6 Impact of increases in output from irrigated land on product prices

Gross margin calculations generally assume that a change in output has no effect on prices. While for small-scale changes at the individual farm level this may well approximate the truth, the large-scale land use changes generated by irrigation on the national scale are likely to have some measurable effect on output prices.

The impact of the estimated output volume changes on price was assessed using the Lincoln Trade and Environment Model[1] (LTEM) for those products in the irrigation analysis that are incorporated in the model (dairy products, sheepmeat, beef, wool, kiwifruit and apples). The analysis was run separately for the current irrigated area and for Scenario 1 (the “future likely” area). This analysis is indicative at best, and more detailed modelling than was possible in this project would be needed to improve the accuracy of the estimates in the following sections. A discussion of the key factors determining the size and direction of any price impacts is included in Appendix 1, section 4.

6.1 Price impacts of current irrigated area

The LTEM results are presented in Table 7. In this Table, the volume and price changes are those that would occur if the currently irrigated area in New Zealand was in dryland farming systems compared with the current situation. For example, the Table indicates that if there were no irrigation in New Zealand, dairy production would be 9.7% lower and prices paid to New Zealand dairy farmers would be 1.8% higher.

Table 7: Changes in output and prices of key products in the absence of irrigation

The LTEM results indicate that for most products, the change in output from current irrigation has had very little impact on producer prices. The exception to this is kiwifruit. The estimated percentage decrease in kiwifruit output that would occur if irrigation were not available is substantial. In addition, New Zealand dominates world trade in kiwifruit during the Southern Hemisphere selling season, so a high percentage decrease in kiwifruit production from New Zealand has a very significant impact on the quantity of kiwifruit traded world-wide and therefore the price, assuming other factors remain constant.

If the prices used in the “without irrigation” scenario are adjusted to reflect the price changes indicated by the LTEM, the contribution of irrigation to GDP falls in the order of $30 million (3%) from $920 million to $890 million from the currently irrigated area. That is, the prices for these products would change in the absence of irrigation by the amounts in Table 7, which would have the effect of reducing the contribution of irrigation to GDP by the order of $30 million.

If the boundaries of this analysis are extended beyond the irrigated area to the whole of New Zealand production, the impact on GDP is further reduced. This occurs because the price of all milk solids (for example) produced in New Zealand is lower as a result of the increased output of milk solids from the irrigated area. When the price changes in Table 7 are applied across all New Zealand output of LTEM products, the impact of irrigation on GDP at the farmgate is reduced in the order of $100 million, about 11% of the farmgate benefit from the irrigated area.

The products covered by the LTEM contribute 45% of the total contribution of irrigation to GDP. Other products of irrigated agriculture that are not modelled in the LTEM are grain and seeds, vegetables, flowers, other fruit crops, wine and deer. The prices of most of these products tend to be sensitive to changes in output volumes, particularly those supplying the local market. Intuitively it would be expected that the increases in production generated by irrigation would result in a fall in price of these products. However, the impact of a “without irrigation” scenario implies very significant changes in the nature of these sectors, the impacts of which on price are not straightforward to determine. In some cases the crop would not be produced at all, in which case discussions on “what the price would be to New Zealand’s producers without irrigation” are unnecessary. The likely impacts by product type are discussed in appendix 1 section 4. In summary, the impact on the price of the products produced under irrigation not able to be modelled using the LTEM are likely to be neutral or positive.

Overall, the changes in output as a result of irrigation development in New Zealand have had a small impact on the price of the major agricultural and horticultural exports from New Zealand. The overall impact of such price changes on the contribution of irrigation to GDP is small but significant, reducing the contribution to the order of $820 million.

6.2 Price impacts of Irrigation Development

In the same way as in the assessment of the current farmgate value of irrigation (section 6.1), the impact of the estimated volume changes on price for the future scenarios was assessed using the LTEM.

For the LTEM products, the sensitivity of prices to output changes was tested using three different output scenarios. These were scenarios 1 and 2 as described in section 5.1, and a refinement of Scenario 1 in which the conservative area under irrigation by 2013 assumptions were combined with very conservative land use change assumptions (see Table A2.4 in Appendix 2). This provides a conservative, most likely and optimistic view of the possible changes in output by 2013 as a result of irrigation development.

The LTEM results are presented in Table 8. In this Table, the volume and price changes are those that would occur if the irrigated area expanded. For example, the Table indicates that if, by 2013, the irrigated area had expanded to that thought “most likely”, dairy production would be 4.33% higher than would be the case if the irrigated area remained static, and prices paid to New Zealand dairy farmers would be 0.81% lower. 

Table 8: Impact of irrigation on output and price of key products

Note: In the Table, the change in quantity reflects the change in output as a result of irrigation above what would have been produced in 2010, rather than the change from the current level of production.  The 2010 output levels were used as a best approximation to 2013, as the LTEM does not extend to 2013.

The LTEM results indicate that for most products, the change in output from future irrigation is likely to have very little impact on price even at the most optimistic estimates of output change. The price results are reasonably insensitive across the range of output scenarios considered. The exception to this is kiwifruit for the reasons described in 6.1.

Using Scenario 1 (the “likely future” scenario) from Table 8, the price changes result in a fall in the estimated contribution of irrigation to GDP of $7.1 million (or 2.1%). If the boundaries of the analysis are extended beyond the irrigated area, the impact on GDP would be further reduced. When the price changes in Table 7 (most likely column) are applied across all New Zealand’s forecast output of LTEM products in 2013, the impact of irrigation on GDP falls by a further $71 million, or a total adjustment to the contribution of irrigation to GDP of $78 million.

The impact of the likely increases in output on the price of non-LTEM crops is exceptionally difficult to determine (appendix 1, section 4). For the purposes of this exercise, a reasonably pessimistic estimate of the likely impact on price was used, based on the impact on apple and kiwifruit prices as indicated by the LTEM results – it was assumed that prices of non-LTEM crops would fall by 5%. Using the most likely future scenario, and incorporating the LTEM price changes and a 5% fall in non-LTEM crop prices, the estimated contribution of future irrigation to GDP falls by $32 million or 10% for the Scenario 1 area of 201,000 ha. This was not extrapolated across all of New Zealand’s production of these crops as there are not projections available for all these crops for 2013.

6.3 Summary

Table 9 provides a summary of the results of the impacts of irrigation on prices across all of New Zealand’s output. At best, these results are indicative given the assumptions in the LTEM model and those of land use and productivity.

Table 9: Summary of modelling of irrigation production impacts on prices

Table 9 shows that the impacts on New Zealand’s current production due to the additional production from irrigated land reduces the net benefits to New Zealand by the order of 10%. Given the degree of variability possible in the assumptions made in this study, this is a relatively minor impact. The impacts of more irrigation development are even less precise and considerably more information and modelling is required to have confidence in the calculation of impacts across the rest of New Zealand’s production.

The historical performance of the kiwifruit sector illustrates the complexity of the relationship between increases in the production of New Zealand kiwifruit and price[2].  In recent years, production increases have not always been associated with price falls due to a range of factors such as the production of kiwifruit in competitor countries, exchange rates, fruit quality and (possibly most significantly) the effort put into marketing New Zealand kiwifruit as a premium product.   The LTEM takes into account exchange rate and competitor production but cannot incorporate improved marketing strategies. This would also apply in various ways to the other products modelled.

[2]“ Situation and Outlook for New Zealand Agriculture and Forestry 2003”, MAF Policy