Financial Viability of Standalone Wood Pellet Production Using Pine Beetle Fibre Aaron Sinclair Project Submitted In Partial Fulfillment Of The Requirements For The Degree Of Master Of Business Administration UNIVERSITY OF NORTHERN BRITISH COLUMBIA LIBRARY Prince George, SC The University ofNorthem British Columbia April2008 © Aaron Sinclair, 2008 ABSTRACT Northern British Columbia is experiencing an infestation of epidemic proportions from the mountain pine beetle. The British Columbia Provincial and Canada Federal Governments have proposed that uses other than dimensional lumber should be encouraged to maximise the economic value of the dying and dead lodgepole pine. Future wood pellet production facilities would need to become standalone and utilise whole trees as a source of wood fibre inputs. The primary objective of this study was to examine the financial viability of a Northern British Columbia standalone wood pellet production facility located in Prince George when fibre input comes from primary harvesting using a whole mountain pine beetlekilled lodgepole pine tree. The secondary objective was to understand whether incentives by way of stumpage relief provided by the Government of British Columbia would provide financial viability of a standalone wood pellet production facility. Data obtained from the British Columbia Ministry of Forests and Range, Wood Pellets Association of Canada, and European Pellet Centre was used to project cash flow for five, seven, and ten-year baseline, realistic, pessimistic, and optimistic scenarios. Analysis was done using net present value of cash flows with an annual 8.9% return requirement. In all but the optimistic scenario it was proven that a standalone wood pellet production facility was not financially viable. It was further determined that mountain pine beetle-killed lodgepole pine was already assessed the lowest stumpage rate and further relief would have no bearing on the financial viability of a standalone wood pellet production facility. Government encouragement of additional wood pellet production facilities would require direct or indirect subsidies aimed at capital costs and taxation relief. 11 TABLE OF CONTENTS Abstract 11 Table of Contents Ill List of Tables v List of Figures VI 1 Chapter One - Introduction 1 1.1 1.2 2 4 2 3 Chapter Two - Background of Wood Pellet Production 5 2.1 2.2 2.3 2.4 7 9 10 Market Opportunity Status of Pellet Production in Northern British Columbia Environmental Benefits Government Policies Chapter Three - Methodology 11 12 Framework of Financial Viability Calculations 14 Chapter Four - Financial Viability of Wood Pellet Facility 16 3.1 4 Background Objectives 4.1 4.2 4.3 Cash Flows of Wood Pellet Production Capital Cost Estimate Harvesting Cost Estimate 4.3.1 Tree-to-Truck Cost Estimate 4.3.2 Transportation Cost Estimate 4.3.3 Stumpage Cost Estimate 4.3.4 Delivered Raw (Chipped) Fibre Cost Estimate 16 16 17 18 22 25 25 4.4 4.5 Conversion Cost Estimate Finished Wood Pellet Transportation Cost 4.5.1 Rail Transportation to Port ofVancouver 4.5.2 Port Processing Costs 4.5.3 Ocean Freight Costs 27 28 29 29 29 4.6 4.7 Return on Investment Estimate Economic Factor Estimates 4.7 .1 Exchange Rate Projections 4.7.2 Bulk Wood Pellet Price Projections 4.7.3 Inflation Projections 4.7.4 Transportation cost Projections 4.7.5 Shipping Cost Projections 4.7.6 Taxation Trends 30 30 31 32 33 34 34 Ill 29 4.8 5 Calculations 4.8.1 Baseline Scenario 4.8.2 Realistic Scenario 4.8.3 Pessimistic Scenario 4.8.4 Optimistic Scenario 4.8.5 Mixed Fibre Source Scenario 34 35 36 37 38 39 Chapter Five- Conclusions 40 5.1 5.2 5.3 5.4 40 40 41 42 Financial Viability Stumpage Relief Incentives Policy Implications Study Limitations 6 Bibliography 44 7 Appendices 48 IV LIST OF TABLES Table 4-1: Harvesting Method Cost Comparison 21 Table 4-2: Annual Raw Fibre Material Requirements 22 Table 4-3: Annual Raw Fibre Harvesting Cost 22 Table 4-4: Delivered Raw Fibre Cost 26 Table 4-5 : Scenario Average Income Statement Percentages 35 v LIST OF FIGURES Figure 2-1: European Wood Pellet Consumption 7 Figure 2-2: European Wood Pellet Production 7 Figure 2-3 : European Wood Pellet Production Deficit 8 Figure 2-4: European Retail Wood Pellet Price per Tonne 8 Figure 3-1: Prince George Forest District 12 Figure 4-1: Ground Skidding Cost Scatter Plot 18 Figure 4-2: Harvesting Flow 19 Vl 1 CHAPTER ONE -INTRODUCTION It is generally accepted in the forest sector in Northern British Columbia that standalone wood pellet production facilities are not financially viable without harvesting, transportation, and primary processing costs being incurred by a dimensional lumber sawmill. Trees harvested for dimensional lumber purposes are transported from the forest to a sawmill with maximum utilization of the log for production of dimensional lumber. Production of dimensional lumber incurs all of the initial tree harvesting and log transportation costs. Waste fibre from the production of dimensional lumber can then be economically transported and processed in a secondary processing facility such as finger-jointing, pulp, or wood pellets. Northern British Columbia has been undergoing an infestation epidemic from the mountain pine beetle that started in 1993. It is expected that approximately eighty percent of all lodgepole pine in Northern British Columbia will be dead by 2013 (Ministry of Forests and Range 2006a). The quality of mountain pine beetle-killed fibre degrades after the initial attack, eventually making it unsuitable for processing into dimensional lumber applications (Byrne, Stonestreet and Peter 2005). Significant excess inventory of dead standing mountain pine beetle-killed lodgepole pine is available in the working forest in Northern British Columbia. There is an opportunity for traditional secondary manufacturers such as wood pellet producers to become primary manufacturers if the costs of harvesting, transporting, and processing this dead standing fibre are economically viable. Without an economically viable harvesting solution, there is unlikely to be immediate reforestation and instead the forest will have to rely on natural regeneration to replenish the dead fibre. This is a waste of merchantable standing timber today and further delays the recovery of the forests that both 1 provide employment and act as natural carbon sinks to counteract the effects of pollution and global warming. The purpose of my study is to determine whether a traditionally secondary manufacturer, a wood pellet producer located in Prince George, British Columbia, could become a primary manufacturer using mountain pine beetle-killed fibre that is no longer suitable for dimensional lumber production. 1.1 BACKGROUND Production of dimensional lumber from spruce, pine, and fir trees has been the primary industry in Northern British Columbia for decades. The industry has been cyclical in nature, expanding and contracting, following the ebb and flow of the North American economy. The forestry practices in this region are sustainable with a cut-cycle of approximately onehundred years. A typical spruce, pine, or fir stand reaches a maturity level for harvesting in approximately eighty years creating a natural twenty-year buffer in the standing merchantable timber in Northern British Columbia's forests. In 1993, the health ofNorthern British Columbia's forests began to change. An infestation of the mountain pine beetle, Dendroctonus ponderosae, in lodgepole pine, Pinus contorta, became evident and rapidly increased in magnitude." A combination of fire prevention activities and warmer than normal temperatures during winter lead the infestation to be able to increase in size and eventually begin a rapid expansion into the merchantable standing timber used as the source for lumber production (Gawalko 2004). 2 In 2006, British Columbia' s merchantable mature lodgepole pine was approximately 1.8 billion cubic metres with over 400 million cubic metres already killed by the mountain pine beetle (Ministry of Forests and Range 2007a). Approximately thirty-seven percent of the merchantable standing timber in the Prince George Timber Supply Area is lodgepole pine (Ministry of Forests and Range 2007a). It is expected by 2013 over eighty percent of lodgepole pine will have been killed by the mountain pine beetle. Standing beetle-killed timber may only have a useful life for dimensional lumber of between one and three years post-beetle (Byrne, Stonestreet and Peter 2005). Currently the British Columbia Ministry of Forests and Range has allocated an Allowable Annual Cut (AAC) of all merchantable standing timber species of almost 69 million cubic metres per year (Ministry of Forests and Range 2007b). There is a projected 1.44 billion cubic metres of merchantable standing lodgepole pine being dead by 2013. Estimates are that it will have a useful life no later than 2016 for late beetle-killed timber. There would be an estimated surplus over the next ten-years of 750 million cubic metres, assuming a harvest of only beetle-killed lodgepole pine. Current regulations and uses cannot utilise this surplus. This equates to a minimum of eleven years of merchantable standing timber that will be dead or dying and will not be suitable for production of dimensional lumber. In actuality, beetle-killed lodgepole pme only amounts to about seventy-one percent (Ministry of Forests and Range 2007a) of actual annual harvest in the Prince George Timber Supply area. Thus, there is a supply of almost one billion cubic metres available for alternative production, assuming financial viability of the alternate uses. 3 1.2 OBJECTIVES The objectives ofthis study are as follows: 1) The financial viability of a Northern British Columbia standalone wood pellet production facility located in Prince George when fibre input comes from primary harvesting using a whole mountain pine beetle-killed lodgepole pine tree. 2) Whether incentives by way of stumpage relief provided by the Government of British Columbia would provide financial viability of a standalone wood pellet production facility. 