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Abstract
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.