University of Twente Student Theses


Biomass Contracting: Biomass contract structures for digestion installations

Sleen, Peter van (2010) Biomass Contracting: Biomass contract structures for digestion installations.

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Abstract:In the biomass market all kinds of different biomass products - products from biological origin (vegetable or animal) - are traded. The current problem in the market is that demand-side organizations want to sign longer-term contracts in this non-transparent market on the delivery of biomass. This is necessary to achieve investment security and is demanded by investors and banks before finance is supplied. One of the organizations struck by this problem is the sustainable energy organization Raedthuys - the principal of this research. The market, however, only developed the institutional environment (laws, regulations etc.) and the resource allocation level, leaving contract structures undeveloped. Therefore, the goal of this research is to give an advice on what contract structures to use in the non-transparent biomass market. The problem definition of this research is: How can Raedthuys use contract structures in the biomass sector to obtain more investment security on the purchase of biomass? This research is mainly focused at exploring the biomass field on its problem and possible contract structures. The research method used is existing data research. Besides, information from the market is gathered using survey research. The focus of this research lays on market actors taking part in the positive list digestion installation market. These installations produce biogas from (liquid) biomass in a heated, mixed and gas-proof tank using bacteria and/or enzymes to ultimately produce electricity and heat. These positive list digestion installations only use biomass which is listed on the positive list developed by the government and digest at least 50 percent manure. Besides manure, co-substrates are used in the installation to heighten the gas production. The manure and co-substrate submarkets are analyzed using agricultural organizations, the animal feed industry and the food industry as main analysis units. Theory is used to analyze market structures and contracts. Theory about markets shows trade emerges in markets when some kind of benefit (private or public) can be gained. These benefits meet on a market, using specific trading rules or systems, where an equilibrium quantity and price is produced. However, not all markets, including the biomass market, are operating efficiently due to non-transparency, illiquidity and volatile prices. The market is illiquid, because it is hard to assess the costs for a trade at a given size. Theory on contracts, on the other hand, analyses the alignment of transactions with governance structures. This research uses two theories in this field. First, agency theory, which is used to describe the conflicting goals between contract partners and to analyze risksharing and information asymmetry. Second, transactions cost economics, which is used to analyze governance structures using risk-neutral actors. Besides, four contract durations or commitments are identified, namely: spot-, full-, long-term and short-term commitment. Also the value of renegotiation in contracts is outlined, because long-term contracts are by nature incomplete. The manure market is a quite stable market and has a growing manure surplus in the Netherlands in the near future, which means an increasing manure price. However, some influences like governmental policy and phosphate shortages can have an effect on further prices. Due to these developments contract competition in the manure market will focus on duration and risk avoidance. Due to the fact there are no relationship-specific investments in the market and the transaction costs are low, theory advices to use short-term contracts in this market. The market, although, demands long-term contracts. When closing longer-term contracts the central goal should be to find a credible supplier, who can fix short-term problems on the longer term. Three contract structures which can be used in this market are:  Continuous renewal of short-term contracts of 1 year  A long-term contract for the full length of the SDE subsidy with profit-sharing  A 3-5 year contract with a fixed price 5 The co-substrate market is a still developing market with higher value products when compared to the manure market. The market is still growing with more availability and demand in the future. Due to non-transparency, heterogeneous products, and the positive list of the government, the cosubstrate market is very price volatile. Due to the fact a lot of co-substrates are not available structurally, the main basis for contract competition in this market are prices. From theory there are both signs for using short-term and long-term contracts in this market. Long-term contracts can be used best because of recurrent transactions, high transaction costs and high price volatility. Shortterm contracts, on the other hand, can be used best because there are no relationship-specific investments and products can be codified. In general, a digestion installation operator should not get locked into one supplier and should include the option of renegotiation in contracts. Two contract structures can be used in this market:  A combination of a long-term volume contract and a short-term price contract  A basket contract for an energy-mix of co-substrates One of the contract structures, the basket contract, was tested empirically using data gathered from the animal feed industry. In this contract structure a fixed price is paid for a basket of co-substrates and the supplier is given the option to vary with the co-substrates in this basket. The structure works in theory, but practice shows some drawbacks. Two examples of these drawbacks are determining the fixed price using normal distributions and the reliability of computations. Therefore, it can be concluded a contract structure like the basket contract is too early for this market and should be reconsidered in the future again. The idea can, however, be used as internal system already, by introducing the profit/risk question into menu calculations. In the end, it can be stated that some investment security can be obtained on the purchase of biomass. Especially, in the efficient functioning manure market, biomass can be obtained with some certainty. The co-substrate market, on the other hand, can provide less investment security. In this market not structurally available co-substrates can only be purchased on a spot market. On the more structurally available co-substrates, only longer term volume security can be obtained nowadays and the actual co-substrates delivered with their price should be determined on the shorter term. For Raedthuys, who is a newcomer on the market, a manure contract for a period of 3 years with profit sharing is advised at first. The company is then not locked-in to a contract and has the possibility to close better contracts when market changes occur due to regulation changes or new techniques in the future. With such a contract investment security can be gained, market movements are followed, risk is reduced and incentives are in place to remain the contract till the end. In the co-substrate market, on the other hand, a supplier has more private information on the market, which can be used by the supplier to close better contracts. Besides, when closing contracts where the cosubstrates are not specified in front, Raedthuys cannot control the search process of the supplier. Therefore, it is advised to search for one supplier, who gathers all sorts of biomass, and to build a trust relationship with this partner for the first three years. This partner can be used to get to know the co-substrate market better, and with the feedback from Raedthuys' digestion installation, standardized rules can be developed for contracts as well as innovative co-substrate mixes. Raedthuys should, however, be aware not to get locked-in to this supplier for the whole subsidy period. Therefore, after three years, Raedthuys should assess the market again, and use the knowledge gained, to close more profitable contracts.
Item Type:Essay (Master)
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:85 business administration, organizational science
Programme:Business Administration MSc (60644)
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