Revisiting energy efficiency

As with many energy intensive industries these days, the forest products industry is facing increasing pressure from rising energy costs. This is particularly acute in key developed regions, such as Europe and the U.S., where the industry is already struggling to remain competitive against global players with significant factor cost advantages in other key cost elements. Though the industry has made major strides in increasing energy efficiency, the challenge is as great as ever. However, we have seen that companies can reap significant additional savings from increasing energy efficiency in their operations. To capture these opportunities, companies must reassess energy efficiency programs in light of the new energy reality.

 A new energy reality

Energy has become more and more important over the past several years, something the forest products industry has felt in a rising energy share in overall production cost, with annual energy expenditures reaching 25% of operating costs. The key drivers are the combination of rising oil and gas prices, an increasing focus on regional security of energy supply, and increasing concerns for the environment. Energy prices have risen significantly over the last few years, with oil currently trading over $100 per barrel and natural gas prices more than doubling since 2001 to over $6 per thousand cubic feet. World energy markets are more interlinked than ever, with supply shortages in one region – such as refinery downtime from hurricane Katrina in the U.S. or disruptions in Venezuela – quickly having ripple effects on global energy markets. This has made regional security of energy supply a focus for many governments, and led to increasing efforts to diversify energy supply. Compounding this challenge is growing concern over CO₂ emissions and the need to combat global warming. One result is the current call for a greater share of renewable energy in the final energy consumption mix. This could further increase energy costs. For example, many countries in Europe are granting large subsidies to energy producers to make renewable energy economically viable. Eventually, these higher production costs could be passed on to the utilities’ customers. The days of low-cost energy clearly seem numbered, if not gone entirely.

 An energy-intensive industry

The forest products industry is one of the major energy-intensive industries in the world, and energy is a key cost element driving competitiveness of individual companies. Today, the industry’s global energy consumption accounts for roughly 4.1% of total industrial end-use energy demand. Energy intensity does vary by region and product, as shown in the Illustration. These differences highlight that the levers and absolute potential for improved energy efficiency could vary significantly at the firm level.

However, the industry does benefit from a substantial share of self-generated renewable energy, primarily in the chemical pulp segment. Additionally, the forest products industry has a good track record of improving energy efficiency. There has been a substantial increase in the amount of self-generated energy over the past 30 years or so, particularly in the Nordic countries. Over this time, a significant amount of high-cost fossil fuels has also been replaced with low-cost biomass residues. We have also seen a wide adoption of energy-recovery technologies, such as steam hoods and traps, low pressure steam condensers, high-efficiency motors, etc. And perhaps most importantly, there has been a continuing shift to lower energy-intensity papermaking based on recovered paper with advances in deinking and secondary fiber processing technology.

 Opportunity to further increase energy efficiency

Though the industry has realized impressive gains, significant opportunity exists to further improve energy efficiency. For
example, according to the EIA, the U.S. production of pulp and paper has decreased primary energy intensity by 1%
per year over the last 25 years, compared to, for example, 3.6% per year in the European chemicals industry over the last 15 years.  It has been estimated (by the Berkeley National Laboratory) that the overall incremental energy efficiency opportunity in the U.S. is roughly 20-30% for the industry. Capturing these savings can have an impact equivalent to 3-5% return on sales. In McKinsey’s work we have seen large and profitable improvements from several key levers, particularly:

• Investments in more energy efficient technologies
• New operating procedures
• Recovery and reuse of waste process energy internally and externally

Examples of these opportunities are numerous. Energy efficient technologies are probably the most familiar and well-trodden ground. Among cost-effective technologies with returns greater than 10%, the most prominent are improved drying technologies, enhanced steam systems, efficiently designed motor systems, and combined heat and power generation.