4 2 CHAPTER TWO- BACKGROUND OF WOOD PELLET PRODUCTION The greatest challenge faced by an industry asked to find alternative uses of mountain pine beetle-killed fibre is the economic implications of those uses. The majority of alternative uses such as pulp, wood pellets, and bioenergy have not proven successful unless paired with a primary dimensional lumber sawmill that typically obtains the highest recovery rates and economic value from a log. The current mountain pine beetle infestation has presented three main challenges to the forest industry: 1) Burning in the bush is normal practice for waste fibre from branches and tops with a diameter less than five-and-a-half inches (Ministry ofF orests and Range 2006b ). The majority of tenure holders view this waste as not economically viable to transport out of the bush for alternative uses. Faced with a smaller log profile, Daishowa-Marubeni International Ltd (DMI) of Peace River Alberta is one of the few companies utilizing in-bush chipping as a source of chips for pulp purposes (Tice 2005). The lodgepole pine waste left in the bush is similar in profile to the fibre chipped by DMI and could be used as a model for alternative consumers such as wood pellet producers to source their raw material. 2) Mountain pine beetle fibre is drying in the bush and becoming less dense (Lewis and Hartley 2005) which impacts the use in traditional primary manufacturing facilities to produce dimensional lumber (Byrne, Stonestreet and Peter 2005). As the moisture 5 content in the wood decreases, it begins to check, or crack, into the heart of the log. As these checks get deeper and wider they reduce the amount of wood that can be sawn into lumber and can cause logs to fracture in the head saw of a sawmill causing delays to clear the log and reduced efficiencies. 3) Transportation of a log is by way of loading it into bunks on a special trailer designed to hold them. Transporters earn their income based on a tonne-hour calculation that compensates them based on the estimated cycle time and weight of each load of logs they are transporting. The loss of density in the mountain pine beetle-killed lodgepole pine logs presents profitability issues for transporters (Jokai 2006). If transporters are going to maintain financial viability there needs to be considerations of increased tonne-hour parameters or greater volume loads on trailers to create incentives for transporters to haul greater volumes of mountain pine beetle-killed fibre. These industry issues have solutions but involve increased costs for the producer. Traditional producers are seeing their source of pine becoming less attractive for production inputs. This leaves a significant volume of merchantable standing timber in the forest that does not have a destination for consumption. Ultimately, the Government of British Columbia and the industry need to find financially viable alternative uses of this fibre to ensure both a commercial application and regeneration of the working forest for future economic opportunities. 6 2.1 MARKET OPPORTUNITY The North American and European wood pellet market consumed an estimated six million tonnes of wood pellets per annum in 2006 and is expected to expand to about sixteen million tonnes by 2010 (Swaan 2006). North America is a small component of the market consuming approximately 1.6 million tonnes in 2006 and projected out to approximately 3.2 million tonnes by 2010. Europe consumed approximately 4.5 million in 2006 and projected to consume approximately 12.75 million tonnes by 2010. In 2006, America North had a production surplus of approximately one million tonnes while Europe had a million tonne (Swaan two Figure 2-1: European Wood Pellet Consumption Source: computed using data from European Pellet Centre 5,000 ..,.....-- - - - - - - - - - - - - - - 4,503 ~ 4,000 = .e= 3,000 "CI = c= : 2,000 ~ 1,000 deficit 2001 2006). From 2002 2003 2004 2005 2006 Figure 2-2: European Wood Pellet Production 2001 through to 2006, Source: computed using data from European Pellet Centre Europe had an average consumption growth of 23 .8% (Figure 2-1) with production growth averagmg (Figure 24.9% 2-2). The 4,000 3,173 ~ 3,000 = = E = "CI 2,000 01 "' = ~ 1,000 .:::.- 2001 2002 2003 2004 2005 2006 deficit growth between production and consumption during the same period averaged 22.8% 7 with lower Figure 2-3: European Wood Pellet Production Deficit a Source: computed using data from European Pellet Centre consumption growth rate in 2006 causing a slight decrease in the deficit (Figure Estimates are 2-3). that 1,600 ~ 1,200 = = 0 ... 800 "C = 0:1 "' = 400 0 ..c ~ Europe will continue to 2001 2002 2003 2004 2005 2006 have a deficit of production reaching almost two million tonnes by 2010. Currently Europe imports only about 12% of its total consumption (Swaan 2006). The expected growth in the production deficit provides a great opportunity for new Northern British Columbia based producers to enter the European market. Five countries Ill Europe primarily make up the bulk wood pellet market Denmark, Austria, Finland, Germany, and Sweden. Consumer pnces m each country have a varying levels of cost but stayed relatively Figure 2-4: European Retail Wood Pellet Price per Tonne Source: computed using data from European Pellet Centre - 250 225 cu r::: 200 r::: ....0 175 ......... Ill 0 150 II. ::::1 w 125 -.. - - - :"!:" _. J >J "\. - _....... - 100 -- .... -..........:: ~ - Denmark .....,._ Finland ~ - sweden ....... Average 8 static from 2003 through to the first quarter of 2005 (Figure 2-4). The average retail price during this period for one tonne of wood pellets in bulk was € 169. 2.2 STATUS OF PELLET PRODUCTION IN NORTHERN BRITISH COLUMBIA The pellet production competition in Northern British Columbia is relatively small with only three companies operating in the region - Pinnacle Pellet Inc. (Quesnel & Houston), Premium Pellet Ltd. (Vanderhoof), and Pacific BioEnergy Corporation (Prince George). A fourth company, TallOil Canada (Vanderhoof & Prince George) had committed to construction of two wood pellet production facilities but has not completed either (Karidio 2007). More recently, Pinnacle Pellet Inc. purchased TallOil Canada to join that company's operations (Pinnacle Pellet Inc. 2008). These companies are privately held with the exception of a joint venture between Pinnacle Pellet and Canfor Corporation in Houston. All of the operating wood pellet production facilities have arrangements with dimensional lumber sawmills and utilize the waste material from them. Sourcing wood waste fibre material is a highly competitive market with an increasing demand from the pulp and paper production facilities in Northern British Columbia due to declining dimensional lumber production and increasing world pulp prices. There are no known wood pellet production facilities in Northern British Columbia that operate on a standalone basis using chipped whole logs as a source of input. The majority of the wood pellet production from Northern British Columbia is sold to the European market in bulk form. Typically, this is under long-term purchase contracts with wholesalers or governments in the European market. The deficit in the European production 9 market has created great opportunities for low-cost wood pellet producers in Northern British Columbia and has not created significant competitive pressure among the companies. An additional competitor in Northern British Columbia producing 150,000 tonnes annually will not have significant difficulties in obtaining access to European consumption demand nor significant competitive pressure from existing producers. 