RISK ANALYSIS OF TILAPIA RECIRCULATING AQUACULTURE SYSTEMS: A MONTE CARLO SIMULATION APPROACH Bledar Kodra Thesis submitted to the faculty of the Virginia Polytechnic Institute and State University in partial fulfillment of the requirements for the degree of MASTER OF SCIENCE in Agricultural and Applied Economics APPROVED: Daniel B. Taylor Darrel Bosch Ewen McLean April 06, 2007 Blacksburg, Virginia Keywords: Risk Analysis, Tilapia, Recirculating Aquaculture Systems, Monte Carlo Simulation, Latin Hypercube, Conviction Weight Method, @Risk Risk Analysis of Tilapia Recirculating Aquaculture Systems: A Monte Carlo Simulation Approach Bledar Kodra (ABSTRACT) The purpose of this study is to modify an existing static analytical model developed for a Re- circulating Aquaculture Systems through incorporation of risk considerations to evaluate the economic viability of the system. In addition the objective of this analysis is to provide a well documented risk based analytical system so that individuals (investors/lenders) can use it to tailor the analysis to their own investment decisions—that is to collect the input data, run the model, and interpret the results. The Aquaculture Economic Cost Model (AECM) was developed by Dr. Charles Coale, Jr. and others from the department of Agricultural and Applied Economics at Virginia Tech. The AECM is a spreadsheet model that was developed to help re-circulating aquaculture producers make strategic business decisions. The model can be used by potential producers interested in investing in re-circulating aquaculture through development of a financial analysis that in turn will help them obtain funding for the enterprise. The model is also useful for current producers who want to isolate inefficient aspects of their operation. AECM model consists of three major sections which include the Data Entry, Calculations and Analysis. The first section requires that the producer conducts background research about their operation to ensure accurate calculation and analysis. The calculation section provides a great deal of information about the operation’s finances, while the analysis section provides information about the operation’s financial stability. While the AECM is a powerful model, it is based on single, usually mean, values for prices, costs, and input and output quantities. However, market, financial and production uncertainties result in fluctuating prices, costs and yields. An individual who is making management decisions for a re-circulating aquaculture system will be faced with some or all of these uncertainties. By adding simulation to the AECM model to account for these uncertainties individuals will be able to make better management decisions. Information of the varying likelihoods or probabilities of achieving profits will be of crucial interest to individuals who plan on entering into or modifying an existing aquaculture system. Risks associated with six variables were examined in this paper: feed cost, feed conversion, mortality rate, capital interest rate, final weight, and output price. Data for the Interest Rate and output price were obtained from the Federal Reserve System and NMFS website respectively. Expert opinion was the source of data for the other variables. After probability distributions were applied to the random variables to account for the uncertainty the model was simulated for ten thousand iterations to obtain expected returns for three years in advance that the model calculates an income statement. In addition to that, sensitivity analyses were carried out in order to inform the producer which factors are contributing the most to the profitability of the operation. In this way the producer will have a better idea as to which aspects of the operation to monitor closely and consider modifying. The analysis shows that the mean income for the three years will be negative and thus the business would be losing money. The simulated mean net incomes were: -$216,905, - $53,689, -$53,111 for year1 through year3 respectively. Sensitivity analysis confirmed that output price is by far the most significant input that makes the overall bottom line to fluctuate most. Output price was on top of the list for all the three years analyzed in this study. Feed cost and Feed conversion were the next most significant inputs. The other inputs were also significant in explaining the fluctuation of the bottom line; however both their regression and correlation coefficients were small. iii ACKNOWLEDGMENTS ACKNOWLEDGEMENTS The task of researching and completing this thesis was made much easier by the continuous support and encouragement of my parents, my sister, my special wife and my wonderful nine month old boy Jonel. I would like to express my highest gratitude to my committee chairperson Daniel B. Taylor for his invaluable support and guidance throughout this work and my overall graduate studies at Virginia Tech. His numerous revisions made the final draft of this thesis more complete and much better. I am also indebted to my other committee members, Darrel Bosch and Ewen McLean. Their help and guidance from the start of this work enabled me to enrich and improve this thesis substantially. I must also thank Jim Pease for his invaluable help in explaining the Conviction Weight method, without which the procedure of collecting expert based data would have been impossible. I would also like to thank Lori Marsh from the Biological Systems Engineering for her help in arranging and helping during the interview process. The financial support provided by the Department of Agricultural and Applied Economics during the entire course of my masters program is greatly appreciated. Great appreciation is also extended to Darrin Prillanam and Peter Van Wyk for their time and willingness to participate in the interview and provide the data. They were a major source of data used in this analysis. Bledar Kodra iv ACKNOWLEDGMENTS I thank all of my colleagues and professors whose encouragement gave me inspiration to complete my degree and made my stay in the Department pleasant and worthwhile. I express my thanks to my colleagues Eric Sarver, Darin Young, Jason Maupin, Josh Edwards, Zelalem Chala, Elton Mykerezi, Gentian Kostandini, Eftila Tanellari, Joby Kauffman and all the others who are equally appreciated. Bledar Kodra v TABLE OF CONTENTS TABLE OF CONTENTS ABSTRACT....................................................................................................................................II AKNOWLEDGEMENTS.............................................................................................................IV TABLE OF CONTENTS..............................................................................................................VI LIST OF FIGURES.......................................................................................................................X LIST OF TABLES.......................................................................................................................XII CHAPTER 1...................................................................................................................................1 INTRODUCTION..........................................................................................................................1 1.1 PROBLEM STATEMENT AND STUDY JUSTIFICATION................................................................1 1.2. STUDY PROBLEM AND OBJECTIVES.......................................................................................8 1.3 WHO WILL BENEFIT FROM THIS STUDY?...............................................................................10 1.4 BRIEF OVERVIEW OF METHODS...........................................................................................11 1.5 ASSUMPTIONS AND DATA SOURCES.....................................................................................12 CHAPTER 2.................................................................................................................................14 BACKGROUND INFORMATION ON LIFE, BIOLOGY AND ECONOMICS OF TILAPIA 14 2.1. GENERAL INFORMATION ON TILAPIA..................................................................................14 2.1.1 Taxonomy....................................................................................................................15 2.1.2 Biology of Tilapia........................................................................................................16 2.2 ECONOMICS OF TILAPIA.......................................................................................................17 2.2.1 Market Overview.........................................................................................................17 2.2.2 Tilapia Supply in the U.S.............................................................................................18 Bledar Kodra vi TABLE OF CONTENTS CHAPTER 3.................................................................................................................................26 RECIRCULATING AQUACULTURE SYSTEMS AND TILAPIA PRODUCTION...............26 3.1 OVERVIEW OF RECIRCULATING AQUACULTURE SYSTEMS..................................................26 3. 