NFAPP's Newsletter February 1997

Featured Articles :

"Jack Frost: The New Reengineering Champion", by Timothy J. Richards
 Topic: Economic Hysteresis in Relation to the Florida Frost

"Legislative Update.....Senate Agriculture Committee Establishes Priorities for 105th Congress", by Pamela A. Mischen
 Topic: Priorities 105th Congress

"Market Watch.....Oranges", by Timothy J. Richards
 Topic: Orange Market

Jack Frost: The New Reengineering Champion

by Timothy J. Richards

It is an ill wind that blows no good. This seemingly paradoxical truism has arisen once again in the fruit and vegetable industry. While the loss of a healthy, vital crop is never a welcome occurrence, Florida's devastating frost in mid-January, like the March 1995 floods in Central California, may in fact bring some good. In the spring of 1995, this newsletter showed that the floods in Central California caused lettuce growers to earn record receipts on the crop they could salvage (see NFAPP Newsletter, March 1995). Because lettuce is generally inelastic in demand, a reduction in supply causes total lettuce revenue to rise as the price rises more than proportionately, more than offsetting the reduction in sales volume. While this same phenomenon is no doubt true this year for growers of beans, peppers, squash, and sweet corn in Florida, the citrus industry as a whole is likely to reap a longer term benefit. How can a killing frost possibly help citrus growers? The answer lies in the concept of economic hysteresis.

In economics, hysteresis refers to a situation where a firm continues to sell in a market, or hold onto an investment, even after the promise of favorable returns has gone. Hysteresis will arise when an enterprise entails significant start up costs that are irretrievable, when terminating the enterprise is costly, or when abandonment causes it to become worthless. Combine any one of these features with returns that are inherently risky, or variable, and perfectly rational economic agents will appear to exhibit some irrational emotional attachments to bad investments. In agriculture, for example, hysteresis is often cited as the source of the "fixed asset problem." Assets such as buildings, tractors, or even farmers themselves remain in production despite the fact that their value no longer supports the construction of a new building, buying some machinery, or acquiring human capital or training. Hysteresis argues that these assets stay in production because there remains a probability that the uncertain returns will once again rise high enough to justify staying with the investment. The value that firm owners derive from this possibility is called a real option value, or a value of waiting to make an investment or disinvestment. Investments in orange groves in marginal climatic areas, or in apple orchards or vineyards with varieties that are no longer in demand, represent excellent examples of this type of economic persistence.

A simplified example shows how a real option value can arise with respect to a prospective orange grove investment. Similar, but opposite logic applies to a decision to abandon the grove and grow something else on the same land. Assume that the on-tree price for oranges is currently $8.00/box, our overhead cost amounts to another $1.00/box, yield is 300 boxes per acre, the interest rate is 5%, and that our grove will produce forever. Now suppose that the price of orange grove land is $40,000 per acre. Taking into account the time value of money, the present value of this investment is a positive $2,000. So, should we make the investment? Not necessarily. Suppose further that we can wait until next year to make the decision, and that prices have an equal probability of rising to $9.00/box or falling to $7.00/box. For lack of better knowledge, we will expect these new prices to persist over the life of the investment. In the former case, we now make the investment next year, and the perpetual stream of income also begins one year from now. Weighting the present value of this alternative by the probability of its occurrence, the expected value of this investment is now $3,809. However, if the price falls to $7.00 the net present value of the investment is negative, so we would not buy the grove (Table 1).

The option value is the value of waiting one year, thereby obtaining more information about future prices, and is equal to the difference between the present value of investing now as compared to next year, or $1,809 ($3,809 - $2,000). Hysteresis arises as growers, or potential growers in this case, continually compare the income lost from waiting to the option value of waiting for more information. As long as waiting is preferred, no investment or disinvestment (as would be the case if the grove were abandoned) will take place.

So how does a frost enter the equation? Simply, a frost or a windstorm that causes irreparable damage to an orchard or vineyard breaks the hysteresis bond. Growers are forced anew to consider whether or not the investment is viable on its own financial merits. If new varieties are in demand, or growers are bringing product to the market at a lower cost elsewhere in the state, it is likely that a reinvestment decision will not be made. In the long run, therefore, the whole industry benefits as the surviving groves, orchards, or vineyards are the most efficient or under demand from the market. While "reengineering" among industrial firms is a conscious decision subject to much internal analysis and scrutiny, reengineering in agriculture often comes about as an act of God. In both cases, however, a more productive and competitive industry emerges.


Legislative Update......
Senate Agriculture Committee Establishes Priorities for 105th Congress

by Pamela A. Mischen

Continuing under the leadership of Richard Lugar (R-IN), the Senate Agriculture, Nutrition and Forestry Committee of the 105th Congress looks much like that of the 104th Congress with the notable absence of Bob Dole. Even more so than the House Agriculture Committee, members representing major fruit and vegetable producing states are overshadowed by those representing states know for food and feed grain, cotton and tobacco production.

Senators Dole (KS) and Warner (VA) are gone from the majority, replaced by Grassley (IA), Gramm (TX) and Roberts (KS)-- who is no stranger to agricultural issues as he steps over from chairing the House Agriculture Committee. Minority members Pryor (AR) and Heflin (AL) have been replaced by Landrieu (LA) and Johnson (SD)-- also no stranger to agricultural issues.