2.3 ENVIRONMENTAL BENEFITS Wood pellets are created through a process that involves a high-temperature combustion process used to form the materials into a pellet without the need of additives or glues to bind them into shape (Wood Pellet Association of Canada 2007). The consumption of wood pellets does not contribute to particulate pollution in the atmosphere and the carbon dioxide released during combustion is considered carbon neutral under the Kyoto Protocol (Swaan 2007). Consumption of a tree, whether through combustion or natural decay, releases carbon back into the atmosphere to be absorbed by new trees as they grow. The production and consumption of wood pellets as a renewable resource is a part of a natural cycle that exists in nature. The major devastation caused by the current mountain pine beetle infestation in Northern British Columbia has interrupted the natural cycle of a renewable resource. Huge hectares of dead lodgepole pine trees are in the forest release carbon into the atmosphere as they decay. The death of so many trees within a short period leads to the forest both releasing significant amounts of carbon into the atmosphere because of a lack of regenerating trees and no longer acting as a carbon sink by absorbing the carbon. The lack of such a large carbon sink acting against carbon in the atmosphere does have implications for global warming. Proactive 10 pursuit of alternative applications for consumption of mountain pine beetle-killed lodgepole pine and thereafter regeneration efforts will restore the absorption of carbon in British Columbia's forests (Ames 2000). 2.4 GOVERNMENT POLICIES In 2006, the British Columbia Provincial government issued its Mountain Pine Beetle Action Plan (Ministry of Forests and Range 2006a). This action plan has seven core objectives with the third objective relating directly to the economics of forestry in mountain pine beetle infested areas, "Recover the greatest value from dead timber before it burns or decays, while respecting other forest values." This objective is consistent with the need to find commercially viable alternative applications for using mountain pine beetle-killed lodgepole pine. The government may need to provide incentives or subsidies to obtain value for timber that is no longer suitable for production of dimensional lumber. This objective is the basis for the British Columbia Provincial Government and Canadian Federal Government to promote expansion of alternative uses of pine beetle fibre into bioenergy applications (Friesen 2007) such as wood pellets (Ministry of Forests and Range 2005). Both the British Columbia Provincial Government (Konkin 2007) and Canadian Federal Government (Knubley 2007) see mountain pine beetle-killed fibre as a source of energy, not just a source of dimensional lumber (Stennes and McBeath 2006). 11 3 CHAPTER THREE- METHODOLOGY This study used secondary data sources to gather the required information to respond with confidence to the financial viability of a Northern British Columbia standalone wood pellet production facility located in Prince George when fibre input comes from primary harvesting usmg a mountain whole Figure 3-1: Prince George Forest District Source: British Columbia Ministry of Forests and Range pme beetle-killed / lodgepole pine tree. The secondary data sources Regtanal - • e ~ Regeonal & Otscnet Offices ~ Offtee of information consisted of a thorough literature review concerning the mountain pine beetle, implications on Northern British Columbia's scale ----- working forest, and wood pellet production. I selected the Prince George geographic area of Northern British Columbia (Figure 3-1) for this study based on two reasons: 12 1) The geographic location is ideal with significant access to mountain pine beetle-killed fibre. With almost twenty-two percent (Ministry of Forests and Range 2007b) of British Columbia's existing annual allowable cut and over thirty-seven percent of the harvested timber (Ministry of Forests and Range 2007c) within two-hundred kilometres of Prince George, it provides a sufficient test area size for cost structures. There is also a sufficiently large sample size for harvesting activities to provide a realistic baseline average harvesting and transportation cost assumption. 2) Existing infrastructure already in place for pnmary manufacturing dimensional lumber mills such as forest service roads, access to railheads, power transmission lines, skilled workforce, and complimentary industry make a wood pellet production facility a natural addition to the existing forest sector. Information obtained from the British Columbia Ministry of Forests and Range was used to conduct a review of actual costs associated with all stages of harvesting (including bunching, skidding, processing, and loading) and transportation costs. A Tree-to-Truck Cost Survey Report prepared on behalf of the British Columbia Ministry of Forests and Range using data obtained through the 2003 and 2004 Interior Logging Cost Surveys is the source for harvesting costs. The British Columbia Ministry of Forests and Range utilize this report to determine guidelines for the Interior Appraisal Manual. The British Columbia Ministry of Forests and Range Forest Revenue Branch then use this manual to determine economically viable stumpage rates. 13 3.1 FRAMEWORK OF FINANCIAL VIABILITY CALCULATIONS Financial viability is determined using projected income statements of a wood pellet production facility over five-years, seven-years, and ten-years. In year one of all scenarios the capital cost component is considered. External economic factors applied to four scenarios for each return on investment period provide robust project income statements: 1) Baseline Scenario - This scenario is the baseline that assumes all things being equal during the entire return on investment period. 2) Realistic Scenario - This scenario has economic factors considered the most realistic for an operating wood pellet production facility. 3) Pessimistic Scenario - This scenario utilizes the baseline scenario in year one and then provides for pessimistic impact of inflation and currency exchange during the return on investment period. 4) Optimistic Scenario- This scenario utilizes the baseline scenario in year one and then provides for optimistic impact of inflation and currency exchange impacts during the return on investment period. Considerations to reductions in transportation costs are also included in this scenario. Once the determination of cash flow was established a net present value calculation was utilized to determine the financial viability using a pre-determined minimum rate of return. A 14 positive net present value indicates a financial viability rating while a negative net present value indicates a non-financial viability rating. 15 4 CHAPTER FOUR- FINANCIAL VIABILITY OF WOOD PELLET FACILITY 4.1 CASH FLOWS OF WOOD PELLET PRODUCTION Analysis of the financial viability of a standalone wood pellet production facility has three distinct cash flow components: 1) Capital Cost Estimate - This is the estimated capital cost associated with the construction of a suitable wood pellet production facility. 2) Harvesting Cost Estimate - This is the estimated cost for harvest of the fibre in the forest and transportation to the wood pellet production facility. The harvesting cost estimate includes the total cost to harvest the tree, transport it to the wood pellet production facility, and the stumpage royalties paid to the Province of British Columbia. 3) Wood Pellet Production Cost Estimate- This is the estimated cost of production of the raw fibre source into a saleable wood pellet and sale of the finished product. This includes all costs associated with production and transportation to the customer. 4.2 CAPITAL COST ESTIMATE Estimates of capital cost to build a wood pellet facility are not definitive. The Wood Pellet Association of Canada uses a rule of thumb of $1 00 per tonne of annual production (Swaan 2006). Wood pellet facility sizes range from annual production of 50,000 tonnes to 200,000 tonnes. There does not appear to be any synergies in scaling a wood pellet facility upwards 16 and is more dependent upon the availability of cost effective fibre supplies and a ready market for the finished product. My study assumes that the wood pellet production facility will have a fmished product capacity of 150,000 tonnes per annum. This is within the typical size of wood pellet production facilities in the Prince George region (Karidio 2007). This equates to a total capital cost estimate of$15 ,000,000. 4.3 HARVESTING COST ESTIMATE The harvesting cost estimate encompasses the entire process, specifically getting the tree from the forest into a processing facility. Third-party harvesting contractors will perform this process therefore not requiring either capital investment or harvesting expertise within the wood pellet production facility. There are three distinct stages of this process: 1) Tree-to-Truck Costs - This first stage involves the harvesting of a tree and getting it loaded onto a truck for hauling to a processing facility. 2) Transportation Costs - This stage involves the costs associated with transporting the raw material fibre from the forest to the processing facility. 3) Stumpage Costs- This stage does not involve the movement of the fibre but involves the costs associated with harvesting timber from Crown lands in British Columbia. 