Center for North American Studies CNAS 98-1 June 1998

Transcription

1 Center for North American Studies CNAS 98-1 June 1998 Department of Agricultural Economics Texas Agricultural Experiment Station Texas Agricultural Extension Service The Texas A&M University System

2 Center for North American Studies The Effects of Economic and Environmental Factors on Investment Decisions in the Texas Grapefruit Industry CNAS 98-1 June 1998 Edited by Flynn J. Adcock 1 1 Research Associate and Assistant Director, Center for North American Studies, Department of Agricultural Economics, Texas A&M University System.

3 Executive Summary The Effects of Economic and Environmental Factors on Investment Decisions in the Texas Grapefruit Industry Nicole Elmer, Amy Thurow, Jason Johnson, and Parr Rosson Economic and environmental factors were examined to determine their influences on grapefruit investment in the Lower Rio Grande Valley of Texas. Price instability explained 17 percent of the variation in investment decision making, while 83 percent was explained by uncertainty related to severe freezes impacting the Texas grapefruit industry. Trade and environmental factors were not identified as a significant source of uncertainty affecting investment decisions. Increased investment in freeze protection technologies and improved price risk management are the most effective ways to reduce the uncertainty associated with grapefruit production and marketing. Micro-sprinkler systems could eliminate the risk of future freeze damage, conserve valuable water resources, and reduce the variable costs of production, resulting in an estimated savings of $6,250 per acre. Price risk could be reduced by producing and marketing more fancy-grade fruit and reducing the proportion of choice fruit in the marketing mix. Key words: Investment, environmental factors, price risk management, trade

4 INTRODUCTION The Effects of Economic and Environmental Factors on Investment Decisions in the Texas Grapefruit Industry Nicole Elmer, Amy Thurow, Jason Johnson, and Parr Rosson 2 Although economically important, the Texas grapefruit industry has experienced significant, rapid decline since the early 1980s. Lower planted acreage, greater price variability, and severe freeze damage are the major factors contributing to this decline. Many observers believe that the industry cannot remain economically viable, especially with higher costs induced by more stringent environmental regulation. This study identifies and analyzes both the economic and environmental factors affecting investment in the Texas grapefruit industry. Increasing population growth, changing land use, and the effects of more trade between the United States and Mexico are included in the analysis. Implementation of the North American Free Trade Agreement (NAFTA) has increased trade, with 1997 exports from Texas to Mexico reaching $31.2 billion. Trade growth has stimulated economic development, job creation, and population growth in South Texas. During the 1980's, 14 percent of the land used in agricultural production shifted to other uses, with grapefruit acreage declining from 43,300 in 1984 to 20,400 in 1997 mainly due to two severe freezes in 1983 and Texas citrus production contributes $47 million annually to the state s economy, with the industry concentrated in Cameron, 2 Former Graduate Research Associate, Assistant Professor, Assistant Professor and Extension Economist, and Professor and Extension Economist, respectively, Department of Agricultural Economics, Texas A&M University System. This paper is an excerpt from Elmer, N.A. The Environmental Effects of Expanded Trade: A Firm-Level Simulation Analysis of Investment In Texas Grapefruit, unpublished MS Thesis, Texas A&M University, December 1997, which won the Outstanding MS Thesis Award, Department of Agricultural Economics, Texas A&M University System, 1997, and will receive an Honorable Mention Master s Thesis Award from the American Agricultural Economics Association in August 1998.

5 Hidalgo, and Willacy counties. Citrus sales have a major economic impact on the region. It is estimated that for each $1.0 million in sales an additional $1000 in economic activity is generated, along with 72 jobs. This report focuses on a localized area in the U.S.-Mexico border region, the Lower Rio Grande Valley (LRGV) of Texas, an ecologically vulnerable area (Figure 1). The examination of uncertain and irreversible investments in prototypical grapefruit groves was pursued to determine if expanded trade is likely to displace or change existing land uses and environmental quality in the LRGV. Such concerns were voiced by local residents and environmental activists during the NAFTA debate and in subsequent public hearings staged by environmental agencies. Grapefruit was selected as the focal point for this analysis because it is a traditionally important sector in the regional economy and because it is land extensive, waterintensive, and pesticide-intensive. Accordingly, grapefruit investment seems likely to be affected by water scarcity and costs, concerns about congestion, and pollution from pesticides. Furthermore, grapefruit investments are capital-intensive and are made in 25 year increments, thus there is a significant irreversible component. The purpose of this study was to identify and analyze economic and environmental variables associated with investment decisions in grapefruit groves in the Lower Rio Grande Valley. This includes determining the significance of economic and environmental risk factors on the future investment decisions and demonstrating the importance of changes in investment factors associated with increased population growth, changing land use patterns, and expanded trade in the Lower Rio Grande Valley. Further, analysis of investment in the grapefruit sector in Texas is an opportunity to characterize local environmental factors which affect investment decisions and thus the future economic and environmental character of regions experiencing the effects of expanded trade. 2

