The U.S. Energy Independence and Security Act of 2007 mandates blending into transportation fuels of 16 billion gallons of cellulosic fuels annually by 2022. Dedicated energy crops are being explored to provide more efficient and environmental friendly feedstocks for cellulosic biofuel production. Devoting land to energy crops represents a long-term commitment, involves adjustment costs and great uncertainties. This research develops a dynamic land conversion model to take into account these factors. The model is applied to address two separate but related questions: under what conditions farmers are willing to convert production land to energy crops? Which subsidy policies encourage energy crop production most cost effectively?

This dissertation is divided into two essays. The first essay studies a farmer's decision to convert a unit of traditional crop land into dedicated energy crops, taking into account sunk conversion costs, uncertainties of traditional and energy crop returns, and learning. The optimal decision rules differ significantly from the expected net present value rule, which ignores learning, and from real option models that allow only one way conversions into energy crops. These models also predict drastically different patterns of land conversions into and out of energy crops over time. Using corn-soybean rotation and switchgrass as examples, we show that the model predictions are sensitive to assumptions about stochastic processes of the returns.

The second essay evaluates the cost-effectiveness of four types of governmental subsidies in encouraging energy crop production. We first present a land conversion model to show how the subsidies that are expected net present value (ENPV) equivalent can change a representative farmer's optimal land conversion rules differently for converting land into an alternative use as well as converting out of it. This is because these subsidies affect the land conversion costs, land return level and uncertainty differently. Then in the context of encouraging switchgrass production, we compare the probabilities of inducing the representative farmer to convert land from corn-soybean to switchgrass across four subsidies for the same, fixed 30-year expected government budget. Results of Monte Carlo simulations show that the insurance subsidy results in the highest probability of land being converted to the energy crop, followed by the constant subsidy. Although the cost-sharing subsidy and the variable subsidy encourage land conversion to the energy crop, they also discourage land from staying in it. Over time, these two subsidies have little effect on the land area in energy crops compared to the no-subsidy baseline. Combining the establishment cost-sharing subsidy with other annual subsidies has no added effect over single subsidies in inducing land conversion to the energy crop.