17 4.3.1 TREE-TO-TRUCK COST ESTIMATE The Tree-to-Truck Cost Survey Report prepared on behalf of the Ministry of Forests and Range contained a sample size of 2,230 respondents over a two-year period. The report details five different types of logging methods - ground skidding, overhead cable, skyline, helicopter, and horse (Jahraus & Associates Consulting Inc. 2007). I used the ground skidding method for my study based on its current popularity in harvesting. Approximately eighty-five percent of respondents used the ground skidding logging method. The Tree-to-Truck Cost Survey Report contained a ground skidding sample size of 1,896 separate respondents over a two-year period of which 632 were within the Prince George region. This sample is more than sufficient in size to assess harvesting and transportation costs within Northern British Columbia and specifically the study area of Prince George. Harvesting and transportation costs for a Figure 4-1: Ground Skidding Cost Scatter Plot Source: Jahraus & Associates standalone wood pellet production facility come from the Tree-to-Truck Survey Report averages. The ground skidding costs had a range from a low of $10.00/m3 to a high of $69.22/m3 (Figure 4-1). When excluding the abnormally high and low ranges of survey results the true cost range is estimated to be ~ 0 ~~ 100 ~ 200 Distance to support centre (km ) ~ 300 between $14.86/m3 and $27.11 /m3 with an average cost of $18.32/m3 . The ground skidding method uses the typical four stages of harvesting operations (Figure 4-2): 18 1) Bunching - This process involves harvesting the Figure 4-2: Harvesting Flow tree from the stump and laying it in piles on the ground in preparation for skidding to a landing where it will be processed and loaded on to a log truck. 2) Skidding- This process involves dragging the trees from the point of bunching to a central landing within a cut block where it will be processed and then loaded on a log truck. 3) Processing - This process involves removing the branches and cutting the tree into appropriate lengths as logs before being loaded on a log truck. 4) Loading - This process is that last stage prior to transportation and involves loading the logs on to a log truck in preparation for transportation to a processing facility. Alternatively, the fibre can be harvested in the forest using a buncher, skidded to the central landing, and then chipped using a portable chipper. The chips would then be loaded into a 19 chip truck and transported to a wood pellet processing facility as chips. This reduces average harvesting costs prior to transport to $14.24/m3 (Kumar, Flynn and Sokhansanj 2005). This reduction equates to $4.08/ m3 . Two reasons for the reduction in the average cost: 1) The typical processmg and loading costs are no longer undertaken in favour of chipping the entire tree on-site as opposed to later chipping at the wood pellet processing facility. This reduces the number of times that a tree needs handling and the amount of equipment required on-site in the forest. Logs can be skidded to the portable chipper and loaded via a conveyor directly into the chip truck for transport. 2) Instead of using only a log, the entire tree including the branches and the top are used. The branches and top are normally left in the forest and burned after harvesting. This provides a greater fibre contribution with a recovery rate of between 79.9% and 89.9% (Bicho, et al. 2006) for a lower cost as the tree is handled the same amount of times but produces a greater volume of fibre for the same harvesting and processing cost. Following the typical harvesting model provides more flexibility with the use of logs but still requires incurring a chipping cost at the wood pellet production facility for approximately $4.00/m3 (Kumar, Flynn and Sokhansanj 2005). This creates a raw fibre input cost, exclusive of transportation, of $22.32/m3 instead of the $14.24/m3 realised in roadside chipping. My study examined both cost structures but clearly roadside chipping provides the greatest opportunities for financial viability (Table 4-1 ). 20 Table 4-1: Harvesting Method Cost Comparison ($/m 3) Roadship l.Dg; ~ ~ ........ . $ $ 18.32 4.00 $ $ 10.24 4.00 $ 22.32 $ 14.24 The volume of raw fibre required to produce 150,000 tonnes of wood pellets annually in a wood pellet production facility ranges between 2.42 (Bicho, et al. 2006) and 2. 78 cubic metres (Peksa-Blanchard, et al. 2007) of raw fibre per tonne of production. The latter study reviewed all types of wood, with a focus on European growing conditions. It does not have the same reference to the fibre quality indigenous to the central interior of British Columbia. The former study specifically analysed mountain pine beetle-killed lodgepole pine in the red and grey attack stages during both summer and winter harvesting seasons. The harvest of source fibre were from two separate areas, the first 25 kilometres north of Vanderhoof and the second 40 kilometres south of Fraser Lake. Both of these sites are located central to the current mountain pine beetle infestation in British Columbia. They are excellent samples of the fibre quality required for feedstock for a wood pellet production facility. Based on the results of the Bicho et al (2006) study the average results experienced on a mixed summer and winter harvesting programming using both red and grey attack mountain pine beetle-killed lodgepole pine suggest a requirement of 2.49 cubic metres of raw fibre per 21 one tonne of finished wood pellets. Therefore, approximately 373,500 cubic metres of fibre would need to be harvested and delivered annually (Table 4-2). Table 4-2: Annual Raw Fibre Material Requirements .Arruil Proch:ction ~ Raw J\.lbterial M.ili:iplier (rrf Fibre Requiremrts (rrf) 150,000 2.49 ~ 373,500 This raw fibre requirement would therefore have a harvesting cost of approximately $5,318,640, inclusive of chipping but exclusive of transportation costs (Table 4-3). Table 4-3: Annual Raw Fibre Harvesting Cost 4.3.2 $ $ 8,563,855 1,869,837 $ $ 3,824,640 1,494,000 $ 10,433,692 $ 5,318,640 TRANSPORTATION COST ESTIMATE Following the type of harvesting operations, there are two ways to transport the raw fibre material to the wood pellet production facility : 1) Log Form - Processing the trees to remove limbs and tops and then loading the logs onto bunks of a typical log trailer for transport. This form has a higher transport cost per recoverable cubic metre of fibre based on a reduced portion of the tree actually being usable for producing wood pellets. 22 2) Chip Form - Chipping the trees at the roadside and then loading them into a chip truck for transport. This form has a lower cost as the entire tree is recoverable and used for producing wood pellets. Log transport costs vary greatly depending upon the allocation of tree type, location, and on or off-highway hauling. I used the parameter estimates from the Interior Appraisal Manual (Ministry of Forests and Range 2007d) to determine a log haul price. The calculation for assuming the estimated cost for on-highway hauling is as follows: $1m 3 = Region Constant + (1.90 * Cycle Time) + (0.41 * Balsam%1100) + (2.32 * Deciduous Species%1100) + (0.87 * Fir%/100) + (3.21 * Hemlock%/100) + (0.47 *Lodgepole Pine%1100) The region constant is a proxy to recognise local hauling factors between regions that may influence the cost regardless of tree species hauled. This number comes directly from the Ministry of Forests and Range. The cycle time is the estimated number of hours required for a truck to transport the logs from the harvest point to the mill and the empty truck to return to the harvest location. The remaining variables are factors related to specific tree species harvested. Weighting allocated according to the percentage of merchantable standing timber of each species within the harvest area. To calculate a haul price I used the following assumptions: 23 1) The primary haul would be on-highway and therefore use of the on-highway hauling calculation as opposed to the off-highway hauling calculation. 2) The region for the study is the Prince George area and therefore earns a regiOn constant of -0.26 as per the Interior Appraisal Manual (Ministry of Forests and Range 2007d). 3) The significant quantities of pine beetle-killed lodgepole pine in the Prince George area allow for a short range transportation corridor and therefore a cycle time (defined as the time it takes to load, haul, weigh, unload, return, and including unavoidable delays) of four hours has been deemed appropriate. 4) The study is assuming the primary use of pine beetle-killed lodgepole pine and therefore assumes the composition of the load would be 100% lodgepole pine. The region constant of -0.26 for Prince George is applied, the cycle time of four hours is multiplied by the 1.9 cycle time factor, and a 0.47 premium is added due to the 100% composition of lodgepole pine. Based on these assumptions the cost per cubic metre to transport the logs would be $7.81 as per the calculation as follows: $7.8l/m 3 = -0.26 + (1.90 * 4) + 0.47 24 The weight versus volume problems outlined for hauling logs does not exist when hauling chips therefore providing a more efficient method of moving the raw fibre material from the forest to the wood pellet processing facility. It is estimated that the cost to transport chips is $5.40/m3 based on a one-way trip assumption of an average 62 kilometres (Kumar, Flynn and Sokhansanj 2005). The cost to transport raw chips from the forest to the wood pellet production facility is approximately $2.41/m 3 lower than the cost to transport the raw log. 4.3.3 STUMPAGE COST ESTIMATE The primary source of fibre for a wood pellet production facility in this study is mountain pine beetle-killed lodgepole pine. This fibre is not suitable for dimensional lumber applications and is to be of non-sawlog or salvage quality thereby qualifying for the lowest stumpage rate of$0.25/m3 (Ministry of Forests and Range 2007e). The expected cost for stumpage is below one percent of total expenses and is not a significant factor. However, an application using mixed fibre sources or a non-reliance of mountain pine beetle-killed lodgepole pine or sawlog quality fibre sources could have a material impact on the estimated cost base for the raw fibre source. As an example, the average stumpage collected during 2006/2007 in the Northern Interior Region was $13.31 /m3 (Ministry of Forests and Range 2007c). 