Risk Versus Reward, a Financial Analysis of Alternative Contract Specifications for the Miscanthus Lignocellulosic Suppl
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Risk Versus Reward, a Financial Analysis of Alternative Contract Specifications for the Miscanthus Lignocellulosic Supply Chain Joshua R. Yoder & Corinne Alexander & Rastislav Ivanic & Stephanie Rosch & Wallace Tyner & Steven Y. Wu
# Springer Science+Business Media New York 2014
Abstract We evaluate how different contract designs impact risk sharing along the supply chain for the dedicated energy crop miscanthus. We model the full production and transportation system of the miscanthus supply chain because a sustainable supply chain must procure biomass in a cost-effective manner. Using this model, we estimate the financial returns and risks for both a farmer producing miscanthus and the biofuels plant purchasing miscanthus. We evaluate differences among contracts that are designed to address the miscanthus investment cost and the farmers’ opportunity costs. We find that risk can be reduced to both the farmer and the plant by offering a dollar per acre base payment combined with a dollar per ton payment. The farmer faces the lowest risk when the contract combines a dollar per acre and dollar per ton payment. Lastly, we find that indexed contracts designed to reduce annual counterparty risk associated with the risk of farmers opting out of the contract to produce competing crops actually increases overall financial risk to the farmer and plant. Keywords Contract design . Biofuel supply chain . Miscanthus . Stochastic financial model The 2007 Energy Independence and Security Act (EISA) mandates the use of advanced biofuels, including cellulosicbased biofuels, starting in 2015 and growing to 16 billion J. R. Yoder 7050 Butler Avenue, Plain City, OH 43064, USA C. Alexander (*) : S. Rosch : W. Tyner : S. Y. Wu Department of Agricultural Economics, Purdue University, 403 West State Street, Krannert Building, West Lafayette, IN 47906, USA e-mail: [email protected] R. Ivanic Ivanic & Company, San Diego, CA, USA
gallons ethanol equivalent per year by 2022. Cellulosicbased biofuels can be produced from a variety of feedstocks, including corn stover, woody biomass, wheat straw, and dedicated energy crops such as switchgrass and miscanthus. Unlike the existing corn stover, wheat straw, and woody biomass feedstocks, there are substantial challenges in developing the market and supply chain for dedicated energy crops. Dedicated energy crops are perennial crops with few existing marketing outlets that the farmer must commit to growing for multiple years. This creates substantial counterparty risk for both the biofuel plant and the farmer. From the perspective of the biofuel plant, the counter-party risk is exacerbated because the estimated cost of building a cellulosic ethanol plant can be three times more expensive than building a corn-based ethanol plant. For investors to be willing to invest money in a biofuels plant, they need to be confident that the plant will be able to purchase the needed feedstock. Furthermore, the financial success of the biofuel plant will depend on securing a reliable supply of the feedstock at a
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