What will be the Impact on the US Domestic Heating Pellet Sector of a Positive Oil Shock?

Transcription

1 What will be the Impact on the US Domestic Heating Pellet Sector of a Positive Oil Shock? By William Strauss, PhD, President, FutureMetrics October 26, Crude oil prices have dropped rapidly in recent months. From the point of view of consumers of petroleum products, this is a positive oil shock. From the point of view of the pellet heating markets, this may be a negative shock. Lower crude prices lead to lower heating oil prices. Lower heating oil prices will impact demand for wood pellets and pellet burning appliances in the heating markets. If heating oil prices go below about $2.15/gallon at the retail level then the cost per MMBTU for heating oil and pellets will be about the same (at current pellet prices). At some point, there will be switching from pellet fuel to heating oil. This brief paper analyzes the potential impact of significantly lower heating oil cost. $35.00 $30.00 $25.00 Heating Oil and Pellet Fuel Left Scale = Dollars per Million BTU Right Scale = Dollars per Gallon for Heating Oil #2 heating oil Pellets - Delivered $5.00 $4.50 $4.00 $3.50 $20.00 $3.00 $2.50 $15.00 $2.00 $10.00 $1.50 $5.00 $1.00 $0.50 $- Dec-1995 Mar-1996 Jun-1996 Sep-1996 Dec-1996 Mar-1997 Jun-1997 Sep-1997 Dec-1997 Mar-1998 Jun-1998 Sep-1998 Dec-1998 Mar-1999 Jun-1999 Sep-1999 Dec-1999 Mar-2000 Jun-2000 Sep-2000 Dec-2000 Mar-2001 Jun-2001 Sep-2001 Dec-2001 Mar-2002 Jun-2002 Sep-2002 Dec-2002 Mar-2003 Jun-2003 Sep-2003 Dec-2003 Mar-2004 Jun-2004 Sep-2004 Dec-2004 Mar-2005 Jun-2005 Sep-2005 Dec-2005 Mar-2006 Jun-2006 Sep-2006 Dec-2006 Mar-2007 Jun-2007 Sep-2007 Dec-2007 Mar-2008 Jun-2008 Sep-2008 Dec-2008 Mar-2009 Jun-2009 Sep-2009 Dec-2009 Mar-2010 Jun-2010 Sep-2010 Dec-2010 Mar-2011 Jun-2011 Sep-2011 Dec-2011 Mar-2012 Jun-2012 Sep-2012 Dec-2012 Mar- Jun- Sep- Dec- Mar- Jun- Sep- $0.00 source: EIA, regional sources, FutureMetrics FutureMetrics Globally Respected Consultants in the Wood Pellet Sector Page 1

2 The chart below shows that heating oil prices are highly correlated with crude prices. $125 <== Crude and Heating Oil ==> Prices $4.00 $115 $3.80 $3.60 $105 $3.40 $3.20 $95 $3.00 $85 Europe Brent Spot Price FOB (Dollars per Barrel) $2.80 $2.60 $75 Heating Oil Retail Price in Maine (Dollars per Gallon) $2.40 $2.20 $65 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct $2.00 Source: EIA, October 24, ; Analysis by FutureMetrics Will oil prices go lower? The future of oil prices depends on supply and demand. On the demand side, growth in the global economy has slowed and the growth in demand for commodities including crude has flattened 1. On the supply side, it would appear that OPEC has abandoned a strategy of trying to curtail supply. Stagnant demand growth and rapidly increasing supply have caused crude oil prices to fall dramatically. The chart below shows the surge in global oil supply in September, and the trend in global oil supply over the last 22 months. 1 IMF World Economic Outlook, Legacies, Clouds, Uncertainties, October,. FutureMetrics Globally Respected Consultants in the Wood Pellet Sector Page 2

3 3.0 Global Oil Supply - Source and Total Change on a Year Earlier in Millions of Barrels per Day OPEC Non-OPEC Total Total Change Trend IEA Oil Market Report, Oct., Analysis by FutureMetrics Although one month of data (Sept. ) may not be conclusive, it would appear OPEC has switched from trying to control global volumes to flooding the markets. If prices fall far enough higher cost producers will drop out. The curtailment of some higher cost production, particularly in the US shale oil patch, suggests the potential for a floor on how far prices can fall. Some estimates put that number at around $70/barrel 2. At $70/barrel we would expect to see heating oil retail at about $2.52/gallon 3. For heating oil to reach par with pellet fuel in terms of cost per unit of energy (at current pellet fuel prices), crude prices would have to hit about $52/barrel. As the chart on the first page illustrates, crude prices may overshoot price floors until higher cost oil extractors curtail operations as they did in What does this mean for the domestic heating markets? The discussion that follows is focused on the northeastern states which are heavily reliant on heating oil. 2 $73/barrel by Robert W. Baird Equity Research, Oct. 14; $60-$80/barrel by Morgan Stanley, Oct. 14; $73.80 by UBS Investment Research, Oct Based on regression analysis by FutureMetrics on historical prices of crude and heating oil. FutureMetrics Globally Respected Consultants in the Wood Pellet Sector Page 3