4.3.4 DELIVERED RAW (CHIPPED) FIBRE COST ESTIMATE My study addressed two scenarios for harvesting and transportation to the wood pellet production facility. The first scenario (Scenario A) is a traditional harvesting and 25 transportation method used in existing primary lumber applications. The tree is harvested, delimbed, cut-to-length, and transported as a log on a log truck. Under this scenario there is significant waste left in the forest in the form of trees and tops that have a small diameter. The second scenario (Scenario B) removes the waste issue from the equation and provides a recovery savings that reduces the required net harvested volume of fibre by approximately 20% (Bicho, et al. 2006). Scenario B requires a total harvest of 467,459 cubic metres to transport raw logs to the wood pellet processing facility for chipping to equal Scenario A's 373,500 cubic metres of delivered raw fibre. Scenario B provides a much more cost effective option for the harvesting of raw fibre for the purposes of production of wood pellets with an overall estimated cost approximately 48% less than Scenario A (Table 4-4). Increased volume of fibre requiring harvesting under Scenario A also causes increased costs for transportation, chipping, and stumpage royalty rates. Table 4-4: Delivered Raw Fibre Cost($ thousands) (thousands) Harvesting Cost Scenario Scenario B (Chips) 8,564 3,825 1,494 2,017 A(l...ocls) - Pre- Transport Olipping Cost Transportation Cost Post- Transport Clipping Cost Sturrpage Royalty Cost D:livered Raw Rbre Cost 3,651 1,870 117 14 201 26 - 93 7429 Chips Scenario Savings (4,739) 1,494 (1,634) (1,870) (23) (6 772) 4.4 CONVERSION COST ESTIMATE Conversion of raw fibre into wood pellets involves a five-step process. This process uses a continuous production line arrangement. 1) Drying - Before it is processed, the raw fibre needs to have moisture removed. Feeding the fibre into a rotating heated drum accomplishes this. The drum dries the raw fibre material to a moisture content of approximately 12% to prepare it for further processing and pelletisation (Urbanowski 2005). The heat used to remove the moisture typically comes through natural gas but converting some of the raw fibre material to generate heat has potential to reduce costs. For the purposes of my study, I used the standard natural gas heat cost structure. 2) Grinding - A hammer mill grinds the dried raw fibre to a stze small enough to incorporate into a pellet but not too small that its fibre properties are lost. Further moisture is lost during the grinding stage by both the heat involved and the pressure that squeezes moisture from the fibre. 3) Pelletisation- A compression system receives the ground fibre and forces it through a rotary die. No additives are required due to the natural lignin released during the drying and grinding processes binding the fibre together as it cools after going through the rotary die. The die determines both the diameter and length of the pellets as the fibre is processed. 27 4) Cooling - Pellets coming out of the pelletisation process are very soft and require cooling to harden. A conveyor gradually cools the pellets making them hard and transportable. 5) Storage - The cooled pellet is stored in preparation for transportation. Sale of pellets is in bulk form. Therefore, storage is low cost in preparation for loading on to railcars for transport to a bulk port facility. The conversion process varies by region with a high of $150 per tonne in Austria (Thek and Obernberger 2004) to a low of $25 per tonne for fibre not requiring drying. The average wood pellet produced in Northern British Columbia requires drying with a total conversion cost of$35.57 per tonne or 18.5% of total sale price (University of British Columbia 2007). 4.5 FINISHED WOOD PELLET TRANSPORTATION COST Once the wood pellets have completed the production stage, transportation occurs from the production facility to the end user. In the case of Northern British Columbia, this requires the wood pellets to be loaded into railcars for transport by rail to the Port of Vancouver. Once they arrive at the Port of Vancouver, they are stored until they can be loaded on a suitable ship for ocean transport to Europe. Total finished product transportation costs are approximately $67.85 per tonne or 35.3% of sale price. 28 4.5.1 RAIL TRANSPORTATION TO PORT OF VANCOUVER Wood pellets stored at the production facility get loaded into bulk container railcars operated by Canadian National Railway. Typically, these railcars deliver the finished wood pellet product to the Port of Vancouver but there is likely to be greater opportunities for cost and time savings to use the new Port of Prince Rupert. For the purposes of my study, the cost to transport to the Port of Vancouver is $35.71 per tonne or 18.6% of total sale price (Swaan 2006). 4.5.2 PORT PROCESSING COSTS Once the railcars arrive at the Port of Vancouver, the finished wood pellets need to be unloaded, stored, and then loaded onto a freighter for transport to the European markets. The cost ofthis processing at the port is $7.14 per tonne or 3.7% oftota1 sale price (Swaan 2006). 4.5.3 OCEAN FREIGHT COSTS Ocean going bulk product ships transport the finished wood pellets to Europe. Cost of shipment is high at approximately $25 per tonne or 13% of total sale price (Swaan 2006). 4.6 RETURN ON INVESTMENT ESTIMATE The return on investment is calculated using the projected cash flow and capital cost estimates. A wood pellet production facility would need to obtain an annual return similar to that obtained by the lumber industry over the past ten-years of 8.9% (Dufour 2007). 29 The calculated return uses a net present value of cash flows calculation for five, seven, and ten-years. A shorter payback period would likely permit mostly debt financing while a longer payback period would likely require mostly equity financing. A payback period of sevenyears would likely be eligible for an equal debt and equity financing combination. The decision for a company to choose to finance by way of debt or equity is related to management's decisions and the strategic direction of the company. The difference between debt and equity financing is ignored for the purposes of my study. I assumed the return based on earnings after taxes but before interest, depreciation, and amortization (EBIDA). 4.7 ECONOMIC FACTOR ESTIMATES I used four different scenarios, baseline, realistic, pessimistic, and optimistic, when calculating an estimated return of investment for a standalone wood pellet production facility. Under each scenario, I provided various economic factor projections such as exchange rate, future bulk wood pellet prices, inflation, and other rising costs. 4.7.1 EXCHANGE RATE PROJECTIONS The baseline projections use historical exchange rates during the years 2003 through 2005 of €0.63 per $1.00 Canadian (Bank of Canada 2008). The economic forecast during 2007 through 2009 predicts an average exchange rate of€0.80 per $1.00 Canadian (Royal Bank of Canada 2008). A rising Canadian dollar relative to the Euro will have negative implications on the sale price for bulk wood pellets. 30 The baseline scenario will assume that the exchange rate will stay relatively static over the five, seven, and ten-year return periods. The realistic scenario will assume that the Canadian dollar will continue to appreciate, but at a much slower rate of two percent per annum. This places the exchange rate at €0.70 per $1.00 Canadian over five-years, €0.72 per $1.00 Canadian over seven-years and €0.77 per $1.00 Canadian over ten-years. The pessimistic scenario will take the baseline currency exchange rate value of €0.63 per $1.00 Canadian and assume an annual appreciation of 6.6% during 2007 through 2009. This is in line with the appreciation from the 2003 through 2005. This places the exchange rate at €0.87 per $1.00 Canadian over five-years, €0.99 per $1.00 Canadian over seven-years and €1.19 per 1.00 Canadian over ten-years. The optimistic scenario will assume the Canadian dollar will actually depreciate against the Euro by one percent a year. This places the exchange rate at €0.60 per $1.00 Canadian over five-years, €0.59 per $1.00 Canadian over seven-years and €0.57 per $1.00 Canadian over ten-years. 4.7.2 BULK WOOD PELLET PRICE PROJECTIONS The baseline scenario assumes the bulk wood pellet price will stay the same throughout the entire return period. 