Thesis’s Defense:
Empirical Risk Analysis
of Grape Production
in the Fallon Area, Nevada
Miguel Henry
Department of Resource Economics
University of Nevada, Reno
December 2005
 Determine which production alternative
is stochastically more risk efficient
 Give to the decision makers the
information required to make an informed
decision
Presentation Overview
 Introduction
 Motivations behind research
 Research objectives
 Data
 Model
Charlie Frey Vineyard,
Fallon, NV, 2005
 Empirical Results & Implications
 Conclusions
Motivations behind this research
 Environmental Climatic Reasons
 Political Multiple Use Reasons
 Economic Reasons
Environmental Climatic Reasons
 Limited Water Supply
- Extended droughts since 1987
- Decrease in the Sierra snow pack
Political Multiple Use Reasons
 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)
Changes in Water Allocation
A ctual A rea Irrigated (acres)
65000
- Reduction of
irrigated acres
- Loss of farming
- Low profits
- Land conversion
to other uses
62500
60000
57500
55000
1982
1984
1986
1988
1990
1992
Years
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
To produce 1 acre of
alfalfa/year
Farmers use 1 - 1.5
million gallons of water
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 nonfarming uses
 Actual water use by alfalfa
 Low profits for farmers
Strategies
Strategies
 Preserve agriculture
 Benefit community
 Protect Nevada’s
most valuable
natural resource –
Water
 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:
3.5 – 4.5 acre feet / year
42 – 54 inches of water /acre/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!
(Continue…)
Experience in economic terms?
 To date there is no research that
explains the economic feasibility of
this industry in Nevada
 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
 Characterize the risk
 Derive the cumulative distribution
functions of present net return values
for each crop
 Derive risk efficient production practices
Planning horizon of 10 years
500 iterations
Stochastic Simulation Model
Input Data:
Price & Yield
Economic Costs
Stochastic Budgeting Model:
~ ~ ~
Rit  Pit *Yit
~
~  VCit 

Cit  FCit  Yit * 
 Pit 
~ ~ ~
Nit  Rit  Cit
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
Stochastic Simulation Model
Simulation Phase
Stochastic Present
Net Return Values
Random variable on which
decisions will depend
500
iterations
Probability (%)
Cumulative Distribution Function:
Present Net Return Value ($/acre)
1
1
0.8
0.8
Probabilitty (%)
Probabillity (%)
Stochastic Results
PV_Alfalfa
0.6
0.4
0.2
0
-1500
-1000
-500
0.4
0.2
0
0
0
5000
Present Net Return Values ($/acre)
10000
0.8
PV_Merlot
0.6
0.4
0.2
0
0
2000
15000
Present Net Return Values ($/acre)
1
Probabilitty (%)
-2000
PV_Chardonnay
0.6
4000
6000
8000
Present Net Return Values ($/acre)
10000
12000
20000
Outcomes:
-$1,673 to $18,190
Alfalfa Hay
Probabilitty (%)
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
-5000
Alfalfa has the largest
minimum
Merlot
Chardonnay has the
largest maximum
Chardonnay
0
5000
10000
15000
Present Net Return Values ($/acre)
20000
P≤$5,000/acre =
2.4% for Chardonnay
3.6% for Merlot
P>$10,000/acre =
42% for Chardonnay
0% for Merlot
Stochastic Results
Deterministic Results
Alfalfa Hay
Probabilitty (%)
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
-5000
Alfalfa Hay: -$1,441/acre
Chardonnay: $7,709/acre
Merlot:
$2,055/acre
Merlot
Chardonnay is the best
alternative
Chardonnay
0
5000
10000
15000
Present Net Return Values ($/acre)
20000
This outcome is not robust
enough for actual decision
making in a risky economic
environment!
Stochastic Efficiency with
Bounds of Risk Aversion
12,000.00
Chardonnay
10,000.00
($/acre)
8,000.00
Efficient Set!
6,000.00
M e rlot
4,000.00
Alfalfa
Hay
2,000.00
NR
SRA
ERA
MRA
0.00
0
0.0002
0.0004
0.0006
0.0008
-2,000.00
Absolute Risk Aversion Coefficients
0.001
Utility-Weighted Risk Premiums
12,000.00
Chardonnay
10,000.00
($/acre)
8,000.00
Merlot
6,000.00
Minimum sure
amount of money
that would have to
be paid to a ERA
decision maker
4,000.00
Alfalfa Hay
2,000.00
NR
SRA
MRA
ERA
0
0.0002
0.0004
0.0006
0.0008
Absolute Risk Aversion Coefficients
0.001
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.