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Estimating the Influence of Ethanol Policy on Plant Investment Decisions: A Real Options Analysis with Two Stochastic Variables

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  • Schmit, Todd M.
  • Luo, Jianchuan
  • Conrad, Jon M.

Abstract

Ethanol policies have contributed to changes in the levels and the volatilities of revenues and costs facing ethanol firms. The implications of these policies for optimal investment behavior are investigated through an extension of the real options framework that allows for the consideration of volatility in both revenue and cost components, as well as the correlation between them. The effects of policy affecting plant revenues dominate the effects of those policies affecting production costs. In the absence of these policies, much of the recent expansionary periods would have not existed and market conditions in the late-1990s would have led to some plant closures. We also show that, regardless of plant size, national ethanol policy has narrowed the distance between the optimal entry and exit curves, implying a more narrow range of inactivity and a more volatile evolution for the industry than would have existed otherwise.

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Bibliographic Info

Paper provided by Cornell University, Department of Applied Economics and Management in its series Working Papers with number 126963.

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Date of creation: 2010
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Handle: RePEc:ags:cudawp:126963

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Keywords: Agribusiness; Resource /Energy Economics and Policy;

References

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  1. Insley, Margaret, 2002. "A Real Options Approach to the Valuation of a Forestry Investment," Journal of Environmental Economics and Management, Elsevier, vol. 44(3), pages 471-492, November.
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  3. Amani Elobeid & Simla Tokgoz, 2008. "Removing Distortions in the U.S. Ethanol Market: What Does It Imply for the United States and Brazil?," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 90(4), pages 918-932.
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  7. de Gorter Harry & Just David R, 2008. "The Economics of the U.S. Ethanol Import Tariff with a Blend Mandate and Tax Credit," Journal of Agricultural & Food Industrial Organization, De Gruyter, vol. 6(2), pages 1-23, December.
  8. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June.
  9. Schmit, Todd M. & Luo, Jianchuan & Tauer, Loren W., 2008. "Ethanol Plant Investment using Net Present Value and Real Options Analyses," Working Papers 51145, Cornell University, Department of Applied Economics and Management.
  10. Harry de Gorter & David R. Just, 2008. "The Economics of a Blend Mandate for Biofuels," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 91(3), pages 738-750.
  11. Kim, Hyun Seok & Brorsen, B. Wade, 2008. "Can Real Option Value Explain Why Producers Appear to Store Too Long?," 2008 Conference, April 21-22, 2008, St. Louis, Missouri 37602, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  12. Harry de Gorter & David R. Just, 2007. "The Welfare Economics of a Biofuel Tax Credit and the Interaction Effects with Price Contingent Farm Subsidies," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 91(2), pages 477-488.
  13. Dabin Wang & William G. Tomek, 2007. "Commodity Prices and Unit Root Tests," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 89(4), pages 873-889.
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  15. Nostbakken, Linda, 2006. "Regime switching in a fishery with stochastic stock and price," Journal of Environmental Economics and Management, Elsevier, vol. 51(2), pages 231-241, March.
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