1.1 Fish Growing Tanks....................................................................................................27 3.1.2 Solids Capture and Removal, the Sedimentation Tank...............................................30 3.1.3 Nitrification and the Bio-filter.....................................................................................31 3.1.4 Oxygenation and Aeration of Fish Tanks....................................................................32 3.1.5 Carbon Dioxide Stripping Unit....................................................................................33 3.2 PRODUCTION MANAGEMENT...............................................................................................34 CHAPTER 4 ..............................................................................................................................35 MODEL DEVELOPMENT..........................................................................................................35 4.1 OVERVIEW OF RISK ANALYSIS.............................................................................................35 4.1.1 Analyzing Risk.............................................................................................................36 4.1.2 Measuring Risk............................................................................................................39 MODELING RISK.......................................................................................................................42 OVERVIEW OF RISK MODELING...........................................................................................42 4.2 DEVELOP AN EXCEL SPREADSHEET MODEL.........................................................................43 4.2.1 Data Entry Section:......................................................................................................44 4.2.2 Calculations Section.....................................................................................................45 4.2.3 Analysis Section...........................................................................................................48 4.3 IDENTIFY AND QUANTIFY SOURCES OF UNCERTAINTY IN THE MODEL................................49 4.4 DETERMINING PROBABILITY DISTRIBUTIONS........................................................................57 4.4.1 Distributional Goodness of Fit.....................................................................................67 Bledar Kodra vii TABLE OF CONTENTS CHAPTER 5.................................................................................................................................71 RESULTS.....................................................................................................................................71 5.1 SIMULATING THE AQUACULTURE ECONOMIC COST MODEL................................................71 5.1.1 Monte Carlo Sampling.................................................................................................72 5.1.2 Latin Hypercube Sampling..........................................................................................73 5.2 SIMULATION RESULTS.........................................................................................................75 5.3 SENSITIVITY ANALYSIS........................................................................................................86 5.4 MODIFIED SIMULATION.......................................................................................................93 5.4.1 Simulating the Modified Model...................................................................................94 CHAPTER 6.................................................................................................................................97 SUMMARY AND CONCLUSIONS...........................................................................................97 6.1 INTRODUCTION....................................................................................................................97 6.2 THESIS SUMMARY................................................................................................................97 6.3 OVERALL CONCLUSIONS....................................................................................................102 6.4 FUTURE RESEARCH OPPORTUNITIES..................................................................................103 REFERENCES...........................................................................................................................106 APPENDIX A.............................................................................................................................111 APPENDIX B.............................................................................................................................122 APPENDIX C.............................................................................................................................131 APPENDIX D.............................................................................................................................135 APPENDIX E.............................................................................................................................137 Bledar Kodra viii TABLE OF CONTENTS APPENDIX F..............................................................................................................................139 APPENDIX G.............................................................................................................................142 APPENDIX H.............................................................................................................................147 Bledar Kodra ix LIST OF FIGURES LIST OF FIGURES Figure 1.1 Trend in Total Global Aquaculture Production (1970-2003)........................................4 Figure 1.2 Total U.S. vs. World Aquaculture Production from 1984-2003...................................5 Figure 2.1 Total U.S. Tilapia Production from Aquaculture........................................................20 Figure 2.2 Tilapia imports by product form 1997-2005...............................................................22 Figure 2.3 Whole sale prices for chilled tilapia fillets, origin Costa Rica/Honduras...................25 Figure 2.4 Whole sale prices for frozen tilapia fillets, origin Taiwan Province of China............25 Figure 3.1 Fish per Gallon of Water as a Function of Body Length for Tilapia..........................29 Figure 3.2 Fish per Gallon of Water as a Function of Body Weight for Tilapia..........................30 Figure 4.1: US Federal Prime Rate from 1980 to 2005................................................................52 Figure: 4.2 Comparison Graph for Feed Cost...............................................................................61 Figure: 4.3 Comparison Graph for Conversion Rate....................................................................62 Figure: 4.4 Comparison Graph for Final Weight..........................................................................63 Figure: 4.5 Comparison Graph for Mortality Rate.......................................................................64 Figure: 4.6 Comparison Graph for Interest Rate..........................................................................65 Figure: 4.7 Comparison Graph for Output Price..........................................................................66 Figure 5.1: Fitted Distribution for Net Profit Year 1....................................................................81 Figure 5.2: Cummulative Ascending Net Profit Year 1...............................................................81 Figure 5.3: Histogram graph for Net Profit Year 1.......................................................................81 Figure 5.4: Cummulative Descending Net Profit Year 1..............................................................81 Bledar Kodra x