Robust adaptation decision-making under uncertainty: Real Options Analysis for water storage

Abstract

Planning for climate change adaptation is challenging due to the inherent uncertainty associated with future climate changes. Despite this uncertainty, adaptation decisions may need to be made now, to effectively reduce future vulnerability to climate change. We apply an economic approach for making decisions under uncertainty, Real Options Analysis (ROA), to an irrigation water storage investment decision. Our case study site is the Canterbury region of New Zealand (NZ), where water availability is currently under considerable pressure, and is likely to increase further under climate change. Using the full range of climate model and warming scenario combinations available in New Zealand (24), we develop estimates of water requirements out to 2090 for the chosen location. The ROA involves the development of a decision tree with different decision points (2018 and 2050), so that the size of the reservoir in 2018 will be sufficient to provide water availability until 2050, and have the capability to be extended if necessary at the next time period to provide water availability until the end period (2090). The most economically efficient storage size is sensitive to the discount rate and the milk price, both of which result in larger reservoirs being more cost-effective in the first time period, as well as the likelihood of the different climate scenarios. This analysis illustrates the benefits of ROA when the future is uncertain – by enabling decision-makers to revise their decisions over time rather than locking themselves into a decision made now that has long-term consequences.