, PhD, Adjunct Lecturer, College of Business, Law and Governance, James Cook University, Australia
This case study presents an application of the Real Options approach to evaluate a farming enterprise under sugarcane in the lower Herbert district of north Queensland, Australia. It demonstrates how this approach may be used to calculate the value of a farming enterprise using real-world data as well as the critical prices at which it is optimal for the farm operator to exercise managerial options in order to maximise the value of their investment. In practical terms, this information is useful to assist farmers to make optimal decisions regarding whether or not to plant their field crops for the current season and at which price it is worth considering alternative uses for their crop land, such as rotating their crops or converting their land for other industrial uses.
Results of the case study indicate that the value of the 99.25 ha cane enterprise in 2011-12 sugar pric-es was $1,380,000, which amounts to $13,904 per hectare ($5,629 per acre), and the average value of the enterprise over the period 1998-99 to 2011-12 was $762,500, which amounts to $7,683 per hec-tare ($3,110 per acre). The critical price at which to cease farming operations is shown to be $15.75 per tonne of cane (IPS sugar price of ~$188/t), while the price at which to recommence operations is $24.14 per tonne of cane (IPS sugar price of ~ $286/t). A significant finding from the case study is that the critical price to abandon sugarcane production on a previously decommissioned cane farm turned out to predict remarkably well a period of low sugar prices during which sugarcane growers within neighbouring districts actually exercised their option to exit the industry and the land was con-verted to managed-investment forestry schemes.
Keywords: real options analysis, agricultural evaluation, asset value, investment decisions, sugarcane production.
JEL Classification: G11, G12, G13, G31, G32.
Cite as: Smith, M. (2018). A Real Options Approach To Evaluating Agricultural Investments Under Uncertainty: When To Get In And Out Of Sugarcane Production. SocioEconomic Challenges, 2(1), 21-34. DOI: 10.21272/sec.2(1).21-34.2018
- Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) (2014). Rural commodities: Sugar – farm inputs. Retrieved from http://www.agriculture.gov.au/abares/research-topics/agricultural-commodities/agricultural-commodities-trade-data#2014.
- Australian Taxation Office (2014). Company tax rates. Retrieved from https://www.ato.gov.au/Rates/Company-tax/.
- Board of Governors of the Federal Reserve System (BGFRS) (2014). Federal Reserve Statistical Release: Selected Interest Rates. Retrieved from http://www.federalreserve.gov/releases/h15/data.htm.
- Brennan, M. J. & Schwartz, E. S. (1985). Evaluating Natural Resource Investments. Journal of Business, 58(2), 135-157.
- Cameron, T. (2005). Farm Economic Analysis Tool (FEAT), a decision tool released by FutureCane. Department of Primary Industries and Fisheries, Brisbane, Australia.
- Caumon, F. & Bower, J. (2004). Redefining the Convenience Yield in the North Sea Crude Oil Market. The Oxford Institute for Energy Studies, WPM 28 July, 2004. Retrieved from http://www.oxfordenergy.org/wpcms/wp-content/uploads/2010/11/WPM28-RedefiningtheConvenienceYieldintheNorthSeaCrudeOilMarket-FCaumonJBower-2004.pdf.
- Colwell, D., Henker, T. & Ho, J. (2003). Real Options Valuation of Australian Gold Mines and Mining Companies. The Journal of Alternative Investments, 6(1), 23-38.
- Cortazar, G. & Schwartz, E. S. (1993). A Compound Option Model of Production and Intermediate Inventories. Journal of Business, 66(4), 517-540.
- Cortazar, G., Schwartz, E. S. & Salinas, M. (1998). Evaluating Environmental Investments: A Real Options Approach. Management Science, 44(8), 1059-1070.
- Duku-Kaakyire, A. & Nanang, D. (2002). Application of Real Options Theory to Forestry Investment Analysis. Forest Policy and Economics, 6(6), 593-552.
- Ehmke, M. T., Golub, A. A., Harbor, A. L. & Boehlje, M. D. (2004). Real Options Analysis for Investment in Organic Wheat and Barley Production in South Central Dakota Using Precision Agriculture Technology. Retrieved from http://ageconsearch.umn.edu/bitstream/20346/1/sp04eh01.pdf.
- Engel, P.D. & Hyde, J. (2003). A Real Options Analysis of Automatic Milking Systems. Agricultural and Resource Economics Review, 32(2), 282–294.
- Grafstrom, C. & Lundquist, L. (2002). Real Option Valuation vs. DCF Valuation – An application to a North Sea oil field. Master’s thesis in Financial Economics, Stockholm University School of Business. Retrieved from http://marcoagd.usuarios.rdc.puc-rio.br/pdf/charlie-leo-dissertation.pdf.
- Griffiths, W. E., Carter Hill, R. & Lim, G. C. (2012). Using EViews for Principles of Econometrics (4th edition). New York: John Wiley & Sons.