6 BACKGROUND Texas Grapefruit Industry During , Texas grapefruit production was valued at $12 million, producing 5,300 thousand boxes, and accounting for seven percent of total U.S. production. The entire Texas grapefruit industry is located in three counties in the Lower Rio Grande Valley with 84 percent of the acreage in Hidalgo County, 15 percent in Cameron County and 1 percent in Willacy County. Texas growers strive to produce a premium quality grapefruit for the fresh market. The majority of the grapefruit is moved from independent and cooperative shippers through commercial channels to wholesale buyers (Taylor, Hall, and Molina). Production Instability Climatic risk has been present in the Texas grapefruit industry since commercial production began in the early 1920s. Freezes have caused fluctuations in acreage and production for the Texas grapefruit industry. Texas grapefruit production suffered severe freezes in 1930, 1949, 1951, 1962, 1983 and 1989 and milder freezes in 1935, 1940, 1943, 1973 and 1979 (TAEX). As a result of these freezes, some acreage was permanently removed from production. Bearing grapefruit acreage peaked during the season at 82,000 acres. After the 1983 freeze, 13,304 acres of the 44,346 pre-freeze acres were removed from production and converted to other uses including commercial and residential (TASS). In 1988, production had climbed back to about 58 percent of the pre-freeze level when the 1989 freeze checked the Texas grapefruit industry again. By the marketing year, the industry had reestablished production levels equivalent to the pre-1989 production levels. However, the economic costs of rehabilitating or replanting grapefruit groves following a freeze are increased by the costs of recapturing the markets lost to competing areas during the freeze recovery. 3

7 U.S.-Mexico Border Region Growth and development affecting traditional agricultural and rural lands poses challenges to communities seeking to maintain environmental quality in the LRGV. Biodiversity of resources, water quality and water availability are among the major issues. From 1987 to 1995 Texas exports to Mexico grew 14 percent, and between the fourth quarter of 1995 and the second quarter of 1996 exports to Mexico increased 17 percent (Nalewaik and Taylor). The border communities of McAllen, Harlingen, Mission, Edinburg and Brownsville are the fastest growing metropolitan areas in Texas (Murdock and Hogue and Figure 2). The LRGV also has the lowest rate of income growth in the state. Projected population growth patterns from 1990 to 2010 show Hidalgo County to increase by 483,000 people, the second largest projected growth in the state (Murdock and Hogue). Three of the ten most poverty-stricken counties in the U.S. are located in the Texas border area and 21 U.S. border communities have been designated economically distressed (U.S. EPA). Furthermore, of the 305,400 Texans who do not have potable water, 66 percent reside in the LRGV (Conner et al.). Although agricultural irrigation is projected to decline, it is presently the major source of demand for water in the LRGV (Figure 3). Even with growing manufacturing and municipal use, agriculture is projected to account for a major share of water use well into the next century. Rapid economic growth and development, associated with trade in economically distressed areas surrounded by important and endangered biodiversity resources, emphasizes the significance of environmental effects due to expanded trade and rapid growth and will likely result in greater municipal and industrial demands for water over the longer term. 4

8 METHODS The relative importance of economic and production risk factors likely to influence investment decisions was estimated: expected price, production costs, and the risk of a freeze. The second set of variables thought to influence investment are environmental factors associated with expanded trade and the accompanying economic growth: (1) the cost of water and its availability, (2) land values, and (3) the effects of increased congestion from urbanization. The importance of risky factors likely to influence investment in grapefruit in the LRGV was examined with the goal of estimating the relative importance of economic and production risks and environmental factors. Adverse weather, economic uncertainty, and environmental concerns and regulations were examined to determine if they were major contributing factors influencing future investment in Texas grapefruit. Expected costs and returns for grapefruit production in the LRGV were estimated with the assistance of industry experts. RESULTS The discount rate used as the expected return from a conventional investment for this simulation analysis was 6 percent. However, when accounting for the uncertainty surrounding prices and freezes, the simulation analysis indicated that investors would require a rate of return, or hurdle rate, of at least 24 percent to trigger investment in a grapefruit operation. For a typical Texas grapefruit grove, expected grapefruit prices and freezes were confirmed as important sources of uncertainty which create the need for significantly higher rates of return. To determine whether uncertainty associated with expanded trade in the LRGV is likely to influence future investment behavior, three environmental factors were analyzed: congestion, water scarcity, and increasing land values. Information from discussions with grove managers, extension specialists, irrigation district managers, a rural land appraiser, and representatives from the trade association Texas Citrus Mutual 5

