Big Risks in this Green Business Demand Global Standards

Making wood pellets isn't a complex process. However, this environmentally friendly industry is growing fast, especially in overseas markets that don't have the benefit of cheap natural gas. This is why U.S. players like Rentech (NASDAQ: RTK  ) need to make sure they are on board with European players like Drax Group (NASDAQOTH: DRXGY  ) as the wood pellet industry matures.

It's just wood, right?
Wood pellets are pretty simple. You take wood scraps from operations like lumber mills, chip it up, and mush it into little pellets. Using scraps makes the business that Rentech is opportunistically entering environmentally friendly in one way. However, the green credentials go even further, since tree products are easily recyclable, forests are sustainable using proper forestry techniques, and growing trees to replace the ones cut down helps to pull carbon dioxide from the air.

No wonder companies like Europe's Drax Group are looking to wood to help clean up their environmental image. Drax Group, for example, is in the middle of converting three coal plants to biomass. And in order to ensure a ready supply of biomass, it's been building wood pellet operations in the United States.

However, there's a good reason for this switch beyond going green. Drax Group expects to improve the efficiency of its biomass plants to within half a percentage point of what it's achieving with coal. That's a huge benefit over, say, solar or wind, which operate at a capacity of between 10% and 40% of their potential. The reason why these renewable energy sources don't produce better results is pretty simple: The sun and wind don't always cooperate.

Source: EIA

The output of coal plants, meanwhile, can be controlled. That means you can run a coal plant as hard as you want (or can). And the more power you produce, the more cost effective the operation. Since Drax Group thinks it can make biomass plants nearly as efficient as a coal plant, it isn't far fetched to think that more wood pellet demand is on tap to supply vital base load power.

A growing market
That's particularly true in Europe, which is facing higher natural gas prices than the United States. And with the prospect for more energy price volatility as Russia continues to spar with the West over its Crimea moves, energy price concerns aren't likely to ease anytime soon.

In fact, according to the U.S. Energy Information Administration, exports of U.S. wood pellets nearly doubled last year. No wonder Rentech just bought the largest producer of wood pellets for the U.S. heating market. Even though Rentech now has itself a 15% share of the U.S. pellet market, it was probably looking overseas when it signed the deal.

Source: EIA

Getting shut out
Despite the fact that wood pellets are pretty simple to understand, rapid growth will bring about important industry changes. That will mean industry standards and regulations to ensure that everyone is playing by the same rules. And making sure the United States is at the table is vital, since exports are growing so fast.

This includes such mundane issues as Europe defining standards using the metric system and the United States using inches. If Rentech can't provide the right documentation to Europe, it won't be able to sell to Europe—it's that simple. While Drax Group will be on top of that one, Rentech had better make sure it is, too.

Moreover, there are potential differences in the gasses naturally emitted during storage from the predominant woods in the United States and those in Europe. Since one of the gasses concerning the industry is carbon monoxide, the so-called silent killer, making sure Europe understands the U.S. pellet product is vital to ensuring proper shipping. The same holds true for fire safety, since a huge pile of wood pellets can sometimes start to naturally create enough heat to start a fire.

Wood pellets are developing fast
While the growth of the wood pellet industry is exciting, it's important to keep a close eye on regulations and standards. And to make sure that your investments are ready for any pending changes. That's going to be particularly true for a new entrant like Rentch as it eyes big growth in European demand.

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Reuben Brewer

Reuben Gregg Brewer believes dividends are a window into a company's soul. He tries to invest in good souls.

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