31 The realistic scenario assumes that while other economic factors will have an impact on the fmished bulk wood pellet cost overall the market will see a slight increase of 2.1% in the Euro cost per tonne. The pessimistic scenario assumes that other economic factors will have a greater price impact on the finished bulk wood pellet cost but that overall there will be a slight one percent increase in the Euro cost per tonne. The optimistic scenario assumes that the cost of wood pellets will stay in alignment with normal inflationary pressures I assumed for this scenario. This means the Euro cost per tonne will increase by two percent per annum. 4.7.3 INFLATION PROJECTIONS The baseline scenario assumes there will be net zero inflation to all costs. Some will rise while others will fall by a similar amount over the entire return period. This affects the harvesting, chipping, stumpage, conversion, and port processing costs. The realistic and optimistic scenarios assume that the Canadian headline inflation rate will be at the desired midpoint of the inflation control range set by the Bank of Canada at two percent per annum (Bank of Canada 2006). 32 The pessimistic scenario assumes that the Canadian headline inflation rate will be at the highpoint of the inflation control range set by the Bank of Canada at three percent per annum (Bank of Canada 2006). 4.7.4 TRANSPORTATION COST PROJECTIONS Transportation costs for both truck and rail continue to rise at very high rates, typically in line with the rising cost of fuel. The baseline scenario assumes that while fuels costs are rising other costs are falling creating a net zero impact on transportation costs. The realistic scenano assumes that rising fuel costs will have an impact on long-term transportation costs but believes the annual increases will occur at the lower end of the spectrum for truckload costs at a rate of only 2.6% per annum (Trunick 2005). The pessimistic scenario assumes that rising fuel costs are just one of the many factors involved in the longer-term implications for transportation. This scenario assumes costs will rise similar to the past and projected factors for rail logistics at a rate of approximately five percent per annum (Trunick 2005). The optimistic scenario assumes that trucking costs will rise to transport the raw fibre from the forest to the mill site but that rail costs will decrease through the ability to transport finished wood pellets to the Port of Prince Rupert instead of the Port of Vancouver. The trucking costs expected to rise by two percent per annum while the rail costs expected to fall by two percent per annum. 33 4.7.5 SHIPPING COST PROJECTIONS Oceanic freight shipping rates have been fluctuating over the last few decades with no clear extended up or downwards trend. The baseline scenario assumes that over the return periods that prices will rise and fall for a net zero affect. The realistic and optimistic scenarios assume that on average over the return periods that oceanic freight shipping rates will decrease by 2% per annum. The pessimistic scenario assumes that on average over the return periods that oceanic freight shipping rates will increase by 2% per annum. 4.7.6 TAXATION TRENDS During times of economic prosperity, there is pressure to reduce corporate taxation. However, during weaker economic times there is pressure to tax corporations heavier while maintaining a status quo situation for individual taxpayers. All four scenarios assume that the corporate tax rate will on average stay static at approximately 30% per annum. 4.8 CALCULATIONS The four primary scenarios were analysed with the source information provided to determine proof of the hypothesis. All four scenarios used the same base-starting place and then adjusted using the various economic factors . A fifth scenario was prepared to examine the fmancial viability of using mixed sources of wood fibre. 34 All five scenarios are summarised according to five-year return (Appendix A), seven-year return (Appendix B), and ten-year return (Appendix C). Table 4-5: Scenario Average Income Statement Percentages Baseline Realistic Pessinistic qmristic Other Fib:l! Arimi cross Re\.eru: 100.0'% 100.00'% 100.00% 100.00/o 100.00/ o Raw Fibre Cost Com.ersrn Cost 25.8% 18.5% 35.3% 20.3% 28.3% 20.2% 36.8% 14.7% 38.8% 27.2% 53.6% -19.6% 24.6% 17.7% 23.6% 34.1% 42.7% 18.5% 35.3% 35.3% ~ ~ 10.00/o 10.00/ o 10.00/ o Taxes 3.1% 1.4% -8.9% 7.2% -2.00/o Net CashFbw(H3IDA) 7.2% 3.3% -20.7%, 16.8% -4.6% ~ GussProfit Gereral an:l.Adrrinistrati\ Expen;es 4.8.1 BASELINE SCENARIO I used the baseline scenario to determine whether there is a potential business case to proceed with a standalone wood pellet production facility under circumstances void of changes in the economic factors (Appendix D). Under the baseline scenario, I estimate gross revenues of approximately $29 million annually with net cash flow (EBIDA) of approximately $2 million. The capital cost expenditure estimate of $15 million is recorded as an outflow of cash in year one. Using a net present value calculation with an annual return rate of 8.9% after year five the operation will still be cash flow negative by almost $6.9 million. By year seven negative cash flow is about $4.5 million and by year ten, it is further reduced to $1.6 million. Under this scenario the operation will become cash flow positive during year eleven. 35 Shipping and raw fibre costs is on average 35 .3% and 25 .8%, respectively, and total production and transportation costs are 79.6% of total gross revenues (Table 4-5). This provides for a cash flow average of 7.2% of total gross revenue after overhead costs and taxes. 4.8.2 REALISTIC SCENARIO The realistic scenario attempts to be more robust than the baseline scenano when determining the impact of economic factors (Appendix E). On average gross revenue of almost $29 million is realised annually with approximate net cash flow (EBIDA) of $1 million. The capital cost expenditure estimate of $15 million is recorded as an outflow of cash in year one. Using a net present value calculation with an annual return rate of 8.9% after year fi ve it is determined that the operation will still be cash flow negative by $8.6 million, a significant improvement over the pessimistic scenario and only $1.7 million behind the baseline scenario. By year seven negative cash flow improves to $7.7 million and by year ten it improves slightly, but stays at approximately $7.7 million. It is possible that in time the realistic scenario will provide positive cash flow depending on fluctuations in the economic factors . As compared to the baseline scenario, the costs for the realistic scenario only increased slightly with gross profit showing an average decline of 5.6% (Table 4-5). Net cash flow shows an even smaller decline of 3.9% after adjustments for taxes. Unfortunately, the realistic scenario shows a downward trend in net cash flows with a negative cash flow 36 occurring in year ten. It is very likely that without some moderate to significant changes in economic factors that the realistic scenario will eventually follow the direction of the pessimistic scenario. 4.8.3 PESSIMISTIC SCENARIO I made overly pessimistic adjustments to the baseline scenario economic factors to determine whether a standalone wood pellet production facility can be successful in a more adverse economic environment (Appendix F). On average gross revenue of approximately $22 million is realised annually with approximate negative net cash flow (EBIDA) of $4.7 million. The capital cost expenditure estimate of $15 million is recorded as an outflow of cash in year one. Using a net present value calculation with an annual return rate of 8.9% after year five it is determined that the operation will be significantly cash flow negative by $17.9 million. By year seven negative cash flow deteriorates further to almost $25 million and by year ten it erodes further to negative $38 .5 million. Under this scenario the operation will never become cash flow positive and will always be a drain for its shareholders and investors. The significantly increased cost of shipping incurring 53.6% of total gross revenue, an increase of 18.3% over the baseline scenario, have the greatest detrimental impact on the success ofthis scenario (Table 4-5). Delivered raw fibre costs also increase by 13% to 38.8% of total revenue. This leads to an overall decrease in gross profit of 39.9% causing a permanent state of negative cash flow. 37 Over the entire ten-years of the pessimistic scenario, the average net cash flow is negative 20.7% requiring significant annual capital injection to maintain operations. 