New Futures Market for wood pellets

Futures Market for Wood Pellets?

July 6, 2015

Lloyd C. Irland, The Irland Group

 

“If you want to make a small fortune, start with a large fortune and start trading futures”

–Old joke in the futures business

I first encountered futures markets in a short-term job working for the old Chicago Board of Trade on lumber and plywood futures.  Building on existing cash markets, Euronext, a large European bourse, has announced a wood fuel pellet futures market to open later this year.  It will focus on residential pellets, where seasonal uses create storage costs and inventory price risks for producers, distributors, and retailers.

Some of the major European pellet buyers and users are large utilities accustomed to power exchanges and forwards and future pricing,  carbon markets, coal and oil markets that fluctuate daily and for which highly liquid spot and futures markets exist.  Such buyers have little difficulty making use of new futures trading mechanisms (such as the ETS) should they succeed in developing adequate liquidity.  Whether the actors in the marketing chain for residential pellets possess this human and institutional capital I do not know.

Operating a successful trading program has costs of its own, and can bring risks that must be understood.   You are so heavily leveraged that you can lose your shirt being right, if the market briefly moves against you.  Money is likely to go out the window during the learning curve.    Early stage markets often misbehave in unexpected ways due to lopsided market participation, limited liquidity, sudden adverse market events, abrupt policy changes, or all of the above.

The latter is worth noting: the transatlantic trade in wood  pellets is almost entirely a creation of public policy.  Traders are accustomed to market and business risks;  policy risks add another whole dimension.  Traditional ag Futures markets matured during times when public policies did loom as large in markets as they do today.

It appears the pellet prices delivered to Europe are sufficiently volatile to interest distributors in means of hedging price risk.  But price volatility alone is not enough.  In fact, the track record of attempts to introduce new futures markets is not good.  Almost a decade ago I had the chance to review these issues while studying the emerging European Trading System for carbon emissions allowances.   An unpublished report that I produced in late 2006 review issues very similar to what this proposed pellet contract will face.   A leading power exchange, APX-ENDEX, initiated a power pellet exchange in 2011 and 2012, but at present there is no trace of it on the Web.

I’m not in a position to study details of the proposed contract and assess the issues on this proposed contract, but on re-reading my unpublished 2006 paper, I think those who are interested in this market may save themselves some time by perusing it.  It can be found at:

Lessons for New Futures Markets: the European Carbon Trading System (ETS) up to Fall 2006

https://www.researchgate.net/profile/Lloyd_Irland/contributions

DOI: 10.13140/RG.2.1.1423.4724