Miguel Henry Department of Resource Economics University of Nevada, Reno December 2005 Empirical Risk Analysis of 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 informed decision

Presentation Overview Conclusions Introduction  Motivations behind research  Research objectives Empirical Results & Implications Data Model Charlie Frey Vineyard, Fallon, NV, 2005

Motivations behind this research Environmental Climatic Reasons Political Multiple Use Reasons Economic Reasons

Environmental Climatic Reasons  Limited Water Supply - Extended droughts since 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 Reasons

Changes in Water Allocation - Reduction of irrigated acres - Loss of farming - Low profits - Land conversion to other uses Actual acres irrigated in the Fallon area by year, 1983 – 1992

Economic Reason  Actual water use by alfalfa (Medicago sativa)

(Continue…)  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 million gallons of water To produce 1 acre of alfalfa/year

In terms of irrigated acreage: Much of the land in Fallon is irrigated and farmed as baled hay, using alfalfa  50,000 irrigated acres  Risky climate and soils for other crops

(Continue…) 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?  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 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? (Continue…) No studies have investigated the risk implicit in wine grape production

(Continue…) Research Objective “Provide a better understanding of the economic viability of alfalfa hay versus wine grape production by using probabilistic & stochastic efficiency analyses”

Specific Objectives Characterize price and yield risks associated with alfalfa hay to those of Chardonnay and Merlot wine grapes grown in Fallon, NV Derive probability distributions of 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 years 500 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 Input Data: Price & Yield Economic Costs

Simulation Phase Stochastic Simulation Model Stochastic Present Net Return Values 500 iterations Cumulative Distribution Function: Random variable on which decisions will depend Present Net Return Value ($/acre) Probability (%)

Stochastic Results

Outcomes: -$1,673 to $18,190 Alfalfa has the largest minimum Chardonnay has the largest maximum P≤$5,000/acre = 2.4% for Chardonnay 3.6% for Merlot P>$10,000/acre = 42% for Chardonnay 0% for Merlot

Stochastic ResultsDeterministic Results Alfalfa Hay: -$1,441/acre Chardonnay: $7,709/acre Merlot: $2,055/acre Chardonnay is the best alternative This outcome is not robust enough for actual decision making in a risky economic environment!

Stochastic Efficiency with Bounds of Risk Aversion NRSRAMRA ERA Efficient Set!

Utility-Weighted Risk Premiums Chardonnay Merlot Alfalfa Hay Minimum sure amount of money that would have to be paid to a ERA decision maker NRSRAMRAERA

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.