9 was used as basis to quantify these variables. Adding these three factors to the original model increased the hurdle rate which triggers investment to 25 percent. Although trade and environmental factors were hypothesized to influence future grapefruit investments, they did not constitute a significant source of additional uncertainty and thus had minimal impact on the hurdle rate and the investment decision. Accounting for the risk associated with freezes and price volatility makes a substantial difference in whether and when to invest in grapefruit in the LRGV. Results indicated that 83 percent of the increase over the conventional rate of return was due to the risk of freezes; the other 17 percent was due to price variability. The importance of these factors is borne out by an examination of recent investment behavior in Texas citrus. According to historical data ( ) from the LRGV, freezes occur about once every ten years, and about half of those are severe, destroying the majority of the grapefruit trees. Severe freezes cost growers a minimum of $2,000 per acre in replanting costs and an additional loss of $85,000 in expected future returns for a 20 acre grove. In the aftermath of a severe freeze, growers not only suffer financially, but they also are obliged to re-evaluate their decision to invest in citrus. As a case in point, Texas citrus suffered two major freezes in 1983 and 1989 resulting in a decline in grapefruit acreage from 43,300 acres in 1982 to 17,700 acres in 1996 (Figure 4 and Figure 5). After the devastating 1983 freeze, grapefruit acreage declined by 57 percent, from 44,346 acres in 1983 to 19,110 acres in Just as the growers were recovering, they experienced a less-severe freeze in 1989, and another 20 percent of the groves exited the industry. Price uncertainty is an important factor affecting investment in Texas citrus. From 1960 to 1996 grapefruit prices averaged $3.73/box, but ranged from $1.11/box to more than $15.12/box (Figure 6). 6

10 Price volatility increased in the immediate aftermath of a freeze and appears to be related to supply shortages caused by the freeze and is greater if competing regions, primarily Florida, also experience freeze damage. For instance, there were particularly high prices following the freezes in 1983 and 1989, years when Florida also experienced major losses from freezes. The LRGV is experiencing rapid economic development and population growth. More people and continued economic growth are likely to displace some traditional agricultural land uses in the region. Grapefruit appears to be vulnerable due to its land-extensive, water-intensive, and pesticide-intensive nature. Furthermore, citrus production involves a significant capital investment, and is inherently risky due to climate and marketing factors. This analysis postulated that the environmental consequence of expanded trade might make investment circumstances increasingly uncertain. Water scarcity, higher land values, and congestion in growing areas due to population growth, were not identified to be significant sources of additional uncertainty influencing investment in Texas grapefruit. IMPLICATIONS FOR ANALYSIS OF TRADE AND ENVIRONMENT Expert opinion was employed to estimate how the three trade-and-environment factors affected investment decisions related to grapefruit. Though these three environmental factors were not demonstrated to be important for the grapefruit sector in this instance, the same methods could be used to analyze other investment scenarios for grapefruit investment or to analyze other sectors facing different constraints. Concerns about the localized effects of expanded trade and environmental quality may be important in other industries, other regions, or for other large irreversible investments associated with expanded trade such as roads and bridges. The methods developed in this research could be applied to analyze such scenarios. 7

11 IMPLICATIONS FOR THE TEXAS GRAPEFRUIT INDUSTRY The results of this study demonstrate that prices and freezes are important sources of risk for grapefruit growers in the LRGV. These findings imply that the industry can benefit most from efforts such as technologies and production practices which protect groves from freezes and also from initiatives which reduce price variability. Research and individual investments in cost-effective freeze protection are likely to have a high payoff in reducing the uncertainty associated with investments in citrus. A severe freeze which kills all the trees in a 20-acre grove costs an estimated $85,000 in expected returns plus replanting. Among the several methods used for freeze protection in the LRGV, a micro-sprinkler system is the most effective if used properly. A micro-sprinkler irrigation system is expensive to install, estimated at $700 an acre (Sauls). Furthermore, to service groves with micro-sprinklers, irrigation districts must retro-fit their pumps to supply the needed water. If growers make the investment in micro-sprinkler technology when re-planting after a freeze, they could hope to save an estimated $6,250 per acre by protecting their groves and avoiding the costs of future freeze damage. In addition, since micro-sprinkler technology is a water-conserving technology, increased use of micro-sprinklers is likely to reduce costs associated with purchasing irrigation water. Such savings would be particularly important during periods of water scarcity when water is more expensive. Market price variability is a key source of risk influencing future investments in grapefruit. In fact, pricing problems continue to be a major interest of growers and their trade industry representatives. Currently, the industry is trying to expand into new markets and to increase prices received for fresh fruit. 8

