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Bringing the Heat

A company providing wood-pellet heating that uses existing systems gains support as it manages risks

Written by Tux Turkel   
A startup company in Orono, Maine, is trying to convince midsize businesses and institutions in New England that they can save money by converting from heating oil to wood pellets without buying any fuel or equipment. The concept is intriguing, but some observers in the pellet-fuel industry say Pelletco LLC faces challenges to perform on a large scale over time.

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High and volatile oil prices have commercial users looking for alternatives. The next year or so will help show whether selling just heat, rather than fuel and equipment, is a viable option in Maine.

Pelletco brings a wood-pellet boiler and a storage building, called a HeatPod, to a client’s business, sets it up outdoors and connects it to the heating system. Pelletco operates and maintains the unit.

The client pays only for heat, buying BTUs at a price that’s nearly 20 per cent below the cost of oil. Pelletco says it has 11 HeatPods installed.

The three-year-old company has an ambitious growth plan. Financial material obtained by the Portland Press Herald shows that Pelletco, which expects to lose $366,125 this year, is seeking investors to transform it into a break-even energy-services provider with $3.5 million in earnings. That would require hooking up about 80 new customers by 2016, the company acknowledges.

The company has the support of a key lender for renewable energy that sees enough potential in the plan to provide seed capital. But its business plan has drawn a cautious response from more established members of the state’s pellet-fuels industry.

They remember when a California company, International Wood Fuels, opened an office in Portland in 2009, selling the same kind of pellet-heat service to schools and large workspaces in New England.

Financial troubles forced the company to close in Maine two years later.

International Wood Fuels left behind disappointed customers and a broken promise to build a $20-million pellet mill in Burnham. The episode gave pellet heat a black eye, say industry veterans, at a time when it was struggling to gain acceptance as a viable alternative to oil.

No one is suggesting that Pelletco is destined to be another International Wood Fuels. But William Strauss, an economist and president of the FutureMetrics biomass consulting firm in Bethel, said both business models assume oil prices will stay high and wood prices will remain stable.

“There is a good target market for Pelletco to go after,” Strauss said. “Maybe they can pull it off. But banking on the spread between what you’re paying for energy and charging for heat has inherent risks.”

Strauss is a partner in Maine Energy Systems, which sells a European-designed pellet boiler and distributes pellets.

Pelletco faces other challenges, Strauss said, including the rapid penetration of natural gas lines in Maine and the logistics of operating and maintaining HeatPods on a large scale.

Easy to switch back to oil
James Knight, Pelletco’s chief executive officer, said these risks are being well managed. The trend for oil prices is clearly up, he said, and in his view, the notion that natural gas will reach many Maine businesses anytime soon is overly optimistic.

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Maine Energy Systems, an established pellet heat supplier, follows a different model, where clients own the appliances and buy pellets at market price.

 
Knight also dismisses comparisons to International Wood Fuels. He notes that the HeatPods are hooked up beside oil systems, which remain intact.

“Should we go out of business, the customer is no worse off than they were before they met us,” he said. “They would just switch back to using oil.”

Pelletco got a big vote of confidence earlier this year from Coastal Enterprises Inc. The non-profit financial organization based in Wiscasset invested $500,000, as part of its focus on sustainable and renewable energy ventures in Maine.

“We feel it’s important for groups like ours to be playing a role in making these projects happen,” said Michael Finnegan, Coastal Enterprises’ senior vice president for lending.

The company also has attracted the interest of Eliot Cutler, an independent candidate for governor. Cutler said he has made “a substantial investment” in Pelletco. He said he appreciates the environmental attributes and Maine-based technology.

“Is it risky?” Cutler said. “Of course it is. Most investments are, to one degree or another. But I thought the heat spread and efficiency spread here was, and remains, a bet
worth making.”

Roots in UMaine Project
Pelletco spun off from an effort at the University of Maine to create a high-energy fuel pellet for industrial use by mixing plastic with wood. It won a $25,000 grant from the Maine Technology Institute last year to test the pellets for commercial production.

