Market Analysis:  The Cellulosic Energy Conundrum

By Charles R. Brettell, Principal

Energy Asset Advisors, LLC

May 4, 2010

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You don’t have to be “green” to see the on-going shift to cellulose-based power & fuel.  A good point of reference for both power & fuel is EIA’s Annual Energy Outlook 2010.

In AEO 2010, EIA posits that about 20% of electric power load growth through 2035 will be met solely by biomass sources.  On the fuel side, EIA sees import requirements falling in the face of expanding domestic biofuels production, spurred on by RFS2 and the rising success story of the new-model biorefinery.  They also see the US missing the RFS2 mandate amounts for a number of reasons, some related to technology, others related to hyper-enthusiasm yielding to reality.

Critical to these developments is reasonably priced, abundant physical cellulosic supply from credit-worthy entities with the capacity to manage the logistics of fulfillment.  After all, you can’t spin a turbine or fill-up your tank with a financial guarantee, the  current mechanism that woody-biomass facilities use to get past the “supply dilemma”.  Moreover, in a world that discriminates among feedstocks – as all current incentives / regulatory mandate programs do – supply is even more critical, as a paucity of supply (and suppliers) jeopardizes companies’ ability to sell product (think:  California’s low carbon fuel standards) and investors’ ability to capture available tax benefits (like the full-value PTC for closed-loop biomass), putting at risk the US’ ability to provide for its own power & fuel needs.

That said, from both policy & practical perspectives, US governmental & industrial ambivalence toward cellulose supply markets has forced the nascent supply market to focus instead on Europe, where physical demand is established and growing due to their significant head-start on renewable power & fuel matters, jeopardizing US cellulosic power & fuel development.  Suffice it to say that positioning the US as the raw material supplier to foreign renewable power & fuel programs benefits virtually nobody in the US – not even suppliers.  Logistics issues related to getting cellulose to Europe creates a high-cost supply regime that inflates the price of power on the Continent and artificially reduces payments available to growers.

From where did this US ambivalence spring?  On the power side, US utilities have been slow to encourage development of cellulose suppliers (via bankable off-take agreements for their co-firing & baseload biomass needs) for a variety of reasons, including regulatory, technology, stranded costs, etc.  On the fuel side, the major problem has been technology – though this seems to be fading away as more firms are coming to market with commercial cellulosic biofuels; as a result, these firms will need supply at the same or higher levels than their power-based brethren.  Lack of credible offtake arrangements has stunted the development of cellulose markets, as even investors with the foresight to understand the burgeoning need have committed their capital elsewhere waiting for demand to surface.  For the few reputable non-woody biomass power & fuel projects that exist, this lack of credit-worthy supply has impaired financing & development efforts; especially for closed-loop facilities where that supply “problem” is embedded in the business model.

The result of these shortcomings in policy and practice will likely be evident in short order as incentives and mandates align to create demand for products & services that either won’t exist or are otherwise committed to foreign sources / other uses, resulting in price spikes & supply shortages that threaten existing and planned biomass energy additions.  Worse yet, lack of adequate, reasonably priced resources could delay implementation of the shift to cleaner-burning, carbon-neutral biomass power and low-carbon biomass fuel solutions, something already evident in the cellulosic fuel arena.

Of course, market failure creates winners and losers.  In the winners column are large-scale emitters (coal & other fossil fuels) and petroleum refiners, each of whom win by delaying the inevitable and extracting returns from their current operations.  Solar & wind also win under a scenario of biomass market failure, as there’s no fuel issue to contend with and lots of high-dollar REC’s available.  Finally, spreads in emissions markets are likely to fluctuate wildly to account for divergent opinions of value related to stalled GHG initiatives, yielding both winners and losers.

A number of possible solutions exist to help moderate our shift to cellulosic energy, all of which would provide for more open, orderly and reliable supply markets.  First and foremost, the US government should end the cycle of continuous uncertainty in renewable energy by locking in an incentive structure for the long-term – say 10 years.  This would allow for more certainty in the development & financing sectors and provide a longer-term view to policymakers around the true functioning of these markets.  We should also remove established biomass sources from the incentive structure, as the inclusion of wood, black liquor and some of the other less “green” biomass fuels stunts the development of new & necessary cellulose markets.  We should also end the differentiation among open & closed-loop biomass power, as this serves only to retard the spread of cellulosic energy & corresponding supply markets.  We should also modify BCAP to allow for longer-term CHST support payments to cellulose suppliers (10 years?) and fast-track the grower benefits component to completion.  On the power side, we should learn from the best practices of other countries and implement feed-in-tariffs (FIT’s) for cellulosic biomass (for FIT examples in the US look no further than efforts underway in Florida, Oregon & Vermont).  Once these changes are in effect, we should circle back to our current power & fuel mandate schemes (the state-led RPS & federal RFS2) and give them some teeth.  For each, the government could require that failure to meet these requirements comes with a financial cost – like having to offset shortfall with a “green” credit product (something of a cap & trade mechanism).

Simply put, without robust cellulosic supply markets the future of our burgeoning shift to biomass power and fuel will fall short, a result that is completely avoidable by simply making minor adjustments to our policies, practices – and most importantly – our perspectives. 

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