October 16, 2022
The economic impact of Russia’s invasion of Ukraine is being felt globally. Both food and energy markets have been severely disrupted. A substantial amount of economic pain is being felt in Europe, where the Kremlin has used natural gas supply as a geopolitical weapon. Now that the Nord Stream natural gas pipeline will be offline for some years (if not indefinitely), the EU will need to reorient its energy procurement policies away from Russian resources, towards other forms of energy, such as nuclear and renewables, including biomass.
In addition to Russian gas no longer flowing to Europe, Russia, as of July 2022, has also stopped exporting wood pellets to the European Union, due to sanctions. This has created a perfect storm for European consumers of electricity and heat.
There are three general categories of wood pellets: low-grade power generation pellets manufactured by industry giants such as Enviva, heating pellets for pellet stoves, and cooking pellets for pellet grills and smokers.
In this article, I’m focusing on the supply and demand dynamics for home heating pellets used in pellet stove appliances, as well as pellet boilers used in commercial and industrial heating applications. In the U.S. market, the demand for heating pellets is largely dependent on annual weather conditions and heating oil prices. The increase in the U.S. year-to-date heating pellet price appears to be related to higher oil prices and other domestic inflationary pressures. If colder winter conditions prevail in the coming months, the domestic price per ton in the U.S. market could move up further. The current retail price for wood pellets in the Northeast (which is a key market), is $300-$400 per ton.
European Heating Pellet Prices are Now Higher Than U.S. Prices
Bloomberg recently reported that European Union wood pellet prices reached ~$600 per ton in September. Given that the heating season has not yet arrived in Europe, one might infer that the price of heating pellets could rise much more, as households attempt to reduce dependence on more costly natural gas. While there is room for prices to increase materially, a limiting factor will be that new pellet stoves must be installed in large quantities, in order to increase overall demand in the European market.
That said, the parabolic year-to-date move in natural gas prices, combined with the sanctioning of Russian wood pellet exports, means that there will most certainly be a serious deficit of heating pellets (for consumers who already have a pellet stove) until other producers can make up the difference. An article in Fortune notes that, “As much as 70% of European heating currently comes from natural gas and electricity, and with Russian deliveries drastically reduced, wood — already used by some 40 million people for heating — has become a sought-after commodity.” Given that it generally takes 2-3 years to engineer, build and commission a new pellet mill, we could see an EU pellet deficit for some time. Note also that LNG imports will take years to increase, due to limited port regasification infrastructure.
For that reason, European buyers have been increasing imports from American wood pellet manufacturers. While there is not a tremendous amount of excess capacity in the U.S. heating pellet industry, it is likely that this trend will continue and that American pellet mills will divert part of their annual production to the European export market.
Russian Sanctions Are Likely to Remain in Place for Many Years
Given Russia’s inability to achieve its military objectives in Ukraine, it is likely that the war could continue for at least another 12-24 months. The problem is that, even in a ceasefire scenario (which seems unlikely at this point), the US and EU would be very slow to reverse Russian sanctions. On October 14th, the Parliamentary Assembly of the Council of Europe voted unanimously to declare Russia a “terrorist regime.” So, unless the current Russian regime is completely overthrown, there will be no normalization of relations with the Kremlin for many years. The history of sanctions against Soviet Russia should provide some guidance. Note that the Cold War era “Jackson–Vanik amendment”, which was implemented in 1974 was repealed 20 years after the collapse of the Soviet Union. The key point is that once sanctions are in place, it can take a very long time to unwind them.
With demand for heating pellets in the EU being driven by high natural gas prices and a wood pellet supply deficit, the higher E.U. price level will allow U.S. wood pellet manufacturers to profit from exporting, despite high transportation costs. And with transatlantic container rates declining as global economic activity cools, we should see a steady increase in the flow of American wood pellets to European consumers.
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