Perennial crops under stochastic water supply

Abstract Perennial crops require substantial initial investment in groundwork and planting, as well as a multiyear gestation period without commercial yield. Therefore, a crop's cycle (from planting to felling) should be long enough in order to cover the fixed cost and become profitable. The problem becomes involved when the cycle's duration is stochastic due to occurrence of uncertain event that terminates the cycle prematurely. Studying orchard management under stochastic drought events, we show that to each perennial crop that is profitable without drought hazard, there exists a critical drought hazard above which the crop turns loss making. We refer to this critical drought hazard as the crop's drought vulnerability index and show that it increases with the length of the gestation period, the ratio of fixed cost to average annual profit and the interest rate, and decreases with the natural (uninterrupted) cycle length. We then investigate the economic value of a stable water source, such as recycled water, that stabilizes the water supply and diminishes the drought hazard. An empirical application in northern Israel reveals that the stabilization value of recycled water due to its role in eliminating the drought hazard far exceeds its supply cost.