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Are you brave enough? Economic evaluation of climate change adaptation projects


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presented on March 16, 2011 at IFAD (Rome) by Gretel Gambarelli, IUCN

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Are you brave enough? Economic evaluation of climate change adaptation projects

  1. 1. Are you brave enough? Economic analysis of adaptation to climate change on an agricultural project Gretel Gambarelli IUCN (formerly World Bank) Co-author: Mike Toman World Bank IFAD, 16 March 2011
  2. 2. Outline <ul><li>Introduction </li></ul><ul><li>Economic analysis of adaptation: challenges and possible solutions </li></ul><ul><li>Dealing with uncertainty: beyond CBA </li></ul><ul><li>Summary and conclusions </li></ul>
  3. 3. Outline <ul><li>Introduction </li></ul><ul><li>Economic analysis of adaptation: challenges and possible solutions </li></ul><ul><li>Dealing with uncertainty: beyond CBA </li></ul><ul><li>Summary and conclusions </li></ul>
  4. 4. Source: Adapted from IPCC 2007. What do we have to prepare for? Unsuccessful mitigation Unavoidable warming Successful mitigation
  5. 5. Adapting to climate change: the example of agriculture Adaptation classification Examples Autonomous / private Sectoral Change crops, crop calendars, irrigation schedules Economy-wide Market adjustments in crop prices reflect new production levels / scarcity Planned / public Hard “ Climate proof” infrastructure: irrigation systems, rural roads, … Soft Seasonal climate forecasts, capacity building, research and extension on drought resistant crops, local institutions, economic incentives for efficient water use
  6. 6. Is investing in climate change adaptation economically justified? <ul><li>At the global/sectoral level: a few studies attempting to estimate </li></ul><ul><ul><li>Optimal adaptation-mitigation policy mix </li></ul></ul><ul><ul><li>Total adaptation costs, under a specified temperature increase (EEA 2007, World Bank 2010) </li></ul></ul><ul><li>At the national level: some cost and cost-benefit studies (i.e., Carraro ed. 2009 for Italy) </li></ul><ul><li>At the project level: generally poor economic analysis </li></ul>
  7. 7. Outline <ul><li>Introduction </li></ul><ul><li>Economic analysis of adaptation: challenges and possible solutions </li></ul><ul><li>Dealing with uncertainty: beyond CBA </li></ul><ul><li>Summary and conclusions </li></ul>
  8. 8. Evaluating adaptation at the project level: the cost-benefit approach <ul><li>Estimate economic costs without the project (= damages or impacts of CC under the hypothesis of no adaptation) </li></ul><ul><li>Estimate future economic benefits with adaptation (= “avoided damages” + additional benefits) </li></ul><ul><li>Estimate costs of investing in adaptation </li></ul><ul><li>Sum up all costs and benefits discounted to the present and calculate NPV </li></ul><ul><ul><li>if NPV> 0 adaptation is economically justified </li></ul></ul>[Basic assumption: future GHGs are exogenous]
  9. 9. Economic analysis of adaptation at project level: main challenges <ul><li>Future economic benefits with adaptation </li></ul><ul><li>Low vs. high regret adaptation </li></ul><ul><li>Hard vs. soft adaptation </li></ul><ul><li>Additionality </li></ul><ul><li>Investing now vs. waiting </li></ul>U U U <ul><li>Investment costs </li></ul><ul><li>Costs of autonomous adaptation </li></ul><ul><li>Additionality </li></ul><ul><li>Investing now vs. waiting </li></ul>U U <ul><li>Costs without adaptation </li></ul><ul><li>Future CC impacts </li></ul><ul><li>Autonomous adaptation </li></ul>U U <ul><li>Discounting </li></ul><ul><li>Discount rate for long term benefits </li></ul>U
  10. 10. Step 1: Evaluating the costs of CC on agriculture (1/3) <ul><li>Alternative 1: Agronomic models </li></ul>
  11. 11. <ul><li>Alternative 2: “Ricardian” approach </li></ul>Step 1: Evaluating the costs of CC on agriculture (2/3) Farm value = f (farm characteristics, soil type, climate variables, etc.) 2. This information can be used to estimate how climate change affects agriculture productivity after farmers have adapted to it <ul><li>Estimates how climate variables affect land values </li></ul>
  12. 12. <ul><li>Applications (World Bank) </li></ul>AGRONOMIC RICARDIAN India (nationwide) : Climate change impacts in drought and flood affected areas Africa, China, Brazil, India, Egypt, etc. (nationwide) Morocco (nationwide) : Adaptation to climate change in the agriculture sector Bangladesh (nationwide) : Implications of Climate Change on food security: adaptation responses China (project level) : Mainstreaming climate change adaptation in irrigated agriculture
  13. 13. Step 1: Evaluating the costs of CC on agriculture ( 3/3 ) Alternative 3: Probabilistic methods May be applied to impacts of extreme events, but a better grasp on probabilities is a pre-condition Without adaptation With adaptation Loss Exceedance Probability
