Notes on Applying ‘Real Options’ to Climate Change Adaptation Measures, with Examples from Vietnam

Abstract

A factor common to all adaptation measures is the uncertainty that is the hallmark of climate change. The timing, intensity and location of climate change impacts is not known to any degree of precision. Because most deterministic analyses and policy prescriptions ignore this uncertainty, their recommendations are likely to waste community resources. Except by chance, adaptation measures will either be over-engineered, or they will be inadequate and result in harm. Applying real options thinking allows an incremental and flexible approach. Adaptation measures are implemented only as better knowledge becomes available over time. Several examples are given of real options in the Mekong Delta, with a comparison of net present values of two housing alternatives. It is essential to undertake net present value calculations when comparing different projects to ensure that the value of any options is weighed against other costs and benefits.The Centre for Climate Economics & Policy (ccep.anu.edu.au) is an organized research unit at the Crawford School of Economics and Government, The Australian National University. The working paper series is intended to facilitate academic and policy discussion, and the views expressed in working papers are those of the authors. Contact for the Centre: frank.jotzo@anu.edu.au. 1 NOTES ON APPLYING 'REAL OPTIONS' TO CLIMATE CHANGE ADAPTATION MEASURES, WITH EXAMPLES FROM VIETNAM Leo Dobes Adjunct Associate Professor Crawford School of Economics and GovernmentThe Australian National University Leo.Dobes@anu.edu.au Personal page: http://www.crawford.anu.edu.au/staff/ldobes.php AbstractA factor common to all adaptation measures is the uncertainty that is the hallmark of climate change. The timing, intensity and location of climate change impacts is not known to any degree of precision. Because most deterministic analyses and policy prescriptions ignore this uncertainty, their recommendations are likely to waste community resources. Except by chance, adaptation measures will either be over-engineered, or they will be inadequate and result in harm. Applying real options thinking allows an incremental and flexible approach. Adaptation measures are implemented only as better knowledge becomes available over time. Several examples are given of real options in the Mekong Delta, with a comparison of net present values of two housing alternatives. It is essential to undertake net present value calculations when comparing different projects to ensure that the value of any options is weighed against other costs and benefits.

Real options analysis for land use management: Methods, application, and implications for policy

“…However, the specific magnitude and effects of climate change are highly uncertainty which limits the applicability of deterministic decision making models, such as NPV (Dobes, 2010). While examples of the application of ROA to climate change can be found in Hertzler (2007), Nelson et al (2013) and Sanderson et al (2015), ROA has had limited application to investments in climate change adaptation in agriculture and land use management.…”

“…While examples of the application of ROA to climate change can be found in Hertzler (2007), Nelson et al (2013) and Sanderson et al (2015), ROA has had limited application to investments in climate change adaptation in agriculture and land use management. The analysis of adaptation to climate change also requires the consideration of extremes as climate change is likely to occur along a spectrum that includes both the benign and the catastrophic (Dobes, 2010). Simulation based models provide the opportunity to incorporate the likelihood of combinations of additional stochastic variables including climate futures and spatial variables into ROA, an objective difficult to achieve with simpler, heuristic real options methods.…”

The Value of Flexibility in Adapting to Climate Change: A Real Options Analysis of Investments in Coastal Defense

“…In its Synthesis Report on the Economics of Adaptation to Climate Change, the World Bank (2010, p. 100) also makes a brief reference to real options as a "practical approach" for addressing uncertainty in investments in adaptation. Real options analysis has been applied to adaptation to climate change in the rain-fed agriculture sector in Yemen (Scandizzo, 2010), in the residential housing sector in the Mekong Delta of Vietnam (Dobes, 2010), in the agricultural sectors in Australia (Hertzler, 2007) and Mexico (World Bank, 2009), and in flood management strategies for the Thames Estuary (Woodward et al, 2011).…”

Climate Change Policy: The Effect of Real Options Valuation on the Optimal Mitigation‐Adaptation Balance

“…Szolgayova et al. , 2008; Dobes, 2010; Linquiti and Vonortas, 2011). The optimisation of the combined strategy must therefore build on these applications and balance the two programmes in a manner that provides the greatest total benefit using all the information available for making such a decision.…”