February 2001 - Logging and Sawmilling Journal -

The Canadian forest industry is experiencing power price shock resulting from a dramatic jump in natural gas and electricity prices.

It is rather ironic to be talking about an energy shortage in the province of Alberta, but that is precisely the problem that is causing the cost of electricity to skyrocket for forestry companies in that province, at a time when lumber prices are at historic lows. Deregulation of the electrical industry as well as the move toward North American market prices on natural gas has caused an energy price shock for all Alberta forestry companies. The fact that natural gas is used to generate 35 per cent of Alberta's electricity-up from 23 per cent as recently as 1997- is making the situation worse. Sawmills across Canada are facing increasing natural gas costs, leaving many companies scrambling to find alternative ways to produce kiln dried lumber.

One company, Buchanan Lumber in High Level, Alberta, is already making the transition to producing kiln dried lumber by using power generated from a biomass plant and steam generated heat. Generally speaking, the increase in the cost of natural gas is having less of an impact outside of Alberta because that province's sawmilling industry has enjoyed relatively cheap natural gas prices up until now. "What we were used to was kind of a closed market where we could buy natural gas internally," said Alberta Forest Products Association (AFPA) director of environmental affairs Neil Shelly. "So it's a shock to us because we were a little isolated in the past." A survey of forestry jurisdictions across Canada shows that different sectors of the forest industry are experiencing different energy cost scenarios.

The pulp and paper industry and those manufacturing engineered wood products are experiencing the greatest impact. Forestry companies who are sitting in an enviable position are those who have already invested in power generating systems or cogen plants using biomass fuel. Suddenly the playing field has levelled considerably in terms of the cost of installing and operating a biomass energy generating system as compared to purchasing electricity, particularly in an open market jurisdiction like Alberta. "My suspicion is that we will probably see a good half dozen biomass projects announced across Alberta over the next year or so," says Shelly.

While the impact of rising energy costs has been most dramatic in Alberta, Ontario sawmills expect a 15 to 20 per cent increase in electricity costs as that province also moves toward deregulation of Ontario Hydro in May, 2001. However, Ontario is not suffering from the same supply and demand problems as Alberta, where there is a need for three more powergenerating plants. Although many sawmill owners in Ontario have already braced themselves for higher power bills, according to the Ontario Forest Industries Association, the likely impact of deregulation is still uncertain. Electricity prices could escalate more than expected if a proposal to recommission two nuclear power plants is delayed or abandoned.

According to a study conducted by the AFPA, a medium sized sawmill in Alberta can expect its electricity costs to escalate from $1 million per year to about $2.3 million per year. The increase in natural gas costs, used primarily in kiln drying, is expected to add another $500,000. "The whole theory behind deregulation is that by creating a competitive market, more players will get in, produce more power, and you will actually get cheaper power somewhere down the road," says Shelly. He adds that the problem in Alberta with deregulation is that in the process of moving in that direction, no new power generating capacity has been added to the system over the past three to four years. "This happened at the same time when there has been record growth in Alberta," says Shelly. "The demand for power has been soaring. So even though we entered a deregulated market effective January 1, 2001, it's still going to take some fairly major power generating projects to come on line to help ease the problem."

While larger sawmills many have the financial wherewithal to weather the storm by investing in biomass power generating plants and alternative ways to kiln dry their lumber, the forgotten group is the smaller sawmill owners. A 50 million board feet per year sawmill wanting to construct an onsite generator able to produce 2.5 megawatts of power faces a capital cost of $4 to $5 million. If lumber prices stay low and the price of natural gas and electricity remains extremely high, "it's going to put some of the smaller producers in some pretty tough straits in trying to remain competitive with the rest of the industry," says Shelly. It's not known if the result will be the production of more green and air dried lumber because some sawmills simply will not be able afford to turn the gas on at the kiln or invest in alternative means of kiln drying when lumber prices are so low.