Knight said the test was successful in making high-heat pellets that could cut air emissions at industrial plants, but the market didn’t embrace them. Pelletco is no longer pursuing the project, he said.

Pelletco maintains an “alliance” with UMaine and its forest products research capabilities. That includes appointing Michael Bilodeau, director of the university’s Process Development Center, as Pelletco’s chief technology officer. Bilodeau serves as an unpaid officer for the company, Knight said.

Through that alliance, Knight got interested in a business model to lower the cost of biomass systems in schools and large workspaces. The HeatPod is the product.

Installation sites include two units at the Big Squaw Mountain ski area outside Greenville; the former Loring Air Force Base in Limestone; the China Lake Conference Center; the Mildred Fox Elementary School in South Paris; and the Center for Aquaculture Research in Franklin.

Nick Brown, the aquaculture centre’s director, said the HeatPod performed well last winter. Pelletco estimated that the centre would save $15,000 compared with oil heat. Brown said he hasn’t done the calculations yet but that may be on target.

Pelletco has had at least one startup problem, at the Mildred Fox School. The details are unclear. Knight said the problem involved balancing the temperature in the school’s steam heating unit.

George Soffron, the president of Corinth Wood Pellets, said he learned that the pellets – fuel made by Corinth – were stored improperly, got wet and caused problems with the boiler. Soffron, a former president of the Maine Pellet Fuels Association, said he followed the situation closely because substandard installations reflect poorly on the industry and his company’s product.

Soffron said he’s “not a fan” of the oil-pellet price spread formula on which Pelletco’s business model is based. It makes the price of pellets much higher than the market price, he noted. “It is enticing,” Soffron said, “but it has the potential to rip off the consumer.”

Assuming oil stays high
According to Knight and company financial documents, here’s how Pelletco is set up: The company signs contracts ranging from five to 10 years. That gives Pelletco time to depreciate equipment costs and receive credits for tax purposes. According to documents, Pelletco projects a net loss this year of $366,125. The cost of pellets makes up roughly a third of expenses. Net revenue, from heat sales, is projected at $254,701. To begin to make a profit, Pelletco projects increasing heat sales revenue to $3.5 million by 2016. A key assumption is the price of oil. Pelletco says it can produce heat for nearly 20 per cent less than the cost of oil, at an equivalent of $2.99 a gallon. At current oil prices, making the same amount of heat from a ton of pellets – minus 20 per cent – costs around $350. Pellets can be bought in bulk for about $180 a ton. So there’s a “spread” of $170 a ton between wood and oil – Pelletco’s opportunity to pay its expenses and make a profit. The spread narrows if oil prices fall. In the oil market, commodity traders buy insurance against price swings, a so-called hedge. But hedging isn’t available for biomass, exposing Pelletco to more risk.

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With the volatility of heat prices in the region, Pelletco believes that heating wood pellets and wood chips can save upwards of 20 per cent on a building’s heating cost.

 
Knight said he is confident in projections showing oil prices rising, adding they would have to drop very far to compete with wood.

Strauss, the pellet-fuels economist, said it’s a reasonable bet – as long as oil stays high and pellet prices remain stable, as long as potential customers don’t hook up to natural gas and as long as Pelletco’s equipment and delivery systems work right.

Against this backdrop, Pelletco is looking for money to grow. Knight said he and Bilodeau provided the seed capital, then raised $300,000 from outside sources. Pelletco since has raised equity “in the low millions,” Knight said. It now is seeking a minimum of $25,000 each from private investors.

The coming winter could be pivotal for Pelletco. It must keep raising capital while winning acceptance in the market and the pellet industry to expand its HeatPod network to a critical mass. Knight characterized the company’s growth plan as systematic, limited to 20 or so HeatPods this year.

“I’m a big believer in crawl, walk, run as a business strategy,” he said. “We’re not trying to grow like crazy.” •


This article originally appeared in the Portland Press Herald on Aug. 22, 2013, and has been edited for use in Canadian Biomass magazine by Andrew Macklin.
 
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