by more than 20 percent. About 16 percent reported their annual production trends have stayed about the same or flat. The remaining 8 percent have experienced their annual production trending downward by more than or less than 20 percent in the past two years. Based on this sampling of producers, overall, pellet production is on the rise.
American Wood Fibers began producing wood pellets in 2005 with a 50,000-ton plant in Circleville, Ohio. It opened a 75,000-ton plant in Marion, Virginia, in 2009 and offers 25,000 tons—contract manufactured—from a plant in Schofield, Wisconsin. The company has experienced about the same to marginal improvements in annual production trends over the past few years. American Wood Fibers CEO Stephen Faehner says the company can store well over 10,000 tons of pellets on each site, about 20 to 30 percent of annual production. There seems to be an upward trend in the ability of pellet manufacturers to store more pellets off-season, he says. “This season we carried above 20,000 tons total, so that’s a pretty hefty commitment in dollars, but it’s also a commitment in infrastructure,” Faehner says. “You can only put so much of this out in the weather for so long. I believe more of us are putting a higher percentage of our capacity in storage—at least those of us who have the financial ability to do so.”
Appalachian Wood Pellets Inc. 50,000-ton-per-year plant in West Virginia can store around 20 percent of its production capacity on-site, and its production has been increasing by less than 20 percent over the past two years. “We’ve been fortunate at our facility—and we probably are a little different than most—in that we have more storage capacity than we’ve needed over the last few years,” says Tom Plaugher, vice president of operations with Appalachian Wood Pellets. “We’ve been able to continue moving product in the off-season and have not come close to maxing out our storage capacity. It’s allowed us to produce to our maximum potential.”
Based on the survey, just under 30 percent of the respondents join Faehner and Plaugher in having the capacity to store over 10,000 tons of pellets on-site. Twenty-four of the responding producers, or 46 percent, have the ability to store between 1,000 and 10,000 tons. The remaining 25 percent of respondents split fairly evenly between storing less than 100 tons of finished product on-site and 100 to 1,000 tons. Another way to look at the data is that 35 percent of producers can only store less than 10 percent of their annual production on-site. About 55 percent can store 10 to 30 percent of their annual production, and just 10 percent can store over 30 percent of their yearly production capacity.
Western producer Stan Elliot, vice president of sales with Olympus Pellets, says in the Western two-thirds of the country over the past five years or so there has been plenty of production and storage capacity, but the Northeast has experienced some issues with pellet supply. “Weather in the Northeast has created supply problems these last two years,” Elliot says. “The weather was just so extraordinarily cold that nobody anticipated it would stay so cold for so long.”
Elliot says the real issue in pellet supply arises in the difficulty for a plant to run April through August when there are so few retail accounts that will actually take product. It is a cash flow challenge for many pellet producers to purchase raw materials, bags and wooden pallets, and then store several thousand tons of pellets when few retailers are willing to purchase them, he says. “What can happen in some of these shortage years is many manufacturers have had to limit their summer production because they didn’t have customers paying them for it,” Elliot says. “They may have had a nameplate capacity of 5,000 tons per month, but they may only make 40,000 tons a year simply because they couldn’t afford to run in those lean summer months.”
Elliot adds that in the West, his plant and a few others have had to slow down and not produce at full capacity for short periods of time around December and January simply because they had more inventory on the ground than needed to carry them through the rest of the heating season. “You always build a stockpile and then hope you can keep up with demand, but if the weather was mild, like it was in the West, then you end up with too much supply and then you have to slow your production schedule in late winter,” he says.
Taken in aggregate, the survey results show this wasn’t the case for all producers. Where some Western producers had pellets stocked up, ready for distribution, 42 percent of producers were not able to immediately fill one to 30 of their orders during the 2014-’15 heating season. Another 12 percent of producers couldn’t fill 30 to 100, and 8 percent fell short of immediately supplying over 100 orders. Thirty-eight percent were able to fill all orders on time.
Finding the right balance between the amount of storage one needs and can afford is a challenge due to the fluctuations and uncertainty of pellet demand, but it is considered essential to many producers. “It’s important to us,” Plaugher says. “We don’t have continuous flow of our product 12 months a year, and we need the production 12 months a year to meet the commitments to our customers. A certain percentage of our product we have to be able to store in order to continue that production.” Plaugher adds that “it requires storage space and operating capital to carry that extra production, but it is crucial to our business plan for the entire year to be able to do that.”
Besides storing on-site, there has been some talk among producers and their larger, big box retailers of setting up outlets for storage. “I think the producers in the Northeast have done a very good job communicating with the big box guys—Lowe’s, Home Depot, Tractor Supply—basically to convince them that they need to establish warehouse facilities that they can fill up during those summer months to where they have adequate supply to feed their stores during the winter months,” Elliot says. “They haven’t done that in the West, but in the East I know several pellet companies that have been shipping 10 to 15 truckloads every day into public storage warehouses that are controlled by one of the big box retailers just to ensure that they have enough pellets for when the season comes in.”