The process of power deregulation in Alberta occurred when the province recently hosted two electricity auctions. Wholesalers and consortiums of large industrial power consumers had the opportunity to purchase power generated by private companies, which was previously sold to the provincial grid at a regulated rate, for the purpose of reselling it or consuming it themselves. The only part of power generation and delivery still controlled by the Alberta government are the actual transmission lines. Large to medium size industrial and commercial electricity consumers will share in a $1.2 billion rebate program as a result of the income earned from the provincial power auctions.

However, there has been a general complaint from small to medium sized businesses that there are too few wholesalers and no deals to be had because of high power demand in the province's booming economy. Most recently, the government has backed off from its decision to freeze the residential power rate for one year. It froze residential power rates because of a public outcry at the prospect of huge residential electricity rate increases. The province has since increased the rate that power companies can charge homeowners, has offered to subsidize residential power bills from funds it acquired during the electricity auctions and has wrung a promise out of power companies that they will build more power generating capacity to address the current shortfall.

High Energy Costs Good News for Biomass Projects

The certainty of a fairly long period of higher electricity prices is actually good news for investors interested in developing biomass energy generation projects. One such project is being considered in Grande Prairie, using biomass generated by Canfor's forestry operations in that northwestern Alberta city. Canfor has announced a cooperative venture with Canadian Gas & Electric Co to have a $40million, 20megawatt power plant operating by 2002. Biomass power generation in an uncertain electrical market is still considered risky because of the price differential between generating power using biomass and what power has traditionally been sold for in a regulated market. Also, there is the possibility that the promise of cheap power from deregulation may actually work, and it may happen sooner than later. "In order for an investor to proceed with his biomass project, he needs a long term, 10 year commitment for people to buy the power he generates," says Neil Shelly of the Alberta Forest Products Association. "Some investors are quite concerned about getting into biomass power generation right now because while the present price of energy in Alberta might be $110 per megawatt, in three or four years it might drop down to $50." That uncertainty, he says, is probably the biggest barrier to these projects proceeding. At present, there are 16 new power generating plants proposed for Alberta, slated for construction completion between 2001 and 2005. The great unknowns are whether or not this is just an economic blip, whether natural gas can sustain its unprecedented high prices and whether power deregulation is indeed a runaway locomotive that will roll across North America whether the forest industry likes it or not. New American president George W Bush has already started discussions regarding a new natural gas pipeline, which would send massive amounts of gas from Alaska to fuel US markets. Not only will that project increase supply, but it will also increase the economic viability of the next major Canadian gas development field located in the Fort Liard area of the Northwest Territories. Finally, will all this concern about energy demand become a moot point if the North American economy suddenly goes into a recession? Ask any sawmill owner currently enduring record low lumber prices and he'd predict we are headed in that direction. Only time will tell.

After having to endure the bravado of their neighbors in Alberta for years concerning the so-called "Alberta Advantage", the BC forest industry is for once in an advantageous position insofar as electricity costs are concerned. BC Hydro rates have been frozen since 1993 and will remain so until this September. However, BC has deregulated the natural gas industry and, given its experiences there, forestry spokespeople say it is unlikely there will be any groundswell of enthusiasm to pursue deregulation of the electrical industry at this time. "With what has happened in terms of the rapid increase in natural gas costs and also what we've seen in other jurisdictions that have restructured their electric power supply systems, I think the results have certainly dampened anybody's enthusiasm for pursuing those possibilities at the present time," says Dan Potts, director for pulp and paper and regulatory affairs with the Council of Forest Industries of BC.

However, with a significant percentage of Canadian power generation now having been deregulated and with a global trend toward deregulation, according to the Canadian Electricity Association, the future of BC Hydro itself-which is still owned by the BC government-may become a hot election issue when BC holds its provincial election in this year. The electrical price shock being experienced in Alberta, and to a lesser extent in Ontario, comes as no surprise to Dan Goldberger, a senior advisor concerning financial and taxation issues for the Canadian Electricity Association. He says privatizing a vertically integrated company like Ontario Hydro, "can lead to price shocks in the system until the regulatory uncertainty has been removed, the right financial signals are installed, and you have a balance created between supply and demand". The price shock scenario, he says, is more of a long-term trend and its duration depends on how the entire deregulation process is handled.

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