Organization of the current U.S. biopower industry: A template for future bioenergy industries

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1 biomass and bioenergy 33 (29) Available at Organization of the current U.S. biopower industry: A template for future bioenergy industries Ira Altman a, *, Thomas Johnson b a Southern Illinois University Carbondale, Department of Agribusiness Economics, Mail Code 441, 125 Lincoln Drive Carbondale, Il 6291, USA b University of Missouri-Columbia, Department of Agricultural Economics, 215 Middlebush Hall, Columbia, MO 65211, USA article info Article history: Received 25 June 28 Received in revised form 16 December 28 Accepted 21 December 28 Published online 31 January 29 Keywords: Biopower Industry structure Biomass supply organization abstract The development of biomass based industries face many challenges. Technological and environmental questions are paramount. However, the organization of developing biomass based industries could be a key non-technical barrier. Given that industrial organization is not the focus of many research agendas, this article attempts to fill the void. Biomass sources could be a low cost feedstock for energy production such as cellulosic ethanol. This potential low cost hinges on effective and efficient methods of exchange. One way to address the need to understand the organization of future biomass based industries is to examine current related industries such as the United States biopower industry. This article first examines the broad industrial structure of the current biopower industry by briefly discussing inputs, technology, function and production trends. Then the discussion is narrowed to focus on the type of used to procure or transfer ownership of biomass materials in the current U.S. biopower industry. Based on survey evidence the current biopower industry is found to be highly vertically integrated with little use of spot markets. This result is found to be consistent across the type of biomass fuel used. ª 29 Elsevier Ltd. All rights reserved. 1. Introduction The development of bioenergy industries based on cellulosic feed stocks faces many challenges. The need for technological improvements in processing technologies and proof of environmental benefits are primary among these. However, a lingering non-technical issue is the organization of biomass based industries. How will input suppliers and processors interact? What supply mechanisms will they use? Will long term contracts or vertical integration prevail? Will spot markets for biomass develop? Will the costs of governing these relationships be kept low enough that the technologies can still be competitive? One way to shed light on such questions is to observe the current U.S. biopower industry. The organization of the current biopower industry could provide a template for how future biomass based industries will develop. This article first reviews the biomass and bioenergy literatures with a focus on articles that address organizational issues. Second, the broad industrial structure of the current biopower industry is briefly described based on data from the U.S. Energy Information Administration. Third, based on a survey of biopower producers, current organizational mechanisms are revealed. * Corresponding author. Tel.: þ ; fax: þ addresses: ialtman@siu.edu (I. Altman), johnsontg@missouri.edu (T. Johnson) /$ see front matter ª 29 Elsevier Ltd. All rights reserved. doi:1.116/j.biombioe

2 78 biomass and bioenergy 33 (29) Biomass and bioenergy literatures Much of the biomass and bioenergy literatures are focused on technical questions while organization of future industries is overlooked. Energy policy has received some attention [1]. Klass [2] points out that industrial organization issues are often overlooked when biomass and bioenergy researchers make technical recommendations for the industry. He points to storage and shipping strategies in wood product markets as an example as solutions that have been prescribed by biomass and bioenergy researchers but have not been adopted in industry practice [2, p. 554]. He cites the failure to consider organizational issues as potential barriers to nascent biomass industries as a reason that these industries have not been developed. As van Loo and Koppejan [3] have documented, there are also cases where organizational adaptations have solved technological problems. Their work underscores the importance of understanding organizational issues. Downing et al. [4] and Overend [5] confront the organizational issue directly, although they come to different conclusions. Downing recommends vertical integration while Overend considers spot markets and short term contracts most efficient. Downing et al. [4] describes and recommends agricultural cooperatives as examples of research, financing and exchange mechanisms in the agro-bioenergy industry. Cooperatives are a type of biomass exchange mechanism that should be