12 Prices received for grapefruit are dependent on regulated grades. Grapefruit is graded into two primary categories, fancy and choice. Fancy is the premium grade and receives the highest price. In recent years, Texas growers have had low quality (rough peel and scarring) and shape (sheep-nosed) problems with their fruit. These problems caused fruit to be dropped one to two grades or diverted to processing for juice. Juice prices are lower than choice prices and were even lower in due to large quantities of fruit being held in storage. Price differentials between fancy, choice and juice fruit create additional risk for growers. During the last two seasons about 67 percent of fruit was graded fancy and the other 33 percent was graded choice. Fancy fruit received as high as $10 per box in while choice prices were below $5 per box. While growers can benefit from high prices for fancy fruit, they lose money on choice fruit because their costs of production and marketing are not covered. The costs of marketing choice fruit reduces the profits which growers have earned from selling their fancy fruit. Growers would benefit from concerted efforts to produce and market more fancy-quality fruit, thereby reducing low returns from choice fruit. It may be useful for the Texas grapefruit industry to re-evaluate risk management strategies. Investments in freeze protection technologies appear to be the most promising way to hedge against freeze risk. Efforts to better manage price risk by producing and marketing more fancy-grade fruit are also important, but perhaps less important than exploring avenues to improve freeze protection. 9

13 SUMMARY This study found that 83 percent of the variation in grapefruit investment decision making was explained by uncertainty related to freeze conditions in the growing region, while the other 17 percent was due to price volatility. These findings are further supported by an examination of historical data from the LRGV. Over the past 60 years, there were significant freezes once every ten years, with one-half of those freezes destroying the majority of fruit bearing trees. The most recent freezes in 1983 and 1989 resulted in acreage declines of 57 percent and 20 percent, respectively from 44,346 acres in 1983 to 17,700 in Price volatility, due partly to freezes, has increased in recent years. Price variability was exacerbated by simultaneous freezes in Texas and Florida. Environmental factors tested for significant impacts on grapefruit investment were not found to be significant sources of uncertainty related to grapefruit investment in the LRGV. The results of this study suggest that price instability and adverse weather are the most important sources of risk likely to affect the profitability of the Texas grapefruit industry. Increased investment in freeze protection technologies and improved price risk management may be among the most effective ways to reduce the uncertainty associated with grapefruit production and marketing. Micro-sprinkler systems, while expensive, could virtually eliminate the risk of future freeze damage, conserve valuable water resources, and reduce the variable costs of production. Price risk could be reduced by producing and marketing more fancy-grade fruit and reducing the proportion of choice fruit in the marketing mix. Increased initiatives to protect grapefruit groves from freeze damage and efforts to reduce price instability will provide major benefits to the Texas grapefruit industry. 10

14 REFERENCES Conner, R., L. James, K. Shumann, and B. Jackson. Environment and Natural Resources: Trends and Implications. Prepared for the Texas Agricultural and Natural Resources Summit on Environment and Natural Resource Policy for the 21st Century, Kerrville, TX, November, Elmer, N.A. The Environmental Effects of Expanded Trade: A Firm-Level Simulation Analysis of Investment In Texas Grapefruit. MS Thesis, Texas A&M University, December Murdock, S.H., and Hoque, N. Population Growth: Texas Leads Nation. Tierra Grande (Summer 1996): Nalewaik, J., and L. Taylor. Texas-Mexico Trade After NAFTA. Southwest Economy 5(September/October 1996):1-5. Sauls, J.W. Texas Citrus: Water Management. Texas Agricultural Extension Service, Leaflet 2307, Texas Agricultural Extension Service (TAEX). Report on the Rio Grande Valley Citrus Industry Texas Agricultural Statistics Service (TASS). Texas Citrus Tree Inventory Taylor, M., C. Hall, and G. Molina. Texas Citrus: Grower Marketing Outlets. Texas Agricultural Extension Service, Leaflet 2323, U.S. Environmental Protection Agency (U.S. EPA). US/Mexico Border XXI Program Summary of Domestic Meetings. Washington DC: U.S. Government Printing Office, Report Number 160-R , June

15 Partial support for this study was provided by the Texas Agricultural Experiment Station. The Center for North American Studies is a project of the Department of Agricultural Economics, Texas Agricultural Experiment Station and Texas Agricultural Extension Service, The Texas A&M University System funded by the United States Department of Agriculture, Special Grant # For further information, please contact the Center for North American Studies by phone at (409) or by at cnas@tamu.edu.