New operating procedures can also pay great dividends. One pulp and paper mill that exemplifies this was operating multiple boilers including an electric boiler to meet steam demand. However, overall boiler utilization was well below 50%, with peak steam demand representing just over 50% of overall boiler capacity. Furthermore, there was more than 100% variance from the average production cost to the high-cost electric boiler capacity. By shutting down the electric boiler and using the excess capacity as true peaking capacity, the mill saved nearly 4% of its total annual energy spend across the entire mill. These savings were largely from reduced electricity and maintenance costs, partly offset by increased gas costs and carbon dioxide fees.

Finally, no matter how efficient the processes and procedures, residual process energy always remains. This “waste heat” can often be reclaimed and reused within the process, or its quality and/or quantity may make it valuable to external “heat sinks.”  Internally, waste heat can often directly replace fuel needs, such as using low pressure steam to heat air at furnace inlets.

 Path forward

To capture these opportunities, companies must look within their operations and beyond. Company-wide energy productivity programs are the first step. We have found that a combination approach – combining capital-driven and people-driven projects, overlaid by new financial evaluation economics – is necessary to drive maximum impact and change mindsets and behaviors of the workforce. A central program office with a few dedicated resources can be an effective means to drive this approach across multiple plants and geographies.

One important finding is that the discount rate for capital projects in such programs needs to be aligned with the inherent project risk. By way of example, energy projects are often times evaluated with the same discount rate as capital projects such as paper machine investments. However, the latter have a much higher project risk due to externalities that may impact the business case for the investments. Energy efficiency projects rarely encounter such risks, and the benefits are therefore more certain. When the discount rate is aligned with this lower risk, many energy projects that otherwise would not have been considered become very attractive financially, in terms of IRR¹ and NPV².

In addition to financial metrics, appropriate supporting management infrastructure, such as performance management, benchmarks, “energy efficiency office,” and formal or informal networks at all levels in organization, mindsets and behaviors, such as ownership mentality, change stories, and role modeling, and processes, such as idea databases with quantified examples, Kaizen workshops, and Pareto analysis of energy opportunities, are key enablers for capturing the savings. One company used Kaizen workshops on water and steam usage at their mills to eliminate waste and to find and realize the easiest opportunities in water reduction and heat utilization. It also generated high awareness about the cost of steam, heat, and water and brought momentum to all conservation efforts. The savings were over $ 2 million per year.

Finally, internal energy efficiency initiatives should also have clear links to risk management. For example, newsprint mills that optimize the mix of TMP and recycled fiber based on daily input prices need to coordinate with corporate energy price hedging activities.

Beyond internal projects, industry partnerships constitute the next step to increased energy efficiency. Examples include research consortia and Best Practice sharing through industry associations to leverage investment funds and accumulated industry knowledge.

Lastly, partnerships outside the forest products industry provide a third approach to tap into unrealized potential, particularly for high risk/high reward technologies or for large infrastructure investments. A key barrier to the adoption of breakthrough technologies is that the learning curve costs are borne largely by the first adopter even for a demonstrated, open market technology.  Furthermore, the early adopter often gains little competitive advantage from the initial investment, as any new technology that is successfully deployed rapidly propagates across the industry as highly specialized equipment suppliers seek to monetize their own investments. This discourages efforts to commercialize breakthrough technologies and instead leads companies to concentrate on
optimizing existing processes. Partnerships with the government and other industries can reduce or distribute the costs and risks associated with such projects, and foster adoption of breakthrough technologies. For example, government co-investment in black liquor gasification has brought this technology to the industrial pilot stage more rapidly than through the efforts of any individual company. Similarly, co-investing with other industrial partners is another avenue to reduce cost and risk, such as with local utilities to develop grid heating and power generation.  

Clearly, there are still opportunities to improve energy efficiency. Given the new energy reality and the fact that energy continues to be an important driver of competitiveness, forest products companies will be wise to revisit all options to capture the economic and environmental benefits of energy savings.

¹ IRR (Internal Rate of Return): The discount rate that makes the NPV equal to zero.

² NPV (Net Present Value): An estimate of future cash flows or the value of production to be generated by a project, net of operating costs and expenses, discounted back to present time with a certain discount rate.