considered. Cooperative cases can be compared to contracting and spot market systems that also exist in the U.S. biopower industry. Klass [2] too suggests a highly vertical system. However, he goes one step further and suggests horizontal integration where various bioenergy production functions are linked with co-products fed into lateral bioenergy production systems under unified ownership. Overend [5] provides a description of the main features of a general biomass industry, but does not suggest a highly vertically integrated system. The author concludes: The industry must rely on short term contracts or the spot market for fuel purchases [5, p. 2]. This contradiction compared to the arguments made by Klass and Overend helps focus the discussion to the choice of. Organizational questions have received some attention in the literature but tend to be secondary considerations for many authors. This article shows that the biopower industry today currently relies on captive supplies and integrated systems, contrary to some recommendations. Thus if future biomass based industries develop similarly to the current biopower industry, vertically integrated systems are more likely. 3. The US power industry The overall power industry is typically described as having three main functions: power generation, long distance transmission and local distribution. Retailing and input/fuel production and processing could also be added to create five functions of the power industry: 1 input/fuel procurement, 2 power generation, 3 long distance transmission, 4 local distribution and 5 retail. An efficient input/fuel procurement stage is essential for the biopower industry to be competitive. One of the advantages biopower typically has over conventional sources of fuel is that biopower has relatively low feedstock costs. However, this advantage can be negated if the supply chain system is inefficient, driving up the organizational costs and hence the effective cost of the fuel source Structure of the power industry The structure of the electricity industry has typically been highly vertically integrated, since large regional companies own and operate assets at the generation, transmission, distribution, and retail stages. The regulated component of the industry includes 32 utilities. In the 199s, investorowned utilities provided about 71 percent of the electricity consumed, 1 percent was from publicly owned facilities, 4 percent was from cooperatives, 8 percent was from federal power producers, and 7 percent by non-utilities [6]. Most investor-owned utilities are vertically integrated across the functions of the electric industry. The majority of publicly owned utilities and cooperatives specialize in retail and distribution while federal utilities specialize in generation (mostly hydropower). The greater separation of generation from the other functions has led to an increase in the size of the wholesale market where retail utilities purchase power from generating utilities rather than produce it themselves. There are both long term and short term contracts in this exchange [6]. Municipal and cooperative utilities have tended to be less integrated, focusing on generation or retail only. Biopower from wood has not tended toward the general trend of vertical integration between generation, transmission and distribution since mostly non-utility generators produce biopower from wood. These generators have not integrated forward into transmission or distribution and tend to operate at a smaller scale than the integrated utilities. However, biopower producers have tended to be integrated between input and power production stages. Traditionally, 3 6 MW plants were needed to realize the potential economies of size for generation units. However new combined-cycle plants reduce the minimum efficient size to as low as 1 MW. This change in technology implies that generation could become less of a natural monopoly. Most biopower facilities are in the 1 5 MW range. As a reference point, 1 MW is enough power for about 6 homes. 4. The current biopower industry The biopower industry is a complex array of power utilities and non-utilities using many technologies and many inputs to produce electricity. Utilities are regulated by the state public

