Managing biomass risk

The difficulty in obtaining a guaranteed biomass feedstock – and the consequences of interruption – are hindering project development. Supply chain insurance can help, says Miles Thomas.

The potential for biomass to contribute to the UK’s future energy needs is significant. Indeed, the UK’s Bioenergy Strategy of 2012 estimated that, by 2020, ­sustainably-sourced biomass could meet as much as 11 per cent of the UK’s total primary energy demand (across heat, transport and electricity).
The subsequent November 2013 update of the government’s Renewable Energy Roadmap, first published in 2012, identified that biomass generation capacity increased by 1.6GW between July 2012 and June 2013, reaching 4.9GW. Meanwhile, output rose to 17.3TWh for the same period, increasing by 3.1TWh on the previous 12 months.
Against this backdrop of good news, the supply chain remains challenging, especially because new rules coming into force from 1 April 2014 mean feedstock needs to meet stringent sustainability standards. Research commissioned by the Department of Energy and Climate Change (Decc) in the summer of 2013, focusing on biomass supply chain infrastructure, said that the UK power sector would need 23 million tonnes of feedstock by 2020. Understanding the implications and the security of this supply chain will be key to the continued development of viable biomass projects in the UK.
Many early developers assumed there was a ready supply market that could provide wood fuel to any power plant, whether from domestic or international sources. This has proved a mistaken assumption.
If a feedstock supply chain fails, a plant has to seek alternative inputs to remain operational, potentially on the spot market. Depending on timing, this can compromise its capacity to service debt or generate profit. Despite these costly financial implications, traditional business interruption insurance, which covers loss of income as a result of physical damage, does not cover many of the risks a biomass supply chain faces.
This has become more acute an issue as tighter legislative control has brought heat off-take and its consequential contractual implications to the fore. Add an additional layer of bureaucracy in the form of potentially changeable sustainability criteria, and a bankable feedstock supply contract becomes even more difficult to secure.
Many of the current feedstocks are traded under long-term bilateral contracts, whose length may vary from 12 months to 15 years. The biomass fuel security challenges can be largely traced back to counterparty risk: that is, seller insolvency and supplier credit worthiness. There is also often a disparity between supplier and operator expectations of the quality of the raw materials (including sustainability), pricing, the demand curve and timing of delivery.
In addition, while contracts may operate long term, the need for feedstock is often managed on a short-term basis, with purchases made just months or weeks in advance. Indeed, short contracts for a smaller volumes might be preferable to a single, long, high volume contract if the management strategy is designed to be proactive and flexible in its implementation.
Anecdotally, it is clear that the perception of feedstock supply chain risk has, in many cases, been holding back expansion. More concerning for the industry as a whole, the development of new biomass plants has at times been hindered by the lack of security over continued feedstock supply.
The focus on the supply chain has shifted a  project’s balance of risk, so an innovative approach to risk management is required if developers, landowners and investors in the bioenergy sector are to feel more secure in the development of new plant. Likewise, the door may be opened for more interesting refinancing options for existing operators.
Taking a lead from other markets such as automotive, where the supply chain dominates project risk, products like the Savills and R K Harrison feedstock supply chain insurance service demonstrate how the sector is innovating to respond to the supply chain challenge.
Its approach differs from traditional business interruption insurance by indemnifying the operator for any reduction in turnover as a result of an interruption or failure in the supply chain. As a result, it is not reliant on an event or damage as a trigger to the reduction and can include such risks as a supplier’s insolvency or inability to provide sufficient feedstock, political risks or extreme weather events, which are all excluded under traditional insurance.
Ultimately, pre-empting and managing the financial implications of feedstock supply chain failure better and more proactively will act as a catalyst to unlock the potential in new and existing bioenergy projects, thus supporting the UK’s obligations under the Renewable Energy Directive and opening up opportunities for job creation and economic growth.