“Optimal Procurement from Multiple Contracts in Agricultural Processing: Implications for Biomass Commercialization”
by Assoc. Prof. Onur Boyabatlı
Singapore Management University
This paper examines the procurement strategy of an agricultural processor that sources a commodity input from two quantity-flexibility contracts to produce a commodity output and a byproduct in the presence of input and output spot price uncertainties. We characterize the optimal procurement volume from these contracts (and the subsequent processing, input spot procurement, output spot transactions) and perform sensitivity analysis to investigate how spot price correlation affects the processor’s optimal procurement strategy and profitability. We show that, in contrast to the common understanding in the literature that comes from studies that ignore contract procurement, a higher spot price correlation increases the processor’s profitability in the presence of contract procurement. Using our modeling framework, we also examine the impact of commercializing byproduct as biomass on the procurement strategy and profitability of the processor. While the processor optimally procures only from a single contract (single-sourcing) before the biomass commercialization, the processor may optimally source from two contracts (dual-sourcing) after the commercialization. Using a calibration based on the palm industry, we show that failing to update procurement strategy after commercialization leads to a significant profit loss, and this profit loss is higher when biomass demand is sufficiently high. To understand the environmental implications of biomass commercialization, we characterize the expected greenhouse gas (GHG) emissions of the processor—which is new to the literature—and examine how commercialization affects the expected GHG emissions.