Miguel HenryDepartment of Resource Economics

University of Nevada, Reno December 2005

Empirical Risk Analysisof Grape Production

in the Fallon Area, Nevada

Thesis’s Defense:

Determine which production alternative is stochastically more risk efficient

Give to the decision makers the information required to make an informeddecision

Presentation Overview

Conclusions

Introduction Motivations behind researchMotivations behind research Research objectivesResearch objectives

Empirical Results & Implications

Data

ModelCharlie Frey Vineyard,

Fallon, NV, 2005

Motivations behind this researchMotivations behind this research

Environmental Climatic Reasons Political Multiple Use Reasons Economic Reasons

Environmental Climatic ReasonsEnvironmental Climatic Reasons

Limited Water Supply

- Extended droughts since 1987- Decrease in the Sierra snow pack

Reduction in Irrigation Water for Fallon- Recovery Pyramid Lake level- Maintenance Truckee River flows

* Re-establish endemic fish species* Protect water quality* Protect recreation & sport fishing

- Protection Wetlands * Recreation, fisheries & wildlife

(Recreation is a big business for Native Americans)

Political Multiple Use ReasonsPolitical Multiple Use Reasons

Changes in Water Allocation

- Reduction of irrigated acres- Loss of farming- Low profits- Land conversion to other uses

Years

Actual Area Irrigated (acres)

199219901988198619841982

65000

62500

60000

57500

55000

Actual acres irrigated in the Fallon area by year, 1983 – 1992

Economic ReasonEconomic Reason

Actual water use by alfalfa (Medicago sativa)

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Alfalfa is a perennial legume It lives more than 2 years It is in production for 5 – 10 years It uses 3.5 – 4.5 acre feet of water/year

Farmers use 1 - 1.5million gallons of water

To produce 1 acre ofalfalfa/year

In terms of irrigated acreage:In terms of irrigated acreage:

Much of the land in Fallonis irrigated and farmed asbaled hay, using alfalfa

50,000 irrigated acres Risky climate and soils for other crops

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In short:

Scarce water Changes in water allocation Conversion of irrigated lands into non- farming uses Actual water use by alfalfa Low profits for farmers

Strategies

Preserve agriculture Benefit community Protect Nevada’s most valuable natural resource – Water

Strategies

Conversion of Water Rights More water efficient and profitable crops that consume less water/acre/season compared to alfalfa hay production

Example:Wine Grapes(Vitis vinifera)

Experiences in Nevada?Experiences in Nevada? Technically is feasible to grow “quality wines” in northwestern Nevada

In terms of water savings:

42 – 54 inches of water /acre/year

3.5 – 4.5 acre feet / year

0.27 acre feet / year

4 inches of water/acre/year

Crop ConversionCrop Conversion

What is the Percentage Saving in Water from Alfalfa

to Grapes?

90 – 93%

The underlying topic is water!

To date there is no research that explains the economic feasibility of this industry in Nevada

Experience in economic terms?

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No studies have investigated the risk implicit in wine grape production

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Research Objective

“Provide a better understanding of the economic viability of alfalfa hay

versus wine grape production by using probabilistic & stochastic

efficiency analyses”

Specific ObjectivesSpecific Objectives

Characterize price and yield risksassociated with alfalfa hay tothose of Chardonnay and Merlotwine grapes grown in Fallon, NV

Derive probability distributionsof Present Net Returns Values

Determine which crop is stochastically risk efficient

(Input) Data

Most important constraint Planning horizon of 10 years Historical data, average data, and maximum and minimum values Different sources (CA, WA, ID, NV) Experts and growers Data:

Prices ($/ton)Yields (tons/acre)Variable and Fixed Costs ($/acre)

Model

Stochastic Simulation Models

Planning horizon of 10 years500 iterations

Characterize the risk Derive the cumulative distribution functions of present net return values for each crop Derive risk efficient production practices

Stochastic Simulation Model

Stochastic Budgeting Model:

Empirical distribution:- Capture intra-temporal and inter-temporal correlation effects- Generate correlated stochastic errors

GRK distribution:-Minimum value

-Most likely value-Maximum value

Stochastic Present Net Return Value ititit CRN

~~~ −=

Input Data:Price & Yield

Economic Costs

⎟⎟⎠

⎞⎜⎜⎝

⎛+=

it

itititit P

VCYFCC *~~ititit YPR

~*

~~ =

Simulation Phase

Stochastic Simulation Model

Stochastic Present Net Return Values

500iterations

Cumulative Distribution Function:

Random variable on whichdecisions will depend

Present Net Return Value ($/acre)

Pro

bab

ilit

y (%

)

Stochastic Results

0

0.2

0.4

0.6

0.8

1

-2000 -1500 -1000 -500 0

Present Net Return Values ($/acre)

Probabillity (%)

PV_Alfalfa

0

0.2

0.4

0.6

0.8

1

0 5000 10000 15000 20000

Present Net Return Values ($/acre)

Probabilitty (%)

PV_Chardonnay

0

0.2

0.4

0.6

0.8

1

0 2000 4000 6000 8000 10000 12000

Present Net Return Values ($/acre)

Probabilitty (%)

PV_Merlot

Outcomes:

-$1,673 to $18,190

Alfalfa has the largestminimum

Chardonnay has thelargest maximum

P≤$5,000/acre =2.4% for Chardonnay3.6% for Merlot

P>$10,000/acre = 42% for Chardonnay0% for Merlot

00.10.20.30.40.50.60.70.80.9

1

-5000 0 5000 10000 15000 20000

Present Net Return Values ($/acre)

Probabilitty (%)

Alfalfa Hay

Merlot

Chardonnay

Stochastic Results Deterministic Results

Alfalfa Hay: -$1,441/acreChardonnay: $7,709/acreMerlot: $2,055/acre

Chardonnay is the bestalternative

This outcome is not robustenough for actual decisionmaking in a risky economic

environment!

00.10.20.30.40.50.60.70.80.9

1

-5000 0 5000 10000 15000 20000

Present Net Return Values ($/acre)

Probabilitty (%)

Alfalfa Hay

Merlot

Chardonnay

Stochastic Efficiency with Bounds of Risk Aversion

-2,000.00

0.00

2,000.00

4,000.00

6,000.00

8,000.00

10,000.00

12,000.00

0 0.0002 0.0004 0.0006 0.0008 0.001

Absolute Risk Aversion Coefficients

($/acre)

Chardonnay

Merlot

Alfalfa Hay

NR SRA MRA ERA

Efficient Set!

Utility-Weighted Risk Premiums

-

2,000.00

4,000.00

6,000.00

8,000.00

10,000.00

12,000.00

0 0.0002 0.0004 0.0006 0.0008 0.001

Absolute Risk Aversion Coefficients

($/acre)

Chardonnay

Merlot

Alfalfa Hay

Minimum sureamount of moneythat would have

tobe paid to a ERAdecision maker

NR SRA MRA ERA

Conclusions Before suggesting alternative production methods, stochastic efficiency analyses should be employed whenever research is addressed for the development of new practices.

Probability of producing positive present net return values with Chardonnay and Merlot is 100%, with alfalfa hay 0%.

Growing wine grapes, especially Chardonnay, is stochastically the most risk efficient production alternative.

Alfalfa hay is the least profitable and most risky alternative.

Growing wine grapes represents an excellent agricultural crop production alternative in Fallon, Nevada.