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Using real option analysis to quantify ethanol policy impact on the firm's entry into and optimal operation of corn ethanol facilities

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  • Maxwell, Christian
  • Davison, Matt

Abstract

Ethanol crush spreads are used to model the value of a facility which produces ethanol from corn. A real option analysis is used to investigate the effects of model parameters on the related managerial decisions of (i) how to operate the facility through optimal switching from idled to operational status and (ii) the decision to enter into the project given its expected real option net present value. We present evidence of increased correlation between corn and ethanol prices, perhaps as a result of government policy which has induced more players to enter into the market. This paper investigates the subsequent negative effects on firms. Further, this paper illustrates the impact of an abrupt change in government policy, as what happened in January 2012, on a firm's decision to enter the business.

Suggested Citation

  • Maxwell, Christian & Davison, Matt, 2014. "Using real option analysis to quantify ethanol policy impact on the firm's entry into and optimal operation of corn ethanol facilities," Energy Economics, Elsevier, vol. 42(C), pages 140-151.
    • Handle: RePEc:eee:eneeco:v:42:y:2014:i:c:p:140-151
    DOI: 10.1016/j.eneco.2013.12.004
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    References listed on IDEAS

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    Cited by:

    1. Boomsma, Trine Krogh & Linnerud, Kristin, 2015. "Market and policy risk under different renewable electricity support schemes," Energy, Elsevier, vol. 89(C), pages 435-448.
    2. Xian, Hui & Karali, Berna & Colson, Gregory & Wetzstein, Michael E., 2015. "Diesel or compressed natural gas? A real options evaluation of the U.S. natural gas boom on fuel choice for trucking fleets," Energy, Elsevier, vol. 90(P2), pages 1342-1348.
    3. Ghoddusi, Hamed, 2017. "Blending under uncertainty: Real options analysis of ethanol plants and biofuels mandates," Energy Economics, Elsevier, vol. 61(C), pages 110-120.
    4. Cheng, Lingfeng & Anderson, C. Lindsay, 2016. "Financial sustainability for a lignocellulosic biorefinery under carbon constraints and price downside risk," Applied Energy, Elsevier, vol. 177(C), pages 98-107.
    5. Bigerna, Simona & Hagspiel, Verena & Kort, Peter M. & Wen, Xingang, 2023. "How damaging are environmental policy targets in terms of welfare?," European Journal of Operational Research, Elsevier, vol. 311(1), pages 354-372.
    6. Kang, Sang Baum & Létourneau, Pascal, 2016. "Investors’ reaction to the government credibility problem: A real option analysis of emission permit policy risk," Energy Economics, Elsevier, vol. 54(C), pages 96-107.
    7. Li, Yihua & Tseng, Chung-Li & Hu, Guiping, 2015. "Is now a good time for Iowa to invest in cellulosic biofuels? A real options approach considering construction lead times," International Journal of Production Economics, Elsevier, vol. 167(C), pages 97-107.
    8. Kozlova, Mariia, 2017. "Real option valuation in renewable energy literature: Research focus, trends and design," Renewable and Sustainable Energy Reviews, Elsevier, vol. 80(C), pages 180-196.
    9. Davison, Matt & Merener, Nicolas, 2023. "Equilibrium and real options in the ethanol industry: Modeling and empirical evidence," Journal of Commodity Markets, Elsevier, vol. 31(C).

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    More about this item

    Keywords

    Ethanol; Real options; Policy; Crush spread; Optimal switching; Renewable energy;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q18 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Policy; Food Policy; Animal Welfare Policy
    • Q16 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - R&D; Agricultural Technology; Biofuels; Agricultural Extension Services
    • Q42 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Alternative Energy Sources
    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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