4.8.4 OPTIMISTIC SCENARIO I have used the optimistic scenario to consider other factors that will provide a better return on investment for a wood pellet production facility. I assume there is an established market for wood pellets in China with the European bulk wood pellet commodity price. The opportunity to ship a finished product to Shanghai as the nearest port to Canada and using the Port of Prince Rupert as the departure location significantly reduces ocean freight costs by about half. The impact on the economic factors has been more favourable than those in the other scenarios (Appendix G). On average gross revenue of almost $33 million is realised annually with approximate net cash flow (EBIDA) of $5.6 million. The capital cost expenditure estimate of $15 million is recorded as an outflow of cash in year one. Using a net present value calculation with an annual return rate of 8.9% after year five it is determined that the operation will be cash flow positive by $1.5 million, a significant improvement over all other scenarios scenario. By year seven cash flow improves to $8.4 million and by year ten it improves further to $18.6 million. As compared to the baseline scenano, the costs for the optimistic scenano decreased significantly with gross profit showing an average improvement of 13.7% (Table 4-5). Net 38 cash flow shows a smaller improvement of 9.6% after adjustments for taxes. The economic factors continue to improve the results as time goes on. The largest benefit to the optimistic scenario over all other scenarios is the significantly reduced shipping cost. 4.8.5 MIXED FIBRE SOURCE SCENARIO I also examine the possibility of using a raw fibre supply that comes from sources other than mountain pine beetle-killed lodgepole pine (Appendix H). Consideration given to other softwood sources, specifically spruce and fir, was based on the prevalence of those species within the Prince George region ofNorthem British Columbia. Modification of the baseline scenario by adding the cost of stumpage based on a mixed fibre source that will utilise sawlog quality fibre. This dramatically increases stumpage rates from $0.25 per cubic metre to an average of $13 .31 per cubic metre of fibre harvested. This increase in stumpage rates affects the delivered raw fibre cost upwards by 16.9% reducing net cash flow by 11 .9% from the baseline scenario. This ultimately results in negative cash flow of$1.3 million per annum. 39 5 CHAPTER FIVE- CONCLUSIONS Delivered raw fibre and transportation costs are the greatest hurdles to the financial viability of a standalone wood pellet production facility. Mountain pine beetle-killed lodgepole pine is the lowest cost raw fibre source input available on a standalone basis. Further cost reductions in the raw fibre source are not possible while maintaining a standalone basis. Rail and ocean freight transportation costs compose over a third of total sale price. Reduction of rail and ocean freight distances can improve the financial viability. The optimistic scenario suggests this possibility but new markets need to be found for final determination. 5.1 FINANCIAL VIABILITY Existing markets for bulk wood pellets are primarily located in Europe. The cost of rail transport to the Port of Vancouver and ocean freight costs to Europe make it unlikely that a standalone wood pellet production facility will be financially viable. The baseline, realistic, and pessimistic scenarios clearly demonstrate this. Alternative markets can provide transportation cost reductions. Developing a new market in China will reduce the ocean freight transportation costs. 5.2 STUMPAGE RELIEF INCENTIVES The non-sawlog or salvage stumpage rates provided for mountain pme beetle-killed lodgepole pine are of nominal value. Further stumpage relief provided by the Government of British Columbia is not sufficient to make a standalone wood pellet production facility financially viable. Fibre from mixed fibre sources of sawlog quality has an appreciably 40 higher stumpage rate. Subsidies provided by the Government of British Columbia in the form of stumpage relief will have material benefit to the cash flow of a standalone wood pellet production facility . Unfortunately complete stumpage relief does not change the ultimate findings in my study that a standalone wood pellet production facility is not financially viable. 5.3 POLICY IMPLICATIONS The Governments of British Columbia and Canada both view wood pellets as a solution to the devastation caused by the mountain pine beetle in Northern British Columbia. Standalone production facilities are not financially viable under the existing model of selling wood pellets to Europe. Both governments will need to review the current policies to encourage wood pellet production. Symbiotic relationships with dimensional sawmills as a source of raw fibre is also in jeopardy. The dimensional lumber market continues to suffer and additional mill closures are a foregone conclusion. As these sawmills undergo curtailments and shutdowns the available supply of raw fibre on the market will be reduced. This raw fibre reduction places existing wood pellet production facilities at risk of failure if new raw fibre sources do not become available. If governments want to promote investment in wood pellet production there needs to be considerations to provide subsidies. Individually or together the following subsidies would promote growth of wood pellet production facilities: I) Capital Construction Grants - A typical government subsidy would be an interest free loan. In this case, an interest free loan would have no bearing on the financial 41 viability of a wood pellet production facility. My study has ignored the cost of financing. Therefore, governments would need to provide direct grants to offset some or all of the wood pellet production facility capital construction costs. In all scenarios, except pessimistic, reduction in cash outflow for capital costs would significantly improve the financial viability. 2) Taxation - In all scenarios there are periods of positive cash flow that result in taxation. A taxation subsidy period where little or no income taxes were paid to the governments would improve the financial viability of a wood pellet production facility. Ultimately, governments would need to decide whether there is sufficient long-term socioeconomic benefits to provide direct or indirect subsidies to a start-up wood pellet production facility. 5.4 STUDY LIMITATIONS My study has had an extremely narrow area of focus of primarily using mountain pine beetlekilled lodgepole pine and sales to an existing European market. I have not considered in depth other existing markets or geographic locations that may have lower cost production and transportation costs. 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Forest Products Journal 56, no. 1 (2006): 6-14. 47 25,889 29,244 14,395 4,455 10,394 Q-oss Profit GnTcll arrl Adn:inBtrat:i\e Expernes Taxes Net Cash Flow (EBIDA) Net ~ Value - 28,212 5,574 18,015 51,800 26,783 5,355 18,750 50,888 Mil to Port ~ Cost ~ Port ~ Cost CkeanFreigt Cost ~ Cost 6,893 5,705 27,766 26,678 Comersion Cost - 29,598 5,686 19,515 54,799 38,787 ~ 48 8,581 8,025 3,439 14,424 486 Trarnportation Cost ~ Royahy Cost Raw Fibre Cost ~ 17,901 5,016 - - 2,150 - 12,871 28,327 20,306 7,932 11,145 496 39,878 19,904 7,775 10,623 19,123 7,470 10,085 467 37,145 Pessinistic 128,709 Realistic 144,242 1\null Q-oss ~ (totals, thousands) Baseline 143,954 APPENDIX A- FIVE-YEAR RETURN PERIOD COMPARISON 7 APPENDICES 1,522 21,580 9,249 15,285 46,114 25,732 5,574 9,007 40,313 27,766 38,660 486 19,904 7,775 10,496 qmristic 152,854 20,209 6,678 - - 2,862 - 14,395 4,855 26,783 5,355 18,750 50,888 26,678 19,123 7,470 10,085 24,856 61,534 Other Hire 143,954 9,464 14,552 Taxes Net CashFbw(EBIDA) Net ~ Value 49 7,747 4,056 6,237 GnTcU arrl Adrrinist:rati\ Expenses - 20,214 20,154 G-oss Profit 4,502 33,734 40,942 Mil to Port Shippiq?; Cost Shippiq?; Port Processiq?; Cost Ckean Freiftt Cost Shippiq?; Cost - 43,613 8,206 27,879 79,698 40,550 7,962 24,726 73,239 37,496 7,497 26,250 71,243 Comersion Cost 24,993 17,410 - - 7,462 17,067 7,805 - - 40,883 39,666 37,349 Chippiq?; Cost Tran;portation Cost ~ Cost Raw Fibre Cost 29,306 11,448 16,422 715 57,891 28,433 11,107 15,269 694 55,503 ~ Arn.B1 G-oss Re\eii..e 26,772 10,458 14,118 654 52,002 Pessinistic 170,666 Realistic 202,141 Baseline 201,536 (totals, thousands) APPENDIX B- SEVEN-YEAR RETURN PERIOD COMPARION 37,496 7,497 26,250 71,243 35,319 7,962 12,363 55,645 8,425 33,606 14,403 22,061 9,350 21,745 - 4,007 20,154 - - 37,349 39,666 6,797 26,772 10,458 14,118 34,799 86,148 28,433 11,107 14,994 694 55,229 70,069 OberFllre 201,536 qmristic 220,608 Net Presed: Value Net CashFlow(EBIDA) 1,600 - 50 7,701 9,514 4,077 8,909 20,789 28,921 28,791 Gnr.ll ani Adrrinistrat:i\ Expen;es Taxes 42,512 58,489 G-oss Profit 38,479 46,629 - - 19,984 22,520 44,093 - - 18,612 55,589 23,824 33,005 112,418 48,992 11,727 17, 149 77,869 - - - 67,373 12,278 41,061 120,713 60,287 11,727 34,299 106,313 53,565 10,710 37,500 101,775 ~ Mil to Port ~ Cost ~ Port ~ Cost O::ean Freigt Cost ~ Cost ~ 23,610 13,357 5,724 28,791 9,710 53,565 10,710 37,500 101,775 53,355 58,422 61,166 Comersion Cost 58,422 53,355 Tran;portation Cost ~ Royalty Cost Raw Fibre Cost 38,246 14,940 20,169 49,713 123,068 41,879 16,359 22,084 1,022 81,345 43,845 17,127 25,368 1,070 87,411 41,879 16,359 22,700 1,022 81,960 38,246 14,940 20,169 934 74,289 Other Hire 287,908 Pessinistic 225,196 Realistic 289,207 An:ual G-oss Reverie (totals, thousands) Baseline 287,908 qmristic 330,054 APPENDIX C -TEN-YEAR RETURN PERIOD COMPARISON 5,849 2,879 891 5,357 1,071 3,750 10, 178 5,849 2,879 891 GossProfit Gereral arrl Adrrinistrati\e Expen;;es ~ LOS( INet Presem Value Net Cash Fbw (EBIDA) Taxes ~ Mil to Port St-iwirl?; Cost Shippifl?; Port Processifl?; Cost CX:ean Freigtt Cost 2,079 5,357 1,071 3,750 10, 178 5,357 1,071 3,750 10, 178 2,079 5,336 5,336 5,336 Comersion Cost Trnn;;portat:Dn Cost ~ Royalty Cost RaWF'il:>re-ci:iit-. 