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Optimal Contracts to Induce Biomass Production under Risk

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  • Yang, Xi
  • Paulson, Nicholas D.
  • Khanna, Madhu

Abstract

There is growing interest in biomass from perennial grasses (e.g. switchgrass and miscanthus) for bioenergy production because of their high yields, their potential to be grown on low quality land with minimal competition with food crops and, and their ability to achieve significant reduction in greenhouse gas (GHG) emissions relative to fossil fuels and corn ethanol. In order to guarantee the steady supply of biomass feedstock for mandated biofuel production, a crucial question confronting the biorefinery and policy makers is how to coordinate a market for biomass production. This paper addresses this issue by analyzing the potential design of biomass production contracts between biomass growers and biorefineries to promote the development of the industry. We approach the issue from both the landowner and biorefinery perspectives. We analyze and examine how the optimal contract design depends on both the farmers’ and biorefinery’s characteristics. We also contribute to the existing literature examining the role of risks in contract design by how the risks from multiple sources interact and jointly determine the optimal contract terms. Our preliminary findings suggest that farmers’ land allocation decisions depend on the joint distribution of their individual land quality and risk preferences. For a given level of risk aversion, farmers with low land quality are more willing to sign contracts with biorefineries to produce bioenergy crops due to the low opportunity cost of foregoing row crop production. For a given land quality, the farmer’s choice of biomass contract design varies with their level of risk aversion. More risk averse farmers prefer the fixed lease design to avoid exposure to yield and price risk. As the level of risk aversion is reduced, preferences shift towards the fixed price and profit sharing contract designs since they can gain higher payoff in exchange for the higher risks they are bearing. For reasonable ranges of land quality levels and heterogeneity of risk aversion levels, the optimal solution for the biorefinery tends to include offering of multiple contract designs to producers in the region. The biorefinery can induce highest participation and obtain highest profit in a region with higher concentrations of low land quality. Furthermore, greater profits can be obtained by establishing a processing plant in an area where farmers have low risk aversion.

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Bibliographic Info

Paper provided by Agricultural and Applied Economics Association in its series 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington with number 124699.

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Date of creation: 2012
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Handle: RePEc:ags:aaea12:124699

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Related research

Keywords: Contract Farming; Bioenergy Crops; Risk Preference; Crop Production/Industries; Land Economics/Use; Risk and Uncertainty;

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References

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  1. Daniel A. Ackerberg & Maristella Botticini, 1999. "Endogenous Matching and the Empirical Determinants of Contract Form," Papers 0096, Boston University - Industry Studies Programme.
  2. Larson, James A. & English, Burton C. & He, Lixia, 2008. "Economic Analysis of Farm-Level Supply of Biomass Feedstocks for Energy Production Under Alternative Contract Scenarios and Risk," Transition to a Bio Economy Conferences, Integration of Agricultural and Energy Systems Conference, February 12-13, 2008, Atlanta, Georgia 48706, Farm Foundation.
  3. Bocquého, G. & Jacquet, F., 2010. "The adoption of switchgrass and miscanthus by farmers: Impact of liquidity constraints and risk preferences," Energy Policy, Elsevier, vol. 38(5), pages 2598-2607, May.
  4. Gillespie, Jeffrey M. & Eidman, Vernon R., 1998. "The Effect Of Risk And Autonomy On Independent Hog Producers' Contracting Decisions," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 30(01), July.
  5. Brent Hueth & Ethan Ligon, 1999. "Producer Price Risk and Quality Measurement," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 81(3), pages 512-524.
  6. Allen, Douglas & Lueck, Dean, 1992. "Contract Choice in Modern Agriculture: Cash Rent versus Cropshare," Journal of Law and Economics, University of Chicago Press, vol. 35(2), pages 397-426, October.
  7. Johnson, C. Scott & Foster, Kenneth A., 1994. "Risk Preferences And Contracting In The U.S. Hog Industry," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 26(02), December.
  8. Francine Lafontaine & Margaret Slade, 2007. "Vertical Integration and Firm Boundaries: The Evidence," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 629-685, September.
  9. Allen, Douglas W & Lueck, Dean, 1995. "Risk Preferences and the Economics of Contracts," American Economic Review, American Economic Association, vol. 85(2), pages 447-51, May.
  10. Lajili, Kaouthar & Barry, Peter J. & Sonka, Steven T. & Mahoney, Joseph T., 1997. "Farmers' Preferences For Crop Contracts," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 22(02), December.
  11. Douglas W. Allen & Dean Lueck, 1993. "Transaction Costs and the Design of Cropshare Contracts," RAND Journal of Economics, The RAND Corporation, vol. 24(1), pages 78-100, Spring.
  12. Larson, James A., 2008. "Risk and uncertainty at the farm level," Transition to a Bio Economy Conferences, Risk, Infrastructure and Industry Evolution Conference, June 24-25, 2008, Berkeley, California 48728, Farm Foundation.
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Cited by:
  1. Du, Xiaoxue & Lu, Liang & Zilberman, David, 2013. "Vertical Integration or Contract Farming on Biofuel Feedstock Production: A Technology Innovation Perspective," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 150629, Agricultural and Applied Economics Association.

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