The industrial wood pellet market: is ownership becoming more concentrated?
Enviva has announced its acquisition of Colombo Energy’s 460kt/y wood pellet mill at Greenwood SC and its plans to build new mills and export terminals in the US South. This move will arguably strengthen the industrial wood pellet market as it provides a necessary boost to the development of the new mills and ports that will be needed to meet the expected growth in demand. Yet it may also cause some competitors and buyers to worry about Enviva’s growing influence in the global pellet market. Are such concerns justified?
One way of measuring market concentration is by adding together the market shares of the five largest companies in an industry. This is known as the five-firm (or C5) concentration ratio. At present, the five largest manufacturers of wood pellets (when measured by installed capacity) are Enviva (USA), Grannul Invest (Baltic States), Pinnacle Renewable Energy (Canada), Drax Biomass (USA) and Georgia Biomass(USA). The sum of the annual pellet manufacturing capacities of these five companies at end-2017 (8.6Mt/y) amounts to 40% of the industrial wood pellet capacity worldwide (21.4Mt/y).
This is higher than the C5 ratio of some other forest product industries – the equivalent ratio in the global wood pulp market is 29%, for example – but it is below an accepted, though admittedly somewhat arbitrary, figure of 50% that denotes a threshold between an unconcentrated and a concentrated market.
The wood pellet C5 ratio has been declining over time. As shown in the chart, the C5 ratio was 49% in 2010 and, largely due the growth in supply in southeast Asia, it has since been dropping year-on-year. Despite possible first impressions, Enviva’s share of global capacity has been constant; it was 15% in 2014 and, once the acquisition of the Colombo mill is included, it is still 15% today. The company has been adding capacity regularly, but no faster than the industry as a whole.
Critics will argue, quite reasonably, that a global C5 ratio is a crude measure of industry concentration. A more robust measure is the Herfindahl-Hirschman Index (HHI) as used by many regulatory authorities when they investigate whether a market is appropriately competitive. The HHI is the sum of the squares of the market shares for all producers. This calculation gives the greatest weighting to the largest and potentially most dominant companies and almost no weighting to the smallest. In a perfect monopoly, with one dominant producer and no competition, the HHI would be 10,000 (i.e. 1002). A highly fragmented market would have an HHI close to zero.
The HHI methodology is an improvement on that of the C5 ratio, but the result needs careful interpretation nevertheless. Two concepts must be considered: comparability and contestability. First, are the products being sold by the different suppliers truly comparable? The answer extends to more than just the physical/chemical description of the product. In the industrial wood pellet market, the biggest companies are selling more than just pellets, of course. They are also selling the bankable security of a wood pellet supply chain and everything that goes with it. This includes the assured environmental sustainability of the pellets, a diversity of wood pellet production, the financial strength to agree long-term contracts, the availability of storage capacity, technical support and logistic services etc. Not every company is equal in these regards, so the “population” of companies selling comparable all-encompassing services is necessarily smaller.
Second, how big is the contestable market? Global industrial wood pellet manufacturing capacity is now >21Mt/y, but by no means all this capacity can contest for a share of every market. For example, most southeast Asian pellet manufacturers would find it impossible to contest for a share of the European market. Even if they were competitive financially, many would struggle to meet European sustainability criteria. Likewise, it would be unrealistic to view most European pellet mills as viable suppliers to Japan or Korea. Realistically, therefore, pellet buyers in both Europe and Asia must search for supplies among a smaller-than-global population of wood pellet of manufacturers.
In calculating an industrial wood pellet HHI for the European market I have therefore used global mill-by-mill capacity data, but I have adjusted these to address the comparability and contestability questions. Such adjustments will always be debatable and different analysts will make different assumptions. I have, for example, excluded companies with a capacity <100kt/y on the grounds that such companies are likely to lack the scale necessary to contest for a long-term contract with a major European utility. Some exceptions to this rule are that I have treated all Portuguese producers as a single supplier and I have likewise grouped together all Russian suppliers with the exception of the large Vyborgskya mill. I have also excluded all Asian capacity for the reasons mentioned earlier.
The resulting HHI for the European industrial pellet market in Q4 2017 is 786. Following the completion of Enviva’s purchase of Colombo Energy I expect the market’s HHI to rise to 885, other things remaining equal. These results can be assessed by reference to advice from the US Department of Justice that characterises markets as “unconcentrated” if the HHI is <1000, as “moderately concentrated” if the HHI is between 1000 and 1800, and as “highly concentrated” if the HHI is >1800. See: http://bit.ly/2qSXmD3
On this basis, we can conclude that the industrial wood pellet market is unconcentrated at present and appears to be becoming less concentrated over time. Looking to the future there may be some further consolidation of ownership in the more mature regions – in North America or Europe, for example – but this seems likely to be offset by fragmented growth in new supply elsewhere, for example in Asia, Australia, Latin America, Russia and, possibly, China. Expect the fragmentation of new supply to intensify competition and to bear down on supply costs in the years ahead.
For more information on the international wood pellet markets please see our Outlook for Wood Pellets