The Pellet Dance
Appalachian Wood Pellets provides approximately 50 percent of its annual production to big box stores, with the remaining composed of bulk business and independent retailers. Similarly, American Wood Fibers sells about 50 percent to big box retailers. Olympus Pellets channels about 65 percent of its sales through its big retailers like Home Depot, Tractor Supply, Lowe’s and Costco. These three producers aren’t reflective of the majority of survey respondents, or 63 percent, who reported less than 50 percent of their annual production is sold to big box retail companies. Twenty-one percent of producers reported they sell 50 to 75 percent through big retailer chains and the remaining 16 percent is split evenly between producers who distribute 75 to 80 percent or over 90 percent of their product through big box stores.
Faehner refers to big box retailers as being “an enigma” to the pellet industry. “These big boxes behave differently,” he says, adding he thinks big box stores are going to trend toward purchasing certified pellet product. He believes having the Pellet Fuels Institute standard certification will give producers a leg up in the marketplace. “A lot of producers worry the cost of certification is prohibitive,” Faehner says. “I would argue that the opposite is true. It actually comes back to you in higher quality, fewer complaints, callbacks and replacements, and improved throughputs. I think certification of wood pellets is the future.”
When it comes to bulk sales, the survey indicates that producers either sell very little or quite a bit of their annual production in bulk. Over 50 percent of producers sell less than 10 percent of their production volume in bulk or none at all. However, 27 percent sell more than 50 percent in bulk, and 19 percent fall somewhere in-between.
Variances in the supply and demand of pellets is a result of the inevitable guessing game producers have to play to estimate how much product they’ll need to meet demand and the commitments they receive from their retailers. Often, received commitments are not binding under contract. In fact, 29 percent of producers don’t have sales contracts at all, and another 38 percent have less than 50 percent of their annual production committed under contract. After reviewing the survey, Faehner found it interesting that it appeared as though very few people are actually committed under contract. “Powerful retailers get indemnity from their suppliers,” he says. “When there is written documentation, it is usually in the form of a one-sided vendor agreement that is not a contract and is nonbinding.” Faehner adds, “Once they issue purchase orders and product is shipped against them, then you have something more concrete, but there are very few companies with hard-and-fast contracts.”
Forty-six percent of producers reported that they process in-season orders they receive through customer-priority ranking, followed closely with 40 percent of producers processing orders on a first-come, first-served basis. Others include quickest payment terms, net price, historical customer demand, black-box formula and a combination of ways. Sales are usually made by an in-house sales representative, with 83 percent of producers reporting this is who is responsible for the bulk of their sales.
Without a majority of producers’ production committed under contract, they rely upon forecasts, historical sales, reliable customers and other variable methods to gauge demand. Elliot says big box retailers will give forecast estimates of what they’ll need. “The forecasts tend to be a little slanted because they want to put the burden on the pellet producer to make sure you have enough for them, but of course, if it’s a mild year, it’s very difficult living up to that commitment,” he says. “We’ve certainly had that situation. The big box guys, typically in the West anyway, will only carry pellets say from Labor Day until the end of February, then they start switching out all of their departments into garden and that sort of thing. If they’re behind on their commitments, and this has happened in the last two years for us, then we bring it to their attention. They are normally willing to keep pellets in their stock maybe for another month just to help meet that commitment.”
The survey results show that 67 percent of producer’s big box customers buy in the off-season and that the remaining 33 percent do not. Plaugher says it seems like the number of big box retailers purchasing in the off-season is increasing, especially over the past two seasons, which he attributes to some product shortages. “They’ve started taking products in the off-season, doing some of their own storage, I’m assuming to make sure they don’t run into that type of a situation again,” he says.
According to Faehner, usually big box retailers cease buying quickly once the end of the season approaches. “You have to look at it from the perspective of the big box and how they operate,” he says. “They are a season-to-season business. They are always resetting their stores and they don’t carry the inventory off-season. It’s just not their model.”
None of Olympus Pellets’ main, large retailers purchase in the off-season. “We have a lot of independent or regional pellet retailers that do buy some,” Elliot says. “We offer summer specials and we certainly encourage those, but so far the big box guys haven’t taken advantage of those sales.”
Elliot believes retailers will work with producers when there are projection miscalculations. “Retailers will try to alleviate a projection shortfall, but of course they can’t force the pellets down people’s throats any more than we can,” he says.
As the industry matures, retailers and producers alike will get better at gauging the supply and demand needed to keep pellet plants profitable, retailers’ shelves stocked and pellet consumers supplied. “Sometimes, you just have to work with each other and understand that we’re in a seasonal business,” Elliot says. “You look at their forecast and determine whether you think it’s realistically based on what you think is going to happen. It’s just part of the dance.”