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An economic approach to investing in climate adaptation

An economic approach to investing in climate adaptation
By Jamie Liu and Pieter Krans
Pieter Krans
Deputy Director, ICF Climate Center
Sep 22, 2021

In part one of this series, we introduced adaptation pathways, an approach to climate adaptation that ramps up as climate change hits new triggers rather than going for the biggest and most expensive solutions right out of the gate. This approach embraces flexibility and provides a way to consider uncertainty in decision-making. In this article, we explore an economic assessment tool that, when paired with adaptation pathways, can help stakeholders decide whether to accelerate investment in resilience-building in the U.S. Such an approach would help ensure potential funding from infrastructure bills currently under consideration by Congress has the biggest and best impact on climate adaptation.

Real Options Analysis

When decision-makers consider adaptation investment opportunities, they look for the most cost-effective solution to deliver on their objectives. These decisions are often informed by a cost-benefit analysis (CBA), but traditional CBA approaches do not account for uncertainty inherent in a changing climate or the flexibility needed to address a changing climate. Real Options Analysis (ROA) is an economic assessment technique from the financial sector that acknowledges that there is value in flexibility—and assesses the economic benefit of that added flexibility.

Given the inherent uncertainty in adaptation strategies, the ability to value flexibility in CBA is necessary and beneficial. While traditional CBA considers a limited number of factors and economic benefits accrued from making a single decision at a fixed point in time, ROA considers the difference in value that can result from deciding to invest in a project now, delaying the decision, or leaving multiple investment options open for future decision-making based on new information that becomes available.

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Variability in climate change, socioeconomic conditions, human behavior, and other factors affect the type and magnitude of the costs and benefits, when those costs and benefits occur, and the optimal implementation moment for adaptation investments. Adaptation pathways combined with ROA provides decision-makers a framework to consider these competing factors and model the uncertainty and time dependency. As a result, decision-makers can select investment options that achieve the adaptation objectives with the highest benefit.

From concept to practice

Conceptual models that pair ROA with adaptation pathways show considerable promise. For example, a conceptual scenario analysis of coastal adaptation to sea-level rise in Los Angeles enabled an analysis of investment tipping points that—when reached—would mean more expensive adaptation in the long run. The study concluded that the “flexibility of adaptation pathways presents the possibility of making early investments in adaptation and keeping options open to increase protection standards in the future, while maintaining economic efficiency.”

However, translation of ROA from concept to practice would benefit from reliable data on climate change impacts over time, including impact uncertainty. The technique requires detailed assessment of how potential damage to communities, built infrastructure, and natural systems translates to economic losses (or gains). Additionally, ROA requires estimating how the potential damages can be mitigated by all potential investments in adaptation strategies—even if those investments are not made today.

As a result, the combination of ROA with adaptation pathways to support economically efficient investments in climate change adaptation to meet both short- and long-term challenges is rarely fully implemented. This lack of full implementation is despite its promise to guide large-scale adaptation investment decision-making, particularly for built infrastructure where benefit-cost estimation is relatively straightforward and techniques are well-established.

Parts of the country where detailed climate change impact assessments exist—such as New York, Miami, and California—are good locations for piloting this type of analysis and for rapid review of lessons learned suitable for scaling nationwide as other regions invest in impact assessments.

Turning theory into action

In order to realize the full potential of this approach to guide cost-effective adaptation over time, we’ve identified five actions government agencies can take to integrate adaptation pathways and ROA when using infrastructure funding to build resilience:

1. Build flexible implementation coalitions. Effective governance systems for defining adaptation objectives and implementing adaptation investments must themselves be adaptive as the impacts of climate change evolve over time. Organizations and governments implementing adaptation pathways and ROA can share success stories, learning from each other as the benefits of adaptive investments are understood.

2. Enhance short-term resilience and long-term adaptation at the same time. Avoid the false choice of either addressing short-term priorities to recover from climate extremes, or long-term climate adaptation.

3. Be open to change. Leaning into change enables flexibility and honest engagement with stakeholders. Climate change impacts will reveal themselves in often unpredictable ways that will need us to be responsive to changing information.

4. Deploy the scientific resources of federal agencies to develop regionally-based tipping points. Regional teams are needed to evaluate the signals of climate change underpinned by the science and technical resources of federal agencies, such as NOAA, NASA, the Corps of Engineers, and national laboratories.

5. Don’t set and forget. Effective, long-term adaptation investments will need to incorporate the value of flexibility and risk, as well as careful monitoring and adjustments over time.

The recently published Intergovernmental Panel on Climate Change report is the clearest statement yet on the urgency of tackling the impacts of climate change—both today and in the long term. Significant levels of investments in the climate infrastructure bills moving through Congress could help harden our defenses against flood, fire, extreme heat, coastal erosion, and other climate impacts. Adaptation pathways and ROA are tools that embrace these priorities and provide an opportunity to embed assumptions of uncertainty and change to guide cost effective climate adaptation investments.

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Meet the authors
  1. Jamie Liu, Climate Resilience Specialist
  2. Pieter Krans, Deputy Director, ICF Climate Center