  14. 14. Step 2: Estimating BENEFITS of adaptation <ul><li>Very similar challenges to standard agricultural projects, but uncertainty plays a bigger role if the project comes “with regret” </li></ul><ul><li>Benefits of hard adaptation more straightforward than soft adaptation </li></ul><ul><li>Consider co-benefits and negative spillovers </li></ul><ul><ul><li>E.g. improved agricultural land management practices to prepare for CC can also lead to reduced erosion/siltation and carbon sequestration </li></ul></ul><ul><ul><li>E.g., increased irrigation upstream may limit water availability downstream </li></ul></ul>
  15. 15. Step 3: Estimating COSTS of adaptation <ul><li>Estimate WHAT you need.e.g.: “gap analysis“, participatory approaches, etc. </li></ul><ul><li>Estimate “ HOW MUCH ” you need. You can use ad hoc models, or “educated guesses” </li></ul><ul><li>Look at UNIT COSTS of specific adaptation measures. E.g. through analysis of past projects that financed the same types of interventions </li></ul><ul><li>Need just a rough figure (e.g. for accessing int’l CC financing)? Review & compare projects’ costs! </li></ul>
  16. 16. Steps 2 & 3: Investing now vs. waiting <ul><li>Waiting to invest in adaptation may in some cases avoid capital lock-in, reduce investment costs, or increase economic benefits </li></ul><ul><ul><li>Ex. Dam with right capacity </li></ul></ul><ul><li>But the contrary may also be true: waiting to invest in adaptation can cause irreversible losses </li></ul><ul><ul><li>Ex. Loss of ecosystems (desertification), loss of lives (more frequent and more intense extreme events) </li></ul></ul><ul><li>Traditional CBA does not help decide when it is optimal to invest in the presence of uncertainty </li></ul>
  17. 17. Step 4: Discounting (1/3) <ul><li>Standard DR: shorter-term costs of adaptation dominate over longer-term benefits of reduced CC impacts </li></ul>
  18. 18. <ul><li>Arguments for low discount rate for long-term benefits: </li></ul><ul><ul><li>Intergenerational equity (Stern 2007) </li></ul></ul><ul><ul><li>“ Risk reduction premium” of adaptation investments </li></ul></ul><ul><li>Arguments against low discount rate for long-term benefits: </li></ul><ul><ul><li>Lowering discount rate for specific projects can distort capital budgeting </li></ul></ul><ul><ul><li>Arguments for low DR are relevant at the global or national level, less so at the project level </li></ul></ul>Step 4: Discounting (2/3) <ul><ul><li>So what? </li></ul></ul>
  19. 19. Step 4: Discounting (3/3) <ul><li>Recommendations: </li></ul><ul><li>For small adaptation projects (effects at the local scale): </li></ul><ul><ul><li>Use standard DR by default </li></ul></ul><ul><ul><li>In order to capture risk reduction premium, add risk-reduction benefits to the benefit stream (at least heuristically) </li></ul></ul><ul><ul><li>Sensitivity analysis of DR </li></ul></ul><ul><li>For large adaptation projects (potential to influence the macro-economy): </li></ul><ul><ul><li>Possible to use a lower or decreasing DR </li></ul></ul>
  20. 20. Economic versus multi-criteria approaches to project assessment <ul><li>Some of the problems discussed above are only relevant to cost-benefit analysis, requiring: </li></ul><ul><ul><li>monetization of costs and benefits </li></ul></ul><ul><ul><li>discounting </li></ul></ul><ul><li>Multi-criteria assessment is a possible alternative: </li></ul><ul><ul><li>Project alternatives compared across a range of criteria -> clear tradeoffs </li></ul></ul><ul><ul><li>Non-monetary values can be used -> impact of discounting on evaluation greatly diminished </li></ul></ul><ul><ul><li>… but different issues arise </li></ul></ul>
  21. 21. Example: evaluating adaptation alternatives for agriculture in East Europe & Central Asia <ul><li>Combination of Cost-benefit Analysis and other decision criteria in a “Multi-criteria” type setting </li></ul><ul><li>Ranking of options according to: net benefits, expert judgment, win-win potential, and farmers’ preferences </li></ul>From a menu of 60 to 5 national-level and 9 agro-ecological zone level adaptation measures (including options not suitable for CBA)
  22. 22. Outline <ul><li>Introduction </li></ul><ul><li>Economic analysis of adaptation: challenges and possible solutions </li></ul><ul><li>Dealing with uncertainty: beyond CBA </li></ul><ul><li>Summary and conclusions </li></ul>
  23. 23. Which uncertainties? <ul><ul><li>Different models forecast different temperature / rainfall patterns in some areas </li></ul></ul><ul><ul><li>Extreme events are becoming increasingly difficult to predict (unknown probability distributions) </li></ul></ul><ul><ul><li>Is there a “tipping point”? </li></ul></ul>
  24. 24. <ul><li>Considers stream of future expected benefits </li></ul><ul><li>Deals with uncertainty only by means of sensitivity analysis </li></ul><ul><li>If multiple possible scenarios, how do I make a decision on the project? </li></ul><ul><li>What about investments that “insure” me against future uncertain events? </li></ul><ul><ul><li>Traditional CBA falls short… </li></ul></ul><ul><li>We need something different! </li></ul>The traditional CBA approach