3 biomass and bioenergy 33 (29) Biopower (MW) 35, 3, 25, 2, 15, 1, Total Utiltity Biopower 5, Total Non-Utility Biopower Time (Yr) Source: Calculated from the Annual Energy Review (23) [7] Percent of Non-Hydro Renewable Time Source: Calculated from the Annual Energy Review (23) [7] Fig. 1 Total biopower production utilities and non-utilities. utility commissions while non-utilities like industrial cogenerators are not. Percent Wood of Non-Hydro Percent Waste Non-Hydro Percent Geo of Non-Hydro Percent Solar of Non-Hydro Percent Wind of Non-Hydro Fig. 3 Percent of non-hydro renewable power by source Biopower production trends Biopower production is divided fairly evenly between utilities and non-utilities. The Energy Information Administration (EIA) reports just under 31, megawatts (MW) of biopower from non-utilities with just less than 29, MW produced from utilities in 23 [7]. Fig. 1 reports biopower production from 1989 to 23 by utilities and non-utilities. The biopower production numbers include two categories of feed stocks: wood and waste. The wood category includes direct wood fuel from the forestry industry including bark, limbs and odd shaped wood not suitable for other uses and wood residue from wood manufacturing and pulp and paper industries. The waste category includes landfill waste, landfill gas, recycled tires and agricultural residue. Fig. 2 reports utility and non-utility productions of these two categories. Non-utilities tend to produce more power from wood while utilities produce more from the waste category. The biopower market is a subset of the power market. Power is produced from various renewable and nonrenewable sources for many different consumers. Approximately 2 Biopower (MW) 35, 3, 25, 2, 15, 1, 5, Time (Yr) Source: Calculated from the Annual Energy Review (23) [7] Utilities Wood Utilities Waste Non-Utilities Wood Non-Utilities Waste Fig. 2 Biopower production by fuel category and producer type. percent of electricity is from non-hydro renewable sources annually [7]. Of this renewable power, biomass, including wood and waste, makes up the largest percentage of inputs at about 7 percent. However, most of the biopower is produced from wood, wood residue, municipal solid waste and landfill gas. Less than 1 percent of biopower is produced from agricultural biomass [2]. Fig. 3 presents the percent of non-hydro renewable power by source and Fig. 4 reports the percentage of non-hydro renewables of total power. 5. Biopower producer survey The data utilized for this discussion were retrieved from a mail survey conducted by the University of Missouri Community Policy Analysis Center in 23 [8]. From 198 power facilities (1 MW or larger) actively producing biopower on the Percentage of Total Power Time Source Calculated from the Annual Energy Review (23) [7] Percent Wood of All Power Percent Waste of All Power Percent Geo of All Power Percent Solar of All Power Percent Wind of All power Fig. 4 Percent of non-hydro renewables of total power.

4 782 biomass and bioenergy 33 (29) Energy Information Administration list, 53 responded. This represented a 26.7 percent response rate. These data provided an opportunity to learn about the business practices in the current biopower industry. Wood was the most dominant fuel type reported, 42 of 53 plants used as least some wood based fuel. Therefore we proceed by describing the proportion of wood based fuel used per plant. In terms of the type of fuel used: 18 of 53 biopower plants used 1 percent wood or wood residue products. Five plants used 9 percent wood or more and 1 percent or less of natural gas, tires, agricultural products or paper mill residue. Four plants said they used between 5 and 9 percent wood products as fuel. Ten plants reported that they used between 1 percent and 5 percent wood and four plants 1 percent or less of wood products as fuel. The remaining 11 plants did not use wood as biomass fuel. In terms of agricultural biomass as fuel, eight plants reported that they used at least some agricultural products as fuel. Of these eight plants, 2 also used wood, one plant used 98 percent wood and 2 percent agricultural biomass as fuel while the other 6 percent wood and 4 percent agricultural fuel. Two plants in this category used 1 percent agricultural products and 1 plant used 99 percent agricultural products, the other three used 8 percent, 2 percent, and 1 percent respectively of agricultural fuel. The remaining five plants that used neither wood nor agricultural sources used mainly landfill gas, municipal solid waste (MSW) or tires as fuel. Overall eight plants use some agricultural products (two together with wood), 42 used some wood products, and five used landfill gas, MSW or tires. The biopower industry can also be described in terms of the scale or size of plants in tons of fuel per year. In this sample, the range of biomass fuel used includes a low of 7 tons per year and a high of 1.4 million tons per year. The average use is 225 thousand tons and a standard deviation of 261 thousand tons. Table 1, summarizes these statistics. It must be noted that the sample population only includes those firms producing 1 MW or more (surveys were sent to only producers on the EIA list). In terms of generation technology 15 respondents indicated co-fire, 34 direct fire and three another technologies (gasifier, internal, a steam process). One plant declined to answer this question Organizational mechanisms The main organizational issue of interest here is how respondents procured or purchased their biomass supplies. There were three broad organizational alternatives presented to responding firms. First there was vertical integration or internal