Investment in site-specific crop management under uncertainty: implications for nitrogen pollution control and environmental policy

Abstract

This paper applies an option-pricing model to analyze the impact of uncertainty about output prices and expectations of declining fixed costs on the optimal timing of investment in site-specific crop management (SSCM). It also analyzes the extent to which the level of spatial variability in soil conditions can mitigate the value of waiting to invest in SSCM and influence the optimal timing of adoption and create a preference for custom hiring rather than owner purchase of equipment. Numerical simulations show that while the net present value (NPV) rule predicts that immediate adoption is profitable under most of the soil conditions considered here, recognition of the option value of investment indicates that it is preferable to delay investment in SSCM for at least 3 years unless average soil quality is high and the variability in soil quality and fertility is high. The use of the option value approach reveals that the value of waiting to invest in SSCM raises the cost-share subsidy rates required to induce immediate adoption above the levels indicated by the NPV rule. 0 (M. Khanna). ent uptake as low as 30% of the applied nitrogen by plants (Legg and Meisinger, 1982).Site-specific crop management (SSCM) provides an input efficiency enhancing alternative to conventional methods by acquiring information about spatial variability in soil conditions and using it to target input applications to match that variability. It relies on several interrelated components that include grid-based soil sampling and yield monitors linked to satellite-based global positioning systems (GPS) that provide geo-referenced information about the agronomic conditions and yields at various points in the field and identify the need for spatial variation in input application. Variable rate technologies (VRT) then use this information to vary input flow rates on-the-go, 0169-5150/00/$ -see front matter 0 2000 Elsevier Science B.V. All rights reserved. PII: S 0 1 6 9 -5 1 5 0 ( 0 0 ) 0 0 1 11-0

The effect of uncertainty on pollution abatement investments: Measuring hurdle rates for Swedish industry

“…Diederen, van Tongeren and van der Veen (2003) studied the adoption of energy saving technologies in Dutch greenhouse horticulture with uncertainty in the energy price and the energy tax and found a hurdle rate of almost twice the rate predicted by net present value calculations. Khanna, Isik and Winter-Nelson (2000) analyzed the adoption of site-specific crop management with stochastic output price and expectations of declining fixed costs of the equipment. When accounting for the option value, it was preferable to delay the investment for at least three years compared to the net present value rule, for most soil quality levels.…”

Frontiers in Water Resource Economics

“…However, while the input cost savings and revenue increases occur in the future and the latter are uncertain due to uncertainty about prices, the fixed costs of adoption must be incurred at the time of adoption. Khanna et al (2000) develop an option value framework to examine the adoption decision and its timing and to determine the green payment that induces immediate adoption of site-specific crop management (SSCM) instead of conventional farming methods. They also analyze how these payments need to vary across heterogeneous soil conditions and incorporate the value of waiting that arises due to the need to make an irreversible adoption decision under uncertainty.…”

“…Under the NPV rule, a farmer adopts SSCM at r=0 if no>K or the rate of return is greater than p. However, suppose that the farmer has the option of adopting at some instant r=0,... T in the future whereT is the planning horizon of the farmer. Let % denote the present value of the expected quasi-rent differential due to adoption at time T. Khanna et al (2000) assume that % is stochastic and evolves according to a geometric Brownian motion with:…”

Predicting water allocations and trading prices to assist water markets

“…Asymmetric information remains the main obstacle to water trading decisions for efficient land and water management (Brill et al, 1997;Khanna et al, 2000). For instance, the water trading prices, also called pool prices, are set by the buyer and seller bids but neither the volume offers nor the bid prices are available beforehand.…”