1. 1 Transaction Cost Economics of Agricultural Product Exchanges for Biopower: Theory and Evidence Ira Altman Graduate Research Assistant Community Policy Analysis Center Department of Agricultural Economics University of Missouri-Columbia

2. 2 Overview Background Theory Empirical Literature Application Conclusion

3. 3 Background 2 power plants considering the use of agricultural products in Missouri CPAC current project Complementary project Working research question: How can a biomass exchange be most efficiently organized?

4. 4 Theory Leading organizational economics theory – Williamson’s transaction cost economics Designed to compare the costs and benefits of competing organizational forms The theory is still developing Application to biomass exchange may test the theory on an emerging industry and lead to efficient organization of the biopower industry

5. 5 Theory Working hypothesis: transactions are aligned with organizational form in a transaction cost minimizing way Transaction attributes imply varying levels of transaction costs depending on the organizational form chosen Decisions makers will choose the least cost method of exchange Key attributes of the transaction are: asset specificity, uncertainty and frequency

6. 6 Theory Asset specificity creates bilateral dependency and opens players up to opportunism Asset specificity– durable assets that have a significantly lower value in alternative uses by alternative users Types of asset specificity include physical, spatial, dedicated assets, human asset specificity, and temporal asset specificity

7. 7 Theory Organizational forms include spot markets, hybrids such as the use of contracts, and internal organization (vertical integration) Two key predictions: 1. If asset specificity is low: a market organizational form is least cost 2. If asset specificity is high: an internal organizational form is least cost

8. 8 $ M(k) Organizational Costs as a Function of Asset Specificity Source: Adapted from Williamson, 1991 k Asset Specificity H(k) X(k) k1k1 k2k2

9. 9 Empirical Literature Types: – qualitative case studies – quantitative case studies – cross sectional and panel regressions Focus: – contract level – governance level – institutional level The choice of organizational form is modeled as some function of asset specificity and other explanatory variables

10. 10 Empirical Literature Dependent variables: – internal versus market exchange (the governance level) – price and length of contract or other contract provisions (the contract level) – policy choice as an institutional variable (the institutional environment level)

11. 11 Empirical Literature Common independent variables include some measure of asset specificity and uncertainty Measures for asset specificity: – characteristics of the technology – number of buyers and sellers – closeness of buyers and sellers

12. 12 Empirical Literature Supportive of the theory– asset specificity variables statistically significant Addressing data problems did not change the support of the data for the theory Several studies on natural resource industries such as coal, natural gas and oil

13. 13 Application Mail survey of 200 biopower plants – contact information from the Energy Information Administration Important information from the survey: – Biomass exchange type (external, internal or both) – Asset specificity including: physical asset specificity, spatial asset specificity –Other potential explanatory variables

14. 14 Application Physical asset specificity measured by the flexibility of the technology – high biomass flexibility and fossil fuel flexibility would imply low levels of asset specificity Spatial specificity measured by average hauling distances to the power plant – low hauling distances or adjacency may indicate high spatial specificity

15. 15 Application Data are moderately supportive of the theory

16. 16 Application

17. 17 Application Other variables less supportive What explains why the data may not support the theory? – Survey design – Small sample size

18. 18 Application – Missing important variables– other organizational theories may be required to advise the industry – Inefficient firms – empirical assumption that observed organizational forms are efficient – may be an inappropriate assumption because industry immaturity – a dynamic approach may be necessary

19. 19 Conclusion Use spot markets or short term contracts if: – Flexible technology – Many possible fuel types – High hauling distances – Many suppliers (low asset specificity) Use long term contracting or internal organization under the opposite conditions

20. 20 Conclusion Future research – update the survey results and use more empirical methods to understand the data – apply the theory to logistical questions: who should complete storage and processing of biomass? – apply the theory to contracting questions: what type of contracts should be used? What type of vertical integration should occur?