Long-term Feedstock Contracting

In order to be effective and acceptable to both contract parties, adjustment mechanisms should be implemented with information generated by reliable and unbiased third parties. Governmental agency reporting as well as forest product price reporting services are typically utilized for this purpose.  The project team investigated the Forest Resource and Renewable Energy Decision Support System (FRREDSS) and explored index-based price formulas as two different approaches to determine long-term feedstock contract prices.  The Digital Marketplace was originally designed as a place where public-private partnerships (like Joint Power Authorities) could manage long-term feedstock arrangements. 

FRREDSS Price Mechanism

The Watershed Research and Training Center (WRTC) partnered with UC Davis on the use of the Forest Resource and Renewable Energy Decision Support System (FRREDSS)—an integrated optimization tool for least-cost feedstock procurement. Over 50 model runs were conducted by summarizing the 20-year profit and loss (P&L) statement across silvicultural and harvest types, expansion factors, and inflation rates across six (6) site locations within Nevada, Placer, and El Dorado Counties. Site locations were modeled to test the feedstock costs for a 5 MW combined heat and power conversion system with a general average feedstock demand of 35,753 bone dry tons (BDT) per year.  On a year by year basis, costs were consistently less than reported rates collected from vegetation contractors. It wasn’t until Year 15 of the 20-year P&L statement that prices began to exceed reported contractor rates.  For this reason, recommendations to improve the FRREDSS model were developed in Appendix A of the report.  Among the recommendations, the most important component underserved within the FRREDSS model is the accurate tracking of inflation over time.  This is what informed the development of the contract design report. 

Index-based price contract design  

This report synthesizes literature, conversations, and other sources on a contracting approach for long-term feedstock price management.  An illustrative example on a long-term biomass price formula is developed to support discussions.  Due to the sensitivity of biomass prices to various interrelated variables such as inflation and diesel prices, identifying a price point throughout the life of the contract is challenging.  A formula-based rate (FBR) and an index-based price (IBP) formula were both discussed, and a demonstrative IBP approach for forest biomass was created to support discussions. Price changes were modeled based on inflationary changes between 2013-2023 for various “components” of a biomass price.  A price floor and price ceiling of 10% of baseline price is applied to demonstrate how risk fluctuations can be further hedged over the lifetime of the contract.  The IBP contract design has notable potential to be applied in CA, however, facilities have attempted to use index-based pricing in the past.  They found it to be too complicated and ultimately too opaque for contractors to be comfortable without additional third party oversight.

In recent years, the insurance industry has faced challenges related to shifting macroeconomic conditions and the increased frequency and severity of climate change related events, such as wildfires, storms, floods, and drought. As a result, the availability of insurance coverage and the limits covered have been constrained and, in many cases, required higher insurance policy premiums.

A Woody Feedstock Insurance Playbook (“Playbook”) was developed to focus on the role played by insurance regarding risk mitigation and risk transfer and the opportunities to support the woody feedstock value chain through insurance solutions. Insurance solutions are presented as a mechanism to support greater use of long-term contracts which can provide stability to value chain stakeholders and make it easier to obtain needed credit and investment. As such the Playbook was developed by insurance industry experts to provide an understanding of: 

• The woody biomass/feedstock value chain and its actors; 
• Current insurance coverage, gaps and risks, and insurance needs of actors in the woody feedstock value chain; and 
• Existing and potential market and policy solutions to address insurance gaps and risks.

Feedstock supply insurance

A Feedstock Supply Insurance (FSI) model focuses on guaranteeing feedstock delivery and includes aspects of feedstock price forecasting, although is altogether different from developing a price-adjustment mechanism.  The effort was led by Ecostrat and CLERE Inc. and focuses on being able to compensate suppliers or buyers during market volatility in order to guarantee biomass delivery already under contract.   An insurance product of this sort would operate like a warranty by relying on sophisticated risk assessments within a specified woodbasket to determine the distance at which feedstock would be deemed safe for remuneration. 

A team of advisors, which included insurance market experts and practitioners, reviewed and contributed to the feasibility of the concept as proposed by Ecostrat.  One of the key requirements is that the insurance or risk transfer mechanism cover the duration of the term of the loan or investment of capital, or if not, at least cover 5 -10 years in duration.  The advisory group determined that to meet the requirements for lenders and investors for a long-term woody feedstock supply insurance policy, the only viable option would be a parametric insurance product.  A report was written that describes the application of an insurance product for this purpose, but concluded that it had a very low likelihood of underwriting in the private sector. 

State Claims Fund

Building upon the work around price-adjusting mechanisms and supply insurance, the State Claims Fund is a proposed state- funded financial mechanism designed to de-risk long-term (10-year) forest residue supply agreements between suppliers and biomass facility operators. Modeled after California’s successful Prescribed Fire Claims Fund, the Claims Fund would compensate parties for specific non-performance issues and cost overruns that fall outside their direct control, circumstances that currently prevent suppliers and users from entering into the multi-year contracts that lenders and investors require before financing biomass facility expansions or new developments.