The Case for Vertical Integration in the Developing Bioenergy Industry
82 Pages Posted: 24 Jul 2015 Last revised: 9 Mar 2016
Date Written: July 22, 2015
For many countries, money grows on trees: woody biomass is one of the most important sources of renewable energy in the European Union. In the United States, biomass was the input for almost half of the renewable energy generated in 2000; of the energy generated by biomass, seventy-six percent was produced from wood.1 Currently, biomass is the largest source of renewable energy in the country. The ability to secure a reliable and stable supply of biomass is therefore extremely important for the future of the renewable energy industry. According to the United States Department of Energy, the success of the domestic bioenergy industry relies on many factors, including reliable, adequate supply of highquality biomass. In order for the bioenergy industry to continue to grow and provide energy and fuel to millions of American homes and vehicles, the organizational aspects of the biomass supply chain need to be clearly defined and efficiently arranged. Dedicated biomass crops, which significantly differ from traditional commodity crops, present unique characteristics that bring uncertainties and costs to transactions that parties must contract around. In this Article, we take a transaction cost economics approach to the relationships among biomass market players, and discuss organizational choices ranging from spot market transactions to vertical integration. One approach to vertical integration involves a firm controlling different stages of its input supply chain. Vertical integration internalizes incentives and helps to reduce opportunism. In a vertically integrated bioenergy industry, the biomass end-user would exercise substantial control over the planting, harvesting, transporting, and storage of its biomass feedstock. In this work, we argue that because the nascent bioenergy industry shows evidence of high asset specificity, parties would benefit from a vertically integrated structure rather than a contractual model. We draw our conclusions based on an analysis of model biomass contracts, and an empirical study of agricultural disputes resolved through arbitration. We conclude that at the outset of a dynamic bioenergy industry, vertical integration is the best organizational model to account for the asset specificity, uncertainties, and transaction costs that characterize supply chains for dedicated biomass crops.
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