procurement. Vertically integrated systems involve the biomass producer integrating forward into biopower Table 2 Organizational form choices in the sample of biopower generators. Internal External Both Total production and in more rare cases power producers backward integrating into biomass production. A second organizational choice was external procurement. This system involves independent power producers purchasing biomass as fuel for their generation needs from independent biomass producers. This category includes both the use of spot markets, formal contracts and informal contracts. A final category of organizational arrangements is a combination of both internal and external procurement. This option involves a company that procures part of their fuel need from in-house sources but also purchases externally. Based on the 53 responses, about half the industry or 28 of 53 relied on exclusively vertically integrated systems or a system that used internal procurement. These companies included forestry, wood and pulp and paper manufactures as well as food and agricultural companies that had integrated forward into biopower production. Rather than sell their residues to other processors or dispose of them, they have chosen to utilize their residues in biopower production. The second category of choice of includes 13 of 53 that used exclusively external procurement (spot markets or contracting). These companies were generally traditional power companies that had chosen to enter biopower production. Of these 13, 3 used a spot market system while the other 1 used contracts ranging from 3 months to 2 years in length. The remaining 12 observations used both internal procurement and external procurement. These were wood and agricultural manufacture companies that had increased the scale of their power plant beyond their own residue capacity, or utilities that had partially integrated into fuel production. The method of external organization for these firms included 3 of 12 that used spot markets while 9 used short term and long term contracts. Table 2 summarizes the choice of in our sample of the current United States biopower industry. Table 2 indicates that the biopower industry is highly vertically integrated and spot markets are rarely used to purchase biomass. Only 3 of 53 respondents used spot markets exclusively, while 28 of 53 used vertical integration exclusively. Considering firms that used both types of Table 1 Summary statistics-scale. Variable Observations Mean (tons/year) Standard deviation (tons/year) Minimum (tons/year) Maximum (tons/year) Scale , , ,445,937

5 biomass and bioenergy 33 (29) Table 3 Organizational form choices in the 1 percent wood sample. Internal External Both Total Table 6 Organizational form choices in the 1 5 percent wood sample. Internal External Both Total Table 4 Organizational form choices in the 9 1 percent wood sample. Internal External Both Total 5 1. exchange mechanisms only 3 of 12 indicated that they used spot markets. Thus only 6 of 53 firms indicated any use of spot markets and only 3 used exclusively spot markets. Extrapolating from the 28 firms that used exclusively internal procurement or vertical integration and the 12 that use both types of exchange mechanism, suggests that approximately 75 percent of the current biopower industry is vertically integrated. For firms that used external organization or both, contracts are more preferred over the use of spot markets. Of the 13 firms that used external organization only 3 used spot markets. Similarly 3 of 12 firms that used both internal and external organization preferred spot markets. Thus just under one quarter, 6/25 or 24 percent, of external and both type firms use spot markets and the majority (76 percent) of these firms use short term or long term contracts rather than spot markets. However, is the trend towards internal organization specific to power plant characteristics such as the type of fuel used? Cross tabulation indicates that the choice of internal organization is more preferred with power plants that use 1 percent wood as fuel. From the sample of 18 plants that stated they used 1 percent wood as fuel, 14 use internal organization, and 2 each for the external and both categories. Table 3 summarizes these data. Compared to the sample population internal organization is chosen in 77 percent of this subsample compared to 52 percent for the total sample population. Once the proportion of wood fuel drops, internal organization is less chosen compared to the 1 percent wood fuel sample and the sample population. For plants that used 9 percent to less than 1 percent wood as fuel, 3 of 5 plants chose external organization, and 1 plant each chose internal organization and both. Further, in the sample of wood fuel range of 5 9 percent wood category no plants preferred internal organization, 3 chose both and 1 external organization. Tables 4 and 5 summarize these data. Once the percentage of fuel used