  25. 25. <ul><li>Takes into account the economic value of options created and destroyed by different project alternatives </li></ul><ul><ul><li>Investing creates options of taking certain decisions in the future – such options have a positive economic value in project evaluation. </li></ul></ul><ul><ul><li>Investing may “kill” other options (i.e., the waiting option). These options have a negative value. </li></ul></ul><ul><li>The method relies on subjective scenarios and probabilities . </li></ul><ul><li>It is challenging to apply. </li></ul>Economic approach: Real Option Analysis
  26. 26. Example: Real Option Analysis for an irrigation modernization project in Mexico Source: Scandizzo and Notaro 2008
  27. 27. <ul><li>Assesses how different investments perform under a wide range of possible futures </li></ul><ul><ul><li>Identifies the determinants of vulnerability of alternative project options </li></ul></ul><ul><ul><li>Points to “robust” alternatives that perform well across a wide range of possible futures </li></ul></ul><ul><li>It does not rely on probability functions </li></ul><ul><li>Good when uncertainty is high, but sophisticated approach </li></ul>Non-economic approach: “Robust” decision analysis
  28. 28. Example: investment decisions of a water supply agency in California Source: Groves et al. 2008 Hundreds of scenarios explore assumptions about climate change, resource-development, urban growth, program costs,... Scenarios evaluated according to the cost of supplying water to the end users plus the costs of incurring any shortages. Most important uncertain factors in generating high-cost scenarios identified.
  29. 29. Outline <ul><li>Introduction </li></ul><ul><li>Economic analysis of adaptation: challenges and possible solutions </li></ul><ul><li>Dealing with uncertainty: beyond CBA </li></ul><ul><li>Summary and conclusions </li></ul>
  30. 30. Summary: how to improve the economic analysis of adaptation projects? (1/2) <ul><li>Identify relevant climate risks for the project area and promising adaptation options </li></ul>Estimate impacts of CC without and with adaptation <ul><li>Estimate CC impacts without the project under multiple climate scenarios , taking into account autonomous adaptation to the extent possible </li></ul><ul><li>Estimate potential reductions in CC impacts under the same multiple scenarios </li></ul><ul><li>Quantitatively or qualitatively assess any co-benefits and externalities </li></ul>
  31. 31. Summary: how to improve the economic analysis of adaptation projects? (2/2) <ul><li>Choose between economic or multi-criteria approach. In case of economic approach, select (and justify) an appropriate DR </li></ul>Economic evaluation of alternative adaptation investments <ul><li>Consider opportunities that the project may create or destroy, and attempt an economic estimation </li></ul><ul><li>“ Stress-test ” the assessment to identify vulnerable investment alternatives </li></ul><ul><li>Choose an alternative that is “ robust ” or has a high “ option value ” </li></ul>
  32. 32. Conclusions <ul><li>Why investing time and money in good economic analysis? </li></ul><ul><ul><li>If carried out early in project preparation it can provide important information on project design </li></ul></ul><ul><ul><li>It can help decide whether to go ahead or to postpone the investment </li></ul></ul><ul><ul><li>But… often incentives are not there </li></ul></ul><ul><li>There are alternatives to the standard CBA </li></ul><ul><li>Need more and more detailed quantitative adaptation studies </li></ul><ul><li>Current methods are very data and model intensive – can simpler and broad approximations be developed? </li></ul>
  33. 33. References <ul><li>Carraro ed. (2009) Climate Change and Adaptation Strategies in Italy — An Economic Evaluation. Il Mulino. </li></ul><ul><li>Fankhauser, S. (2006). The Economics of Adaptation. Background Document for the Stern Review. </li></ul><ul><li>Groves D. G., Knopman D., Lempert R. J., Berry S. H., Wainfan L. (2008). Presenting Uncertainty About Climate Change to Water-Resource Managers (Technical Report TR-505, Santa Monica CA, RAND Corporation). </li></ul><ul><li>Scandizzo P. L. and Notaro C. (2008) Adapting to Climate Change: A Case Study of Project Evaluation through Real Option Theory. Background Report for “ Low Carbon, High Growth: Latin-American Responses to Climate Change - An Overview”. By Augusto de la Torre, Pablo Fajnzylber, and John Nash. Washington DC: The World Bank, 2009. </li></ul><ul><li>Stern N. H. (2007) The Economics of Climate Change: The Stern Review. Cambridge University Press, Cambridge, UK </li></ul><ul><li>World Bank 2010 Economics of adaptation to climate change ( </li></ul>
  34. 34. PUBLICATION &quot;Economic Evaluation of Climate Change Adaptation Projects - Approaches for the Agricultural Sector and Beyond&quot;:   GUIDANCE NOTE &quot;Evaluate adaptation via economic analysis“: Other guidance notes: Contact: [email_address] Thank you!