2,079 891 2,879 5,849 3,825 1,494 2,017 93 -- T,429- 3,825 1,494 2,017 93 7,429 3,825 1,494 2,017 93 - - - - - 7,429- ~ CJWifl?; Cost 28,791 28,791 28,791 192 Arrrnl Goss Re\.en.e 192 192 YearTiree 15,00) YearT\\0 Year Ore Capital Cost ExperrlitLre Wood Pellet Sale Prix ($/torre) ~ 28,791 192 YearFi\e 0.00"/c 0.00"/c 0.00"/c 0.00"/c 0.00"/c 30.00"/c 8.90"/c 51 2,079 891 2,879 5,849 5,357 1,071 3,750 10, 178 5,336 - 6,893 2,079 891 2,879 2,079 891 2,879 5,849 5,357 1,071 3,750 10,178 5,849 5,336 5,357 1,071 3,750 10, 178 3,825 1,494 2,017 93 7,429 28,791 192 Year Six 5,336 3,825 3,825 1,494 1,494 2,017 2,017 93 93 7,429 - - T,42g- 28,791 192 YearFOU" - amounts in thousands unless othelwise stated 150,00) Sale Prix Rate (Narnr!V Arrrnl Prochx::tXJn (torres) Sale Prix ($/torrc) 191.94 Inflation Rate (aD costs except) Sale Prix ~ 120.00 CUrercy Fluxwt:KJn (Narnr!V Exch!ry;: Rate Baselire (€/$) 0.63 Tran;portation Cost (Narnr!V Raw Fibre (rrf) 373,500 Shiwirl?; Cost (Narnr!V Tax Rate Required Irterml Rate offietun APPENDIX D -BASELINE SCENARIO - - 4,502 2,079 891 2,879 5,849 5,357 1,071 3,750 10, 178 5,336 3,825 1,494 2,017 93 28,791 192 2,079 891 2,879 2,079 891 2,879 5,849 5,357 1,071 3,750 10, 178 5,849 5,336 5,357 1,071 3,750 10,178 3,825 1,494 2,017 93 7,429 - 1,600 2,079 891 2,879 5,849 5,357 1,071 3,750 10,178 5,336 3,825 1,494 2,017 93 7,429 28,791 192 192 28,791 Year Ten YearNn: 5,336 ~~ 3,825 1,494 2,017 93 28,791 192 Year Se\en Year Edt ---H- INet Presed: Valte Net Cash Fbw(EBIDA) Taxes G:rerai am Adrrinistrati\. Expemes GossProfit Mil to Port ~ Cost ~ Port ~ Cost Ocean Freigt Cost ~ COSt Comersm Cost Tran;portation Cost ~ Royalty Cost RawFiiJre COSt - - OWrgCost 1-br\.estirg Cost 5,496 1,092 3,675 793 891 1,850 2,882 2,879 2,079 5,525 5,849 10;263 5,442 5,357 1,071 3,750 10,178 3,979 1,554 2,123 97 28,848 192 YearTiree 1,613 691 2,885 5,189 52 1,368 586 2,888 4,842 10,451 5,785 1,137 3,529 10,354 5,662 5,639 1,114 3,602 7,m 4,059 1,585 2,178 99 28,'im 193 YearFou- 5,551 95 7,590 -- -1,754 2,(Xf) 3,901 1,524 28,820 192 YearT\\0 5,336 --/,429 3,825 1,494 2,017 93 28,791 Arrull Goss ~ 192 15,000 Capital Cost Experrlill.re Wood Pellet Sale J>Ji:e ($!torn:) YearOre Asstnpions - amounts in thousands unless othetwise stated Arrull Produ:tion (t:orn:s) 150,000 Sale J>Ji:e Rate (NaiiUlV Sale J>Ji:e ($/torn!) 191.94 Inflation Rate (aB costs except) Sale J>Ji:e (€1tot'n!) 120.00 Curen::y Fluxutfun (NaiiUlV Exclmg:: Rate Baselire (€1$) 0.63 Trarnportation Cost (NaiiUlV Raw Fibre (rrf) 373,500 ~ Cost (NaiiUlV Tax Rate Required Irterml Rate ofRetun APPENDIX E -REALISTIC SCENARIO - - 8,581 854 366 1, 115 478 4,114 10,662 - 7,747 585 251 2,896 3,731 10,776 6,248 1,206 3,322 1,182 3,390 6,009 6,090 - 306 131 2,899 3,337 10,897 6,411 1,230 3,255 6,129 4,393 1,716 2,414 107 28,993 193 8,448 --------s-;631 4,307 1,682 2,353 105 28,964 193 YearSe\en YearF.Qt 5,891 2,894 - 8;268 - 103 2,293 4,223 1,649 28,935 193 YearSix 2,891 4,484 10,554 5,936 1,159 3,459 5,775 -g;U9T 4,140 1,617 2,235 101 28,906 193 YearFM: 2.10"/c 2.00% -2.CXJ'/c 2.60"/c -2.CXJ'/c 30.CXJ'/c 8.90% - 20 - 8 - 2,902 2,930 11,023 6,577 1,255 3,190 6,251 4,481 1,750 2,477 109 8,818 29,022 193 ~ 7,701 276 118 2,905 2,511 11,155 6,749 1,280 3,127 6,376 4,571 1,785 2,541 112 9,009 29,051 194 YearTen INet Presem Value Net Cash Fbw (EBIDA) 2,079 504 - 216 - 2,718 891 2,879 Gerernl ani Adrrinistrati\e BqJemes Taxes 3,438 5,849 10,552 Gu;sProfit 10,178 5,624 1,103 3,825 5,496 7,@ 5,336 7,429 3,939 1,539 2,118 96 3,825 1,494 2,017 93 27,179 181 Year 1\\o 5,357 1,071 3,750 Mill to Port Slippirg Cost Shippirg Port Processirg Cost Ckean Freigt Cost ~ Comersioo Cost RawF&eeost HlnestirgCost CJWirgCost Tran;portation Cost StLirpag;: Royalty Cost 28,791 Arn.RIG-a;sRe\en.e 192 15,000 Capital Cost ExpenliU.re Wood Pellet Sale Pri:e ($/torre) Year Ore 1,035 - 443 - 2,566 53 - 2,542 - 17,901 4,022 - 1,724 - 1,090 - - 5,479 - 24,993 6,915 - 2,964 - 2,037 2,158 2,286 2,422 2,348 - 7,842 - 5,(f£) - 3,460 - 7,537 1,317 4,300 8,335 - 3,572 - 1,923 9,985 - 13,162 6,562 7, 178 1,279 4,223 9,494 4,704 1,837 2,838 115 19,233 128 ~ 6,371 9,165 4,567 1,784 2,703 Ill 20,374 136 Year Se\.en 12;680 11,775 6,836 1,242 4,140 6,185 8;848 4,434 1,732 2,574 100 21,583 144 Year Six 12;218 11;351 1,210 - 1,088 - 10,943 6,511 1,205 4,059 6,201 1,170 3,980 6,005 5,830 8,543 5,906 1, 136 3,902 8;249 5,660 7,965 4,305 1,682 2,452 105 22,863 152 Year Fi\.e 4,179 1,633 2,335 102 24,220 161 Year Feu 1.00"/c 3.00"/c -6.6<1'/c 5.00"/o 2.00"/c 30.00"/c 8.90"/c 4,058 1,585 2,224 99 25,657 171 Year 1lree ~ - arr/OWlls in thousands unless otherwise stated Arn.Rl Prodtrtion (torn:s) 150,000 Sale Pri:e Rate ~ Sale Pri:e ($/torn:) 191.94 JnfutDn Rate (all costs except) Sale Pri:e (€/tome) 120.00 G.JTercy F1uxwtion ~ Exclmg:: Rate Baselire (€/$) 0.63 TrarEpCX1ation Cost ~ RawFibre(rrf) 373,500 ~ Tax Rate Required lrtelrnl Rate ofRetun APPENDIX F- PESSIMISTIC SCENARIO - 9,743 - 4,175 - 1,816 12,103 - 38,479 11,140 4,774 1,714 14,201 14,189 8,310 1,397 4,482 13,664 6,962 7,914 1,357 4,394 10,190 6,759 9,836 4,990 1,949 3,129 122 17,140 114 Year Ten 4,845 1,893 2,980 118 18, 156 121 Year Nre 192 8>179 INet Presem Value 1,647 3,391 Taxes Net Cash Fbw (EBIDA) 3,843 2,965 1,453 8,456 5,249 1,092 1,838 5,442 2,879 Gn:raJ arrl Adrriristrat:i\ Experses 8,303 7,724 SlliPP!ll?;COSt cross Profit 5,357 1,071 1,875 5,336 MD to Port Shippirl?; Ca;t Shippifl?; Port Processirg Coot Ckean Freigt Ca;t Comersm Ca>t 7,577 3,901 1,524 2,057 95 3,825 1,494 2,017 93 7,429 29,655 198 Year T\\0 28,791 15,00) ~ Ro)altyCa>t RawM!Jrecait Transportati>n Coot I-hr\est:irg Coot ~ Anuti cross Re\eru: Capital Coot Experrlill.re Wood Pellet Sae Pri::e ($/toire) Year Ore -u 8,059 4,305 1,845 3,054 9,205 5, 144 1,114 1,801 5,551 3,979 1,554 2,098 97 T,7'1.IT 30,544 204 Year 1lree 54 4,778 2,048 3,146 9,972 7,943 5,041 1,137 1,765 5,662 7,884 4,059 1,585 2,140 99 31,460 210 YearFou- Asstfllltions - amow1ts in thousands unless otherwise stated Anutl Prodtx::t:ion (tclrn:s) 150,00) Sae Pri::e Rate (LYarn.nV Sae Pri::e ($/torn:) 191.94 Inflation Rate (aD costs except) Sae Pri::e (€/torn:) 120.00 OJrercy Fh.oo.mion (LYarn.nV Exclwg:: Rate Baselire (€/$) 0.63 Trarnportation Coot (LYarn.nV Raw Fibre (rrf) 373,500 ~ (LYarn.nV Tax Rate Required Irterml Rate ofRetun APPENDIX G- OPTIMISTIC SCENARIO 7,829 1,522 5,262 2,255 3,240 10,758 4,941 1, 159 1,729 5,775 - E;04l 4, 140 1,617 2,183 101 32,404 216 YearFi\e 8.90% l.(XJ'/c -2.oo>/c -2.oo>/c 30.oo>/c 2.00% 2.{XJ'/c 5,759 2,468 3,338 11,564 1,695 7,719 4,842 1,182 5,891 4,223 1,649 2,227 103 8,425 6,267 6,788 2,909 3,541 2,686 3,438 7,508 13,239 7,612 6,129 4,650 1,230 1,628 12,391 4,745 1,206 1,661 6,009 7,407 7,323 3, 138 3,647 14, 109 4,557 1,255 1,595 6,251 4,481 1,750 2,363 109 8,704 243 YearN!re 4,307 4,393 1,682 1,716 2,271 2,317 105 107 8)202 -- 8,366- --g,533 236 ~ 36,471 34,378 229 Year Se\.en 35,409 33,376 223 Year Six 18,612 7,'ir72 3,374 3,757 15,002 7,31.J:J 1,280 1,563 4,466 6,376 4,571 1,785 2,410 112 8,878 37,565 250 Year Ten !Net Presem Value Net Cash Fbw (EBIDA) Taxes G:rera.l arrl Adrrini<;trat:M Expernes Cross Profit 1,336 - 572 - 2,879 971 10,178 5,357 1,071 3,750 5,336 Comersm COO: Mill to Port Sl"ippirgCo>t ~ Port ~ COO: CX:ean Freigt Ca;t ~ 12,307 TrarEpOitrtion COO: ~ Royalty COO: Raw Fibre COSt 1,336 - 572 - 2,fm 971 10,178 5,357 1,071 3,750 5,336 12;30'7 3,825 1,494 2,017 4,971 ~ 28,791 3,825 1,494 2,017 4,971 ~ 28,791 ~ Anu!l 192 YearT\\0 15,000 192 Year Ore Capital Ca;t ThperrlitLre Wood Pellet Sale POCe ($.1t:orr"e) 1,336 - 572 - 2,879 971 10,178 5,357 1,071 3,750 5,336 12,307 3,825 1,494 2,017 4,971 28,791 192 Yearllree 55 - 1,336 - 572 - 2,fm 971 10,178 5,357 1,071 3,750 5,336 12;30'7 3,825 1,494 2,017 4,971 28,791 192 YearFOU" ~ - amounls in thousands unless othetwise stated Anu!l Prodtrtion (torre;;) 150,000 Sale POCe Rate (Narnn9 Sale POCe ($/torn:) 191.94 JnfutDn Rate (all costs except) Sale POCe (€/torn:) 120.00 O.uercy FhixrntiJn (Narnn9 ~ Rate Baselire (€/$) 0.63 Trarnportation COO: (Narnn9 Raw Fibre (rrf) 373,500 ~ COO: (Narnn9 Tax Rate Required Irt.e:rml Rate ofRetun 20,209 1,336 - 572 - 2,879 971 10,178 5,357 1,071 3,750 5,336 12;307 3,825 1,494 2,017 4,971 28,791 192 YearFi\e 0.00"/c 0.00"/c 0.00"/c 0.00"/c 0.00"/c 30.00"/c 8.9(1'/c APPENDIX H- BASELINE SCENARIO USING MIXED WOOD SPECIES - 1,336 - 21,745 1,336 - 572 - 2,879 971 10,178 5,357 1,071 3,750 5,336 12;307 3,825 1,494 2,017 4,971 28,791 192 1,336 - 572 - 2,fm 971 10,178 5,357 1,071 3,750 5,336 12;30'7 3,825 1,494 2,017 4,971 28,791 192 Year Se\en Year Eistt 572 - 2,fm 971 10,178 5,357 1,071 3,750 5,336 12;30'7 3,825 1,494 2,017 4,971 28,791 192 Year Six - 1,336 - 572 - 2,879 971 10,178 5,357 1,071 3,750 5,336 12;307 3,825 1,494 2,017 4,971 28,791 192 ~ 23,610 1,336 572 2,879 971 10,178 5,357 1,071 3,750 5,336 12;30'7 3,825 1,494 2,017 4,971 28,791 192 Year Ten