- Hart, C. (2008). Forestry schemes take over paddocks. The Australian, May 24th, 2008. Available at http://www.theaustralian.com.au/archive/news/forestry-schemes-take-over-paddocks/story-e6frg6oo-1111116429750.
- Iwai, N., Emerson, R. D. & Roka, F. M. (2009). Harvest Cost and Value of Citrus Operations with Alternative Energy: Real Options Approach. Selected Paper prepared for the Agricultural and Applied Economics Association 2009 Annual Meeting, July 26-28, 2009, Milwaukee, Wisconsin. Retrieved from http://purl.umn.edu/49942.
- Kelly, S. (1998). A Binomial Lattice Approach for Valuing a Mining Property IPO. The Quarterly Review of Economics and Finance, 38, 693-709.
- Luong, Q. V. & Tauer, L. W. (2006). A real options analysis of coffee planting in Vietnam. Agricultural Economics, 35, 49–57.
- McNamara, S. (2003). The Market Premium for the Option to Close: Evidence from Australian Gold Mining Firms. PhD thesis, University of Queensland School of Business, Brisbane, Australia. Retrieved from http://espace.library.uq.edu.au/view/UQ:106720.
- Moel, A. & Tufano, P. (2002). When Are Real Options Exercised? An Empirical Study of Mine Closings. The Review of Financial Studies, 15(1), 35-64.
- Nyambane, G. G. & Black, R. J. (2004). The Real Options Puzzle for Michigan Cherry Producers. Selected Paper prepared for presentation at the American Agricultural Economics Association Annual Meeting, Denver, Colorado, August 1-4, 2004. Retrieved from https://ideas.repec.org/p/ags/aaea04/20011.html.
- Odening, M., Mußhoff, O. & Balmann, A. (2005). Investment decisions in hog finishing: an application of the real options approach. Agricultural Economics, 32, 42-60.
- Plato, G. E. (2001). The Soybean Processing Decision: Exercising a Real Option on Processing Margins. United States Department of Agriculture Economic Research Service, Technical Bulletin Number 1897. Retrieved from http://purl.umn.edu/33567.
- Queensland Government Department of Agriculture and Fisheries (2013). Farm Economic Analysis Tool. Retrieved from https://www.daf.qld.gov.au/plants/field-crops-and-pastures/sugar/farm-economic-analysis-tool.
- Queensland Sugar Limited (QSL) (2012). QSL RSSA Marketing Guide 2012 Season Edition: A Guide to How QSL Manages its Marketing, Risk Management and Sugar Pricing Activities for Queensland Growers and Suppliers. Retrieved from http://www.qsl.com.au/sites/default/files/QSL5463_QSL%20RSSA%20Marketing%20Guide%20Amendments_COLLATE_AW_LR.pdf.
- Schwartz, E. S. & Trigeorgis, L. (2004). Real Options and Investment under Uncertainty: Classical Readings and Recent Contributions. Massachusetts Institute of Technology: The MIT Press.
- Seo, S., Segarra, E., Mitchell, P. D. & Leatham, D. J. (2008). Irrigation technology adoption and its implication for water conservation in the Texas Highland Plains: a real options approach. Agricultural Economics, 38, 47-55.
- Smith, M. (2012). Evaluating renewable resource assets under uncertainty: analytical and numerical methods with case study applications. Unpublished PhD Thesis (# b1758186). Griffith University, Brisbane, Australia. Retrieved from https://www120.secure.griffith.edu.au/rch/items/5c89d98d-3fe6-10d5-eed0-19b2a1f64383/1/.
- Smith, M., Telford, P., Poggio, M. & Larard, A. (2013). Providing Economic Support to Project Catalyst: Wet Tropics Final Report 2012. Department of Agriculture, Fisheries and Forestry, Queensland Government.
- Smith, M., Poggio, M. J., Thompson, M. & Collier, A. (2014). The Economics of Pesticide Management Practices on Sugarcane Farms: Final Synthesis Report. Department of Agriculture, Fisheries and Forestry (DAFF), Queensland. Retrieved from http://era.daf.qld.gov.au/id/eprint/4492/1/fin-synth-rep-econ-pest-mgment-sc-farms.pdf.
- Tauer, L.W. (2006). When to Get In and Out of Dairy Farming: A Real Option Analysis. Agricultural and Resource Economics Review, 35(2) (October 2006), 339-347.
- The State of Queensland (2014). Land Tax Act 2010. Schedule 2: Rate of land tax companies, absentees and trustees [Section 32(1)(b)]. Queensland Government. Retrieved from https://www.legislation.qld.gov.au/browse/inforce.
- Trigeorgis, L. & Mason S. P. (1987). Valuing Managerial Flexibility. Midland Corporate Finance Journal, 5(1), 14-21.
- United States Department of Agriculture (2013). Sugar and Sweeteners Yearbook Tables: World and U.S. Sugar and Corn Sweetener Prices. Retrieved from https://www.ers.usda.gov/data-products/.
- United States Department of Labor (2013). Consumer Price Index: CPI Database. Retrieved from http://www.dol.gov/dol/topic/statistics/inflation.htm.