The International Consortium on Agricultural Biotechnology Research (ICABR)


Industry Organization and New Agricultural Products:
The Case of Biomass for Electricity Generation

Conrad J. Choinière
Dept. of Agricultural and Resource Economics
University of Maryland

The formation of a new agricultural industry often requires new and unfamiliar types of commitments on the part of growers and processors. The coordination of these commitments and the organization of the sector play an important role in determining whether an industry ever gets off the ground and the extent to which it remains economically viable. The paper examines the governance issues that are likely to be important in determining the viability of one new agricultural industry in particular: the use of biomass for electricity generation.

The creation of a biomass electricity sector has interested policy makers in recent years due to its potential to offer significant environmental and economic benefits. Biomass energy plantations serve a dual role in the reduction of carbon emissions by producing a substitute for fossil fuels and by increasing the ability of agricultural land to sequester carbon. The perennial crops used for biomass power, like switchgrass and willow trees, provide year-round vegetative cover and are resilient in times of flood. As a result, they protect against soil erosion, prevent watershed deterioration and may effectively manage flood plains. In addition, a viable biomass sector would create new markets for agricultural products and serve to revitalize rural economies.

To date, there has been no serious discussion about the likely structure of the biomass electricity industry or the impact that various structures may have on costs of production, investment decisions and economic efficiency. It is unclear a priori what sorts of arrangements between growers and generators are likely to work best at achieving the optimal investment and production decisions crucial to determining the viability and sustainability of the industry. Optimally, the structure that arises will be an efficient response of the industry to its economic environment. A particular organizational scheme could evolve as a means of capitalizing on economies of scale and scope, minimizing transactions costs, sharing risk, or some other reason.

The paper identifies four critical characteristics of the investment and production decisions necessary for biomass electricity generation. The characteristics are notable in that they are likely to influence the optimal type of governance structure for a biomass electricity firm and sector. They include the presence of relationship-specific assets, temporal considerations such as the frequency and duration of the relationships between energy crop growers and electricity generators, uncertainty in agricultural production, and uncertainty in the markets for energy resources and electricity. The paper reviews the relevant economic theory in industrial organization and identifies the economic implications of each of the critical characteristics. In particular, the discussion focuses on the issues of moral hazard, risk diversification, and incomplete contracting and how they may affect the degree of vertical coordination in the industry. The review is followed by an empirical assessment of each of the issues in order to determine their significance and potential impact on the ultimate structure of the emerging biomass electricity sector. The paper also draws implications for other new agricultural products.

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