is less than 5 percent, internal organization becomes more preferred again, however, not as much as the sample with 1 percent wood biomass used. In the sample of power plants that use between 1 percent and 5 percent wood biomass as fuel, 5 of 11 used internal organization, 4 of 11 used both internal and external organizations and only 2 of 11 used external organization. For plants that used less than 1 percent wood as fuel 2 of 4 used internal organization and 1 used external organization and both. Tables 6 and 7 summarize these data. These results are more consistent when compared to the sample population. For plants that use no wood as fuel, internal organization was used in 6 of 11 of the cases, while 4 used external organization and only 1 both internal organization and external organization. Compared to the overall sample population this result is fairly consistent with the both option being slightly less represented, the external option slightly over represented, and internal organization virtually the same (52 percent compared to 54 percent). Table 8 summarizes these data. Comparing the non-wood and wood firms there is little difference in organizational preferences. Considering the 42 sample firms that used at least some wood as biomass fuel, 22 used internal organization, 9 external organization and 11 both exchange types. These results are fairly consistent with Table 5 Organizational form choices in the 5 9 percent wood sample. Internal External Both Total 4 1. Table 7 Organizational form choices in the 1 percent wood sample. Internal External Both Total 4 1.

6 784 biomass and bioenergy 33 (29) Table 8 Organizational form choices in the percent wood sample. Internal External Both Total Table 9 Organizational form choices in the wood sample. Internal External Both Total fuel firms. Thus, if cellulose ethanol is expected to be based more on non-wood products, this sample of biopower producers, which is dominated by wood biomass use, could be considered representative. This data also serve as a warning to new industrial developers. Those who are hoping to source supplies through the development of spot markets should consider alternative external procurement methods such as short term and long term contracting. Not only was internal organization the most preferred at the full sample population level, but also contracting was preferred by those that used external organization. Over three quarters of firms that used external procurement used contracting over spot markets. Further, considering new biomass industry development, in some cases, vertical integration methods such as strategic alliances and joint ownership should also be considered as mechanisms to procure biomass relative to external organization. the non-wood firms and the overall sample population. Table 9 summarizes these data. 6. Conclusions The biomass exchange mechanism favored in the current biopower industry is clearly vertical integration. This could imply that the future biomass based industries, such as cellulosic ethanol, could rely heavily on vertical integration too. Since three quarters of the current biopower industry relies on vertical integration for fuel procurement the prediction of spot markets being efficient for future biomass industries is difficult to justify with current data. The contention that future biomass based industries could rely heavily on vertical integration is justified further by considering the break down of by fuel mix. Power plants that used 1 percent wood biomass preferred internal organization over 77 percent of that sample. If future cellulosic ethanol plants are more comparable to 1 percent wood biomass biopower plants vertical integration or internal organization should be expected. Further, there was little difference found between wood and non-wood biomass references [1] Morris G. Do we need a biomass energy policy? The California Experience 1999;1:1 7. [2] Klass D. Biomass for renewable energy, fuels, and chemicals. San Diego: Academic Press; [3] van Loo S, Koppejan J. Handbook on biomass combustion and cofiring. Enschede, Netherlands: Twente University Press; 23. International energy agency, Task 32. [4] Downing M, Volk T, Schmidt D. Development of new generation cooperatives in agriculture for renewable energy research, development, and demonstration projects. Biomass and Bioenergy 25;28: [5] Overend R. Biomass power industry: assessment of key players and approaches for DOE and industry interaction. Golden, CO: National Renewable Energy Laboratory; [6] Brennan T, Palmer K, Kopp R, Krupnick A, Stagliano V, Burtraw D. A shock to the system: restructuring America s electricity industry. Washington, DC: Resources for the Future; [7] Energy Information Administration. Annual Energy Review. Available on the World Wide Web at: aer/electr.html; 23. [8] Altman I, Johnson T. The choice of as a non-technical barrier to agro-bioenergy industry development. Biomass and Bioenergy 28;34:28 34.