Download Cost-benefit analysis - adaptation

Economic Analysis of Adaptation
Presentation by Dr. Benoit Laplante
Environmental Economist
Consultant
Asian Development Bank
September 19, 2014
Outline of Presentation
1. Costs of climate change vs. benefits of responding to climate
change
2. Economic analysis versus Financial analysis
3. Cost-benefit analysis versus cost-effectiveness analysis
4. Cost-benefit analysis:
• Selection of Time Horizon
• Discount rate
• Uncertainty
2
Outline of Presentation
1. Costs of climate change vs. benefits of responding to climate
change
2. Economic analysis versus Financial analysis
3. Cost-benefit analysis versus cost-effectiveness analysis
4. Cost-benefit analysis:
• Selection of Time Horizon
• Discount rate
• Uncertainty
3
Outline of Presentation
Economic
value of
water per
m3
Water
supply no
drought
Water
supply with
drought
Aggregate
demand
Cost of
drought
m3
4
Costs of climate change vs. benefits of adaptation
Costs of climate
change
Cost and benefits of the
project without climate
change
Cost and benefits of the
project with climate
change
5
Outline of Presentation
Economic
value of
water per
m3
Water supply with
drought and adaptation
Water
supply with
drought
Water
supply no
drought
Aggregate
demand
m3
Benefits of
adaptation
Cost of CC after
adaptation (residual
damages)
6
Costs of climate change vs. benefits of adaptation
Costs of climate
change
Cost and benefits of the
project without climate
change
Cost and benefits of the
project with climate
change
Cost and benefits of
the project without
adaptation
Note: In all likelihood, costs
of climate change > benefits
of adaptation. Hence, residual
damages.
Cost and benefits
of the project
with adaptation
Benefits of
adaptation
7
Costs of climate change vs. benefits of adaptation
Cost of
climate
change
Cost of climate change without
adaptation
Net benefit of
adaptation
Cost of adaptation plus
residual
Gross benefit of
adaptation
Residual climate change damage
Cost of climate change inclusive of
adaptation
Global mean temperature
8
Outline of Presentation
1. Costs of climate change vs. benefits of responding to climate
change
2. Economic analysis versus Financial analysis
3. Cost-benefit analysis versus cost-effectiveness analysis
4. Cost-benefit analysis:
• Selection of Time Horizon
• Discount rate
• Uncertainty
9
Economic vs Financial
Economic: Point of view is society
Financial: Point of view is the investor
Outline of Presentation
1. Costs of climate change vs. benefits of responding to climate
change
2. Economic analysis versus Financial analysis
3. Cost-benefit analysis versus cost-effectiveness analysis
4. Cost-benefit analysis:
• Selection of Time Horizon
• Discount rate
• Uncertainty
11
Cost-benefit versus Cost-effectiveness
ADAPTATION
Required
adaptation
When adaptation is
not a choice
Cost-effectiveness
analysis
Efficient
adaptation
Cost-benefit versus Cost-effectiveness
ADAPTATION
Required
adaptation
Efficient
adaptation
When adaptation is
not a choice
When adaptation
and how much
adaptation is a
choice
Cost-effectiveness
analysis
Cost-benefit
analysis
Cost-benefit analysis: Invest or Not?
Changes in the Net Present Value of the
Project as a Result of Climate Change
ΔNPV(P) > 0
ΔNPV(P) < 0
Keep project
in portfolio
Economic analysis of projectlevel climate-proofing options
Corollary: The fact that an
infrastructure is projected to
be adversely impacted by
climate change does not
necessarily imply that
adaptation options must be
implemented.
NPV(CP) > 0
NPV(CP) < 0
NPV(P) > 0
NPV(P) < 0
NPV(P) > 0
NPV(P) < 0
Keep project
in portfolio
with
adaptation
Remove
project from
project
portfolio
Keep project
in portfolio
without
adaptation
Remove
project from
project
portfolio
Cost-benefit analysis: Timing of Investment
Invest now or later?
Outline of Presentation
1. Costs of climate change vs. benefits of responding to climate
change
2. Economic analysis versus Financial analysis
3. Cost-benefit analysis versus cost-effectiveness analysis
4. Cost-benefit analysis:
• Selection of Time Horizon
• Discount rate
• Uncertainty
16
Selection of Time Horizon
How do we select time horizon in cost-benefit analysis?
Discount rate
In theory….
Discount rate
In theory….
The Ramsey rule specifies the value of the discount rate as
r
δ
γ
g
is the economic (social) discount rate;
is the rate at which society discounts the utility of present
versus future consumption.
is the marginal utility of consumption with respect to
consumption.
is the percentage change in per capita consumption.
Discount rate
δ
γ
g
r
Weitzman (2007)
2%
2
2%
6%
Nordhaus (2007)
1%
2
2%
5%
Stern (2007)
0.1%
1
1.3%
1.4%
U.K. (HM Treasury 2003)
1.5%
1
2.0%
3.5%
0%
2
2.0%
4.0%
France (Lebegue 2005)
Discount rate
In theory….
In practice….International financial institutions require that
specific discount rates be used to calculate the present value of
costs and benefits. Given the required level of these discount
rates (World Bank requires the use of 10%; ADB requires the use
of 12%), climate change may not really matter (unless the impacts
are very large and expected relatively soon).
Uncertainty
• Sensitivity analysis
• Probabilistic analysis
• Discrete probabilistic analysis
• Continuous probabilistic analysis (Monte Carlo simulation)
• Robust-decision making analysis
Forthcoming Publications
• Climate-Proofing Investments in the Transport Sector: Lessons
from ADB’s Experience
• Economics of Climate-Proofing Investments
• Guidelines for Climate-Proofing Investments in the Water Supply
Sector