The International Consortium on Agricultural Biotechnology Research (ICABR)
Industry Organization and New Agricultural Products:
The Case of Biomass for Electricity Generation
University of MAryland,
Biomass electricity production holds the promise of a sustainable, environment-friendly energy source and a means for rural economic development. The structural organization of an industry based upon the production of energy crops for the purposes of electricity generation will be a factor in determining the full costs of production, which ultimately could have an impact on the ability of this energy resource to fulfill its promise. The issue of organization has received little attention within the biomass energy community where much of the research has focused on engineering aspects of production. The paper seeks to redress this oversight by exploring the economic issues concerning the organization of a viable biomass electricity industry via plantation-style feedstock supply systems and the potential for economic inefficiencies resulting from various governance structures.
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 transaction costs and incomplete contracting, risk diversification and moral hazard 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 findings of the analysis suggest the industry is unlikely to be reliant on spot market transactions as the predominant means of feedstock procurement. Without a viable spot market, some form of vertical coordination will be necessary to ensure adequate production of feedstock for electricity production over a relatively long period of time. The costs of vertical integration are likely to outweigh the benefits within a biomass electricity industry. The challenge in organizing the industry, therefore, rests in the formation of long-term contractual arrangements that can best counteract inefficiencies arising from the use of specific assets in the presence of temporal considerations and multiple forms of uncertainty.