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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.

Suggested Citation

  • Yang, Xi & Paulson, Nicholas D. & Khanna, Madhu, 2012. "Optimal Contracts to Induce Biomass Production under Risk," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124699, Agricultural and Applied Economics Association.
  • Handle: RePEc:ags:aaea12:124699
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    File URL: http://purl.umn.edu/124699
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    References listed on IDEAS

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    1. 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.
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    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.
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    Cited by:

    1. Rosburg, Alicia & Miranowski, John & McFadden, Jonathan, 2016. "Mitigating Feedstock Supply Risk in Corn Stover Biofuel Production," 2016 Annual Meeting, July 31-August 2, 2016, Boston, Massachusetts 235875, Agricultural and Applied Economics Association.
    2. Ye, Fanglin & Paulson, Nicholas & Khanna, Madhu, 2014. "Technology uncertainty and learning by doing in the cellulosic biofuel investment," 2014 Annual Meeting, July 27-29, 2014, Minneapolis, Minnesota 169789, Agricultural and Applied Economics Association.
    3. 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.
    4. Yang, Xi & Miao, Ruiqing & Khanna, Madhu, 2014. "Contracting in the Presence of Insurance: The Case of Bioenergy Crop Production," 2014 Annual Meeting, July 27-29, 2014, Minneapolis, Minnesota 170188, Agricultural and Applied Economics Association.

    More about this item

    Keywords

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

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