IDEAS home Printed from https://ideas.repec.org/p/ags/aaea16/236092.html
   My bibliography  Save this paper

Contracting for Perennial Energy Crops Under Uncertainty and Costly Reversibility

Author

Listed:
  • McCarty, Tanner
  • Sesmero, Juan
  • Gramig, Ben

Abstract

This paper addresses the impact that different contracts can have on a farmer’s willingness to grow perennial crops, and both the risk the cost effectiveness of each type. Growing perennial energy crops such as poplar, requires large up front capital costs that are largely irreversible. It is also associated with highly volatile returns that can discourage cultivation. Traditional approaches to predict the entry threshold for a given project, such as NPV or Marshallian entry neglect to account for the uncertain, sunk, and intertemporal nature of these types of problems and thus under-estimate the profitability required for entry (Dixit and Pindyck, 1994). This study addresses this problem by using real options analysis. Higher degrees of uncertainty and irreversibility translate into higher premiums on entry due to the value of waiting for more information. Our results suggest that different contracts can erode some of this premium. This study finds the specific type of contract that would trigger cultivation at the lowest possible cost to the biofuel plant. This study considers three different types of payment (performance, acreage, and cost index) to induce investment into poplar tree cultivation. It solves for the entry and exit net revenue thresholds under multiple levels and payment types, using real options. It then uses this threshold to calculate performance, acreage, and the total payment required for entry on a per ton of biomass basis.

Suggested Citation

  • McCarty, Tanner & Sesmero, Juan & Gramig, Ben, 2016. "Contracting for Perennial Energy Crops Under Uncertainty and Costly Reversibility," 2016 Annual Meeting, July 31-August 2, 2016, Boston, Massachusetts 236092, Agricultural and Applied Economics Association.
  • Handle: RePEc:ags:aaea16:236092
    as

    Download full text from publisher

    File URL: http://purl.umn.edu/236092
    Download Restriction: no

    References listed on IDEAS

    as
    1. Schatzki, Todd, 2003. "Options, uncertainty and sunk costs:: an empirical analysis of land use change," Journal of Environmental Economics and Management, Elsevier, vol. 46(1), pages 86-105, July.
    2. Price, T. Jeffrey & Wetzstein, Michael E., 1999. "Irreversible Investment Decisions In Perennial Crops With Yield And Price Uncertainty," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 24(01), July.
    3. Feng Song & Jinhua Zhao & Scott M. Swinton, 2011. "Switching to Perennial Energy Crops Under Uncertainty and Costly Reversibility," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 93(3), pages 764-779.
    4. Alexander, Corinne & Ivanic, Rasto & Rosch, Stephanie & Tyner, Wallace & Wu, Steven Y. & Yoder, Joshua R., 2012. "Contract theory and implications for perennial energy crop contracting," Energy Economics, Elsevier, vol. 34(4), pages 970-979.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    real options; contracting; uncertainty; costly reversibility; Crop Production/Industries; Resource /Energy Economics and Policy; Risk and Uncertainty;

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ags:aaea16:236092. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (AgEcon Search). General contact details of provider: http://edirc.repec.org/data/aaeaaea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.