Research report: Simplified real options analysis for climate change adaptation

Uncertainty about the magnitude of climate change will remain high for many decades. If climate change is less severe than communities expect, they may end up spending too much on adaptation; if it is more severe than expected, they may not adapt quickly enough.

Policymakers should choose adaptation actions that minimise total climate-related costs to society, where these costs include the funds spent on adapting and the costs incurred by the community when weather-related events occur. Real options analysis (ROA) is an ideal decision-support tool because it handles the flexibility embedded in investment programmes, such as the ability to accelerate, delay, or rescale investment.

ROA is complex and resource-intensive, so it is not widely used for relatively small projects. This is unfortunate because much adaptation spending will fund relatively small projects under the jurisdiction of local authorities. These authorities have the local knowledge and incentives that are essential to good decision-making, but many

of them have limited analytical resources. They need approaches that are simple enough to be useful for evaluating small- and medium-scale adaptation decisions yet retain a degree of economic rigour.

This report evaluates the performance of six alternatives to ROA.