To accommodate rapid technological change in agriculture, contract farming has emerged as a market response to manage and share risks along the supply chain. Contract farming strengthens vertical coordination for producers and processors motivated by desire to decrease randomness, overcome credit and risk constraints, assure production targets, and address environmental considerations. Using contract theory perspective, this paper shows why multiple contract forms exist to address different types of risk, market size and maturity, and other constraints. Our findings suggest that, in the case of biofuels, contract design depends on land quality, output prices and markets, farmers’ risk preference, and other constraints. In establishing a refinery, the decision-maker must determine the size of refinery, quantity of in-house feedstock production, and strategy for purchasing additional feedstock. When facility capacity exceeds in-house production, the processor needs to rely on external feedstock. Processors and producers with higher land quality are shown to benefit from vertical integration, while lower land quality should result in conversion to biofuel production due to lower opportunity cost. As second generation feedstock production grows and matures, policies must consider contract design, technology adoption, and vertical integration.

Perennial energy crops are a promising source of bioenergy whose production involves production risks, long-term commitment of land and need for crop-specific investments without the coverage of crop insurance potentially available for conventional crops. We conduct a choice experiment in five states in the Midwestern and South-central regions of the U.S. to examine the effect of crop-contract attributes on the joint discrete-continuous choice decisions to adopt an energy crop and convert acres to it from a status quo use, while controlling for the effect of various farmers’ risk and time preferences, sociodemographic characteristics, and availability of crop insurance for conventional crops. We find robust evidence that high discount rates, high upfront establishment costs and need for crop-specific investments create disincentives for adoption and allocation of land to energy crop production. The effects of riskiness of returns and risk aversion are less robust across specifications. The effect of conventional crop insurance on the energy crop adoption decision differs across types of insurance; in particular, farmers with revenue insurance are statistically significantly less likely to adopt an energy crop. Our results have implications for the design of effective contracts and policy incentives to induce the production of energy crops.

Perennial energy crops are a promising source of bioenergy whose production involves production risks, long-term commitment of land and need for crop-specific investments without the coverage of crop insurance potentially available for conventional crops. We conduct a choice experiment in five states in the Midwestern and South-central regions of the U.S. to examine the effect of crop-contract attributes on the joint discrete-continuous choice decisions to adopt an energy crop and convert acres to it from a status quo use, while controlling for the effect of various farmers’ risk and time preferences, sociodemographic characteristics, and availability of crop insurance for conventional crops. We find robust evidence that high discount rates, high upfront establishment costs and need for crop-specific investments create disincentives for adoption and allocation of land to energy crop production. The effects of riskiness of returns and risk aversion are less robust across specifications. The effect of conventional crop insurance on the energy crop adoption decision differs across types of insurance; in particular, farmers with revenue insurance are statistically significantly less likely to adopt an energy crop. Our results have implications for the design of effective contracts and policy incentives to induce the production of energy crops.

Long-term contracts are likely to be critical to induce the production of perennial energy crops as a feedstock for the emerging cellulosic biofuel industry. This paper develops a framework to analyze the determinants of landowner choice among a land-leasing contract, a fixed-price contract, and a revenue-sharing contract for energy crop production. We examine the effect of heterogeneous landowners' risk and time preferences and land quality on the optimal mix and equilibrium terms of these contracts, which jointly maximize the net benefits of the refinery and landowners in a region; this has implications for the extent to which energy crop production is likely to be vertically integrated or independently contracted by a biorefinery. We find that the refinery can potentially earn a higher profit by offering a choice of these three types of contracts rather than a single type of contract only; by allowing self-selection of contract type based on landowner risk and time preferences, the contractual terms needed to induce production of energy crops are reduced. Although it is optimal for vertically-integrated and contracted production to co-exist, we find that the share of the former is predominant across a range of assumptions about the distribution of risk preferences, time preferences, and relative riskiness of conventional and energy crop production. We also find that the impact of having multiple contract types to choose from on landowners' welfare is ambiguous.

This paper investigates the interaction of crop insurance and contracts in improving the risk management of farmers who produce bioenergy crops. Numerical simulation is conducted for 1,919 U.S. counties east of the 100th Meridian that have yield data for corn and for at least one bioenergy crop yield of miscanthus and switchgrass. County-level yield data, both on low quality land and high quality land, are simulated by using DayCent model, and Copula approach is used to estimate a joint yield-price distribution for each county. We model a representative farmers’ optimal choice problem of whether to use their land to grow conventional crops or to use their land for production of bioenergy crops under one of three different contract choices offered by the biorefinery. The terms of these contracts are determined in such a manner that they jointly maximize the net benefits of the refinery and farmers. We do this joint optimization in two scenarios: ‘With insurance’ and ‘Without insurance’ for bioenergy crops to see how presence of crop insurance for bioenergy crops will affect the optimal contract design and will affect land allocation under a certain contract type. (This abstract was borrowed from another version of this item.)

This paper analyzes the effect of landowner risk preferences and land quality on the optimal mix of vertically integrated production and contracted production of an energy crop in a region characterized by heterogeneity in landowners’ risk preferences and land quality and with riskiness of returns from both energy crop and conventional crop production. We examine the determinants of the decision of landowners to grow an energy crop for biofuel production under one of three types of contracts, a land leasing contract, a fixed price contract and a revenue sharing contract and the impact of risk and time preferences, land quality and riskiness of energy crop production and prices on the optimal contract terms and effective cost of biomass. We find that as the degree of risk aversion and rate of time preference increases and as the riskiness of producing both the conventional crop and the energy crop increases, the share of vertically integrated production of energy crops increases. While low quality land is more likely to be converted to energy crop production, an increase in the degree of risk aversion results in an increase in the threshold level of land quality converted to energy crops under a land leasing contract but a decrease in the threshold level of land quality converted under a fixed price contract and a revenue sharing contract. We also find that the refinery can potentially earn a higher profit by offering a menu of different types of contracts rather than a single type of contract only; by allowing self-selection of contract type based on their risk preferences, the risk premium needed to induce production of energy crops is reduced.

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.