Senator Lugar announced the Committee's agenda for the 105th Congress. Stated as a high priority was the Research and Extension Title of the Farm Bill. Four hearings have been scheduled for March 11, 13, 18 and 20, 1997. Questions include:
* How would a research, extension and education system created today differ from the current system which stems from the Morrill Act of 1862?
* Considering that the current level of in-house research is more than twice the average for all government agencies, what should the nature of the in-house research be and what research can be done as well by non-federal institutions?
* What does the American public get for its $1.8 billion annual investment in agricultural research?
* Are the current methods of funding agricultural research (namely intramural funds, formula funds, competitive grants and special grants) the most effective ways of allocating funds?
* Does the President's new line item veto authority enable him to veto special research grants?
* How does America stack up against the world in agricultural research investments?
In addition to addressing research questions, the Senate Agriculture Committee will be holding hearings on:

February 11 and 13: A bill to reform the Commodity Exchange Act. This bill is similar to one that Sen. Lugar introduced with Sen. Leahy (D-VT) last year:

February 25 and 26: The impact of estate and capital gains taxes on farmers. Lugar introduced legislation on the first day of the Senate session to eliminate the estate tax. He also supports the end of the capital gains tax.

March 5: USDA business plans and reorganization management. This will be the first hearing in the continuing oversight of USDA management and downsizing.

The committee also plans to schedule future action on trade, farmer risk management and U.S. energy preparedness including the role of biofuels. At this time limited issues pertaining directly to fruits and vegetables appear to be on the docket.


Market Watch......Oranges

by Timothy J. Richards

USDA forecasts of the 1996-97 orange harvest indicate a record crop, some 6% larger than last years near record 11.0 million tons. Although early reports of January's frost damage in Florida suggested that this record was still possible, recent reevaluations have found the damage to be more widespread. Florida Department of Citrus officials now estimate $70 million damage to roughly 3.5% of the crop. Some growers report "..losses of up to 50 percent and some tree damage" (New York Times, Jan. 28). Consequently, the harvest will likely come in close to last year's level. Prior to the frost, USDA forecasts showed harvests of early and mid-season varieties up 7% over last year to 130 million (90 lb.) boxes, and the Valencia harvest 10% above last year to 90 million (90 lb.) boxes. Juice content of the new crop is also running slightly above last year at 1.53 gallons per box (42° brix) compared to last year's 1.52 gallons per box.

This increase in orange production is largely due to a sharp rise in Florida bearing acreage to 595,000 acres, compared to the 563,000 acres of bearing fruit in 1995-96. California acreage, on the other hand, is nearly the same as last year at 196,000 acres. Lower yields, however, are expected to cause the size of the California crop to fall by 2% compared to last year. This reduction is primarily in terms of Valencia oranges, down 7% to 26.0 million (75 lb.) boxes, while Navel production up 3% from last year to 39.0 million (75 lb.) boxes. Unlike last year's Navel crop, which was of poor quality due to a shortened harvesting season, the California Citrus Mutual reports early indications of a high quality 1996-97 crop. Over the longer term, higher quality fresh product may be one result of the continuing movement of orange groves from the Southern San Joaquin Valley to newer areas primarily in Kern County (California Farmer, Jan. 1997). This year, however, higher quality should cause prices to rebound from last year's levels, which was a breakeven year at best for growers.

Export Markets Weak in Early Part of Season


Expectations of higher prices, however, will find little support from export market performance. Compared to the 1995 marketing year, orange juice exports from January to October 1996 were up nearly 10% to 110.23 million single-strength equivalent (SSE) gallons, but the total value of exports is up less than 1% to $234.78 million due to generally lower prices for U.S. FCOJ on the world market (Florida Dept. of Citrus). Although the volume of exports to all major customers (Japan, Canada, Europe) is up over last year, the FOB value of exports to Canada and Europe are below 1995 (Figure 1).



Imports of orange juice, however, are up both in terms of quantity and price. From January to October of 1996, U.S. importers bought 207 million SSE gallons, up 39% from 1995, at an average price of $1.02 per gallon, which is 16% higher than 1995 (Florida Dept. of Citrus). Brazil regained its status as the largest supplier with 68% of the market compared to 20% for Mexico. In 1995, Brazil had a lower market share in the U.S. than did Mexico (43% versus 44%). In fact, Brazil's total FCOJ export volumes are far higher than in 1995. From July through October of 1996, exports of frozen concentrated orange juice were up 28% to 132 m gallons. Exports to the U.S. rose 120%, while those to Europe were 16% higher (Figure 2).



Despite lower production in California and higher quality, the average price of fresh orange exports is 1% lower than last year at $0.253/lb. Moreover, volumes are down significantly to both Japan and the other minor importers. In fact, total fresh exports are down 11.4% compared to 1995, with shipments to Japan 27% lower. Overall, the total value of fresh exports through October was $249.15 million, or 12.1% below last year at the same time.

Orange Prices Remain Steady

Due to uncertainty over the extent of damage to the Florida crop, frozen concentrated orange juice futures prices have fluctuated over a wide range in early 1997. Although initial reports caused the March contract price to rise from the $0.80/lb range to almost $0.87/lb, concerns that the damage was overstated caused price to retreat to below $0.84/lb. However, the release of more detailed damage information caused limit moves in the March contract, settling above $0.935/lb on January 28 (Figure 3). Grower prices remain significantly above last year's in California at $8.68/box on a packing house door basis in December, while the equivalent price in Florida is slightly below last year's level at $5.33/box. Although most of the Florida harvest is in, growers with quality oranges on the tree should see a significant improvement in prices due to the recent frost damage.

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