4 The chart below shows the capacity for wood pellet production in the northeast (at an assumed capacity factor of 90%). It also shows the estimated demand for wood pellets Wood Pellet Output and Estimated Demand in the NE Region Potential for 110,000 tpy Excess Demand in 1000's of Tons Northeast Pellet Mill Capacity at 90% of nameplate Estimated Demand if Oil Prices Stabilize If Heating Oil Prices Drop Below $2.10/gallon source: Biomass Mag database and HPBA stove sales data,, and data from FutureMetrics on regional production. Tonnage demand estimates and forecast by FutureMetrics As the chart above shows, the market at the beginning of the -15 heating season is estimated to be about in equilibrium (supply equaling demand). As the -15 heating season progresses, FutureMetrics has been estimating that demand will slightly exceed regional capacity. There was a significant increase in pellet stove sales since last winter due to high heating oil prices and a long cold winter. As of the writing of this paper, there are locations with shortages of bagged wood pellets in the northeast. The chart above also shows the last time the market was hit by pellet shortages in That was the when oil prices spiked and pellet demand exceeded supply. New capacity to meet that increase in demand took 12 to 24 months to come on line. Meanwhile oil prices crashed and the rate of increase in demand flattened. The new capacity was in place by but by then supply exceeded demand. Since then the overcapacity in the region has been challenging for the 4 Demand estimates by FutureMetrics are based on pellet stove and pellet boiler sales data, estimates of the average tonnage used per stove and boiler with degree day adjustments, and an assumed attrition rate for older stoves. Supply estimates are based on reported nameplate. Supply in is based on some incremental expansions in capacity of existing mills and one new small mill currently nearing startup. There are some announced projects that have not received construction financing. They are not included. FutureMetrics Globally Respected Consultants in the Wood Pellet Sector Page 4

5 producers. The overcapacity has also kept prices for pellets in the northeast relatively stable. The previous higher price volatility for pellets was during the last shortage event in To further complicate the northeast pellet heating markets, homeowners who had difficulty getting pellets at the end of last year s winter are buying a whole winter s stock of pellets now and in some cases are hoarding pellets (that is, buying enough now for more than one heating season). That demand shock cannot be compensated for in the short term so some shops have nearly empty lots where there should be many pallets of pellets. That dynamic reinforces the perception of insufficient supply. That will also cause inventory management and demand estimation problems for the producers and retail outlets since purchases of pellets in mid and late winter will be unnecessary for the increased number of households that have pre-stocked or hoarded. As the chart on the first page shows, the price of pellets has crept up in recent months. This is a natural outcome of excess demand. But in the face of falling oil prices, it may complicate the market dynamics for the sale of pellets and pellet appliances. Growth in pellet demand is correlated with heating oil price. The chart below shows this relationship. There are other factors driving volumes such as weather, the impact of slow economic growth on pellet appliance sales, and in some regions the price of natural gas. The decoupling after 2009 illustrates the impact of these other factors. The persistence of high heating oil prices, a long and colder than normal -14 heating season, and better economic conditions leading to increased stove and boiler sales has stimulated sales this year. $4.90 <== Heating Oil Prices and Wood Pellet Demand ==> wood pellet demand as change in NE tonnage volumes from a year earlier $4.40 $3.90 $3.40 High Low Average 450, , , ,000 $2.90 $2.40 $ , , , ,000 $ ,000 $ source: EIA, ; Demand estimates by FutureMetrics; 2015 forecast based on various crude oil forecasts; Analysis by FutureMetrics FutureMetrics Globally Respected Consultants in the Wood Pellet Sector Page 5

6 If heating oil prices fall into the low $2/gallon range, then the cost of heating oil per MMBTU is on par with the cost of pellet fuel per MMBTU. That will slow the sales of pellet stoves and boilers, and homes already using pellets may switch back to heating oil. If this happens then demand may not exceed capacity and by mid-winter the pellet producers could be facing curtailments in production. That scenario is shown on the chart on page 4 by the red line. However, if oil prices revert toward the long-term mean within the next year or so, there is the potential for significant excess demand in the heating season. The demand for premium wood pellets could exceed capacity in the northeast by more than 100,000 tons per year. There is a bright side for the pellet producers when crude oil prices are low. Diesel fuel prices will also fall and diesel cost makes up more than 50% of the total cost of delivered wood to the pellet mills. Thus the cost of wood should fall. If wood prices fall as would be expected with lower diesel fuel prices, then for a given pellet price, the producers margin per ton should improve. That margin improvement will be welcomed if volumes do not match the expectations of the markets just a few months ago and expectations that are based on pellet sales now. There is the possibility that, for another year, there will be overcapacity in the northeast pellet heating markets. If that is the case, then the low cost producers and those producers closest to their markets will have an advantage. Moving pellets long distances adds many dollars per ton to the cost of getting those pellets to end users. As the chart on page 5 shows, even in years in which factors depressed aggregate growth in the demand for wood pellets in the northeast, growth in demand never fell below 50,000 tons per year. It is unlikely that the aggregate demand for wood pellets will fall. It is possible, given the risk that crude oil prices will fall farther, that the growth rates that were expected as recently as four months ago may not materialize. FutureMetrics Globally Respected Consultants in the Wood Pellet Sector Page 6