On the Economics of Climate-Proofing Infrastructure Investment Projects

1. On the Economics of Climate-Proofing Infrastructure Investment Projects Presentation by Dr. Benoit Laplante Environmental Economist Consultant Asian Development Bank March 12, 2013

2. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

3. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

4. On the meaning of climate-proofing “Climate proofing is a shorthand term for identifying risks to a development project (…), and ensuring that those risks are reduced to acceptable levels through long-lasting and environmentally sound, economically viable, and socially acceptable changes implemented at one or more of the following stages in the project cycle” (ADB, 2005). The expression “climate proofing” is meant as a process that aims to identify risks that an investment project may face as a result of climate change, and to reduce those risks to levels considered to be acceptable. It does not imply a complete mitigation of the potential risks of climate change.

5. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

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 • Cost and benefits of the project with adaptation Benefits of adaptation

7. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

8. Climate-proofing investments Technical Guidelines Sub-divide the climate-proofing process into 6 sets of activities and 20 steps: Activities Steps 1. Project risk screening and scoping 1 to 6 2. Impact assessment 7, 8, and 9 3. Vulnerability assessment 10, 11 and 12 4. Adaptation assessment 13 to 16 5. Implementation arrangements 17 and 18 6. Monitoring and evaluation 19 and 20

9. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

10. Assessing exposure and vulnerability Activities Steps 1. Project risk screening and scoping: How is the proposed project (project characteristics) exposed to the impacts of climate change over its lifespan? What are the climate parameters of most interest to the project? Is sufficient information available to undertake an assessment? Who are the main stakeholders? Step 1:Screen the project for exposure to climate change Step 2: Establish the adaptation objective Step 3: Survey existing information and knowledge Step 4: Identify and engage stakeholders Step 5: Identify methodology and data needs Step 6: Identify the required expertise

11. Assessing exposure and vulnerability Activities Steps 2. Exposure assessment: What are the current and historical trends in climate? How is climate projected to change in the future and in what ways? How will this affect natural and human systems of interest? What are the root causes for predicted impacts? What reasonable assumptions (quantitative and qualitative) can be made about climate change and its impacts? Step 7: Construct climate change scenarios Step 8: Estimate future biophysical impacts Step 9: Assign probabilities to identified impacts

12. Assessing exposure and vulnerability Many emissions scenarios (SRES) Many GCMs Many downscaling approaches www.cccsn.ca/.../Downscaling_html_m5385e5b8.jpg

13. Assessing exposure and vulnerability Activities Steps 3. Vulnerability assessment: How have people historically coped with heavy rainfall, floods, landslides, drought, storm surges, and other weather events? Where are the most vulnerable areas? Who are the most vulnerable populations? What climatic conditions are limiting? Step 10: Identify vulnerabilities Step 11: Identify biophysical drivers of vulnerabilities Step 12: Identify socioeconomic drivers of vulnerabilities

14. Case study: O MON IV Description: O MON IV is a combined cycle gas turbine (CCGT) thermal power station with a design capacity of 750 megawatt (MW). Under design conditions the plant has a net efficiency of 56.4% and is expected to generate 4,500gigawatt hour (GWh) of electricity per year. Fuel supply will come via pipeline from gas fields in the Gulf of Thailand. Construction is scheduled to begin in 2013 with the plant expected to come online in the fourth quarter of 2015. The O MON IV project is designed for an ambient air temperature of 30°C. The station represents a $778 million dollar investment.

15. Case study: O MON IV Climate change: Exposure – Impact - Vulnerability Increasing air temp GLOBAL Changing precipitation MEKONG BASIN Increasing flooding Increasing water temp MEKONG DELTA Increasing erosion O MON IV PROJECT SITE Exposure Impact Vulnerability

16. Case study: O MON IV

17. Case study: O MON IV

18. Case study: O MON IV Comparison of Baseline with GCM Projections in the Mekong Delta: Average Monthly Temperature

19. Case study: O MON IV Comparison of Baseline with GCM Projections in the Mekong Delta: Total Monthly Precipitation

20. Case study: O MON IV Frequency Distribution Curves of Daily Temperatures under Baseline and A2 Climate Change Scenarios Frequency Distribution Curves of Daily and max Temperatures Change in Plant Power Output with Air Temperature

21. Case study: O MON IV Frequency Distribution Curves of Average Daily River Water Temperatures Relative Efficiency and Energy Output as a Function of River Water Temperature

22. Case study: O MON IV Over the life-cycle of the plant, the combined impacts of climate change could reduce power output by approximately 827.5GWh over the 25 year economic design life with effects more severe in later phases of project operations. Over the design life of the plant this represents a loss in power output of 0.8 %. At a nominal electricity purchase price of 6.78 cent/kW, the combined loss in power output would amount to a reduction in 2040 revenue in the order of USD 6.73 million. Using a 12% discount rate, the present value of cumulative lost revenues over the period 2015-2040 amounts to $9.36 million. If power loss were to follow a linear trend between 2015 and the estimated end value in 2040, then the present value of lost revenues reaches $18.79 million.

23. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

24. On the economics of climate proofing Activities Steps 4. Adaptation assessment: What adaptation solutions are technically feasible to address projected climate vulnerabilities? What are the costs and benefits of these options? What are the preferred options in the context of the project? Step 13: Identify all potential adaptation options Step 14: Conduct consultations Step 15: Conduct economic analysis Step 16: Prioritize and select adaptation option(s)

25. On the economics of climate proofing ADAPTATION • Required • adaptation • Efficient • adaptation MRC: Minimum navigational clearance of 37.5 m for the P05 (5%) annual flood. When adaptation responds to complying with codes and standards Cost-effectiveness analysis

26. On the economics of climate proofing ADAPTATION • Required • adaptation • Efficient • adaptation When adaptation is a choice When adaptation responds to complying with codes and standards Cost-effectiveness analysis Cost-benefit analysis

27. 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 project-level climate-proofing options 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 On the economics of climate proofing 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.

28. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

29. Types of decisions A menu of climate-proofing decisions: A1: Invest now A2: Be ready and invest later if needed A3: Do nothing and invest later if needed

30. Types of decisions • A Type 1 decision may be appropriate where: • costs of climate-proofing now are relatively small while the expected benefits are estimated to be very large (a low-regretapproach), and/or • costs of climate-proofing at a later point are expected to be prohibitive, or climate-proofing at a later point in time is technically not possible (e.g., raising bridge deck); and/or • among climate-proofing options there exist options which deliver net positive economic benefits regardless of the nature and extent of climate change, including the current climate conditions (a no-regretapproach); and/or • the set of climate-proofing options includes options which not only reduce project climate risks, but also have other social, environmental or economic benefits. Co-benefits (if any) should be included in the economic assessment of adaptation options.

31. Types of decisions • A Type 2 decision may be appropriate where: • No climate-proofing investment is needed now, but the project can be designed to accommodate climate-proofing in the future if and when circumstances indicate this to be a better option than not climate-proofing. • Type 2 decisions aim to ensure that aproject is climate ready.

32. Types of decisions • A Type 3 decision may be appropriate where: • costs of climate-proofing now are estimated to be large relative to the expected benefits; and/or • costs (in present value terms) of climate-proofing (e.g. retro-fitting) at a later point in time are expected to be no larger than climate-proofing now; and/or • expected benefits of climate-proofing are estimated to be relatively small. • Both Type 2 and Type 3 decisions may be referred as adaptive management, consisting of putting in place incremental adaptation options over the project’s lifetime.

33. Types of decisions A menu of climate-proofing decisions: A1: Invest now A2: Be ready and invest later if needed A3: Do nothing and invest later if needed Bridge in Bangladesh Khulna Water Supply Most others? Sea dykes in Viet Nam O MON IV

34. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

35. Thought 1 There is no need to adapt cost-benefit analysis to climate change. The general framework of analysis works just fine. However, there is a need to do better cost-benefit analysis. “Cost-benefit analysis is conducted after the decision to go ahead with the project has been made, which puts the analysis under considerable pressure to reach conclusions consistent with the decisions already taken.” World Bank. 2010. Cost-Benefit Analysis in World Bank Projects.

36. Thought 2 The greatest difficulty in conducting an economic analysis of a climate-proofing investment is not with the economics. The greatest difficulty is with the identification of projected changes in climate variables, and then of the physical impacts of these changes on infrastructure. Once these impacts are quantitatively identified, the economic analysis of climate-proofing investment is relatively straightforward. As is ALWAYS the case, the economic analysis of an investment project is a multi-disciplinary exercise which requires the inputs of multiple experts and which is conducted in a context of uncertainty.

37. Thought 3 The type of (simplistic) sensitivity analysis typically conducted in an economic analysis is inappropriate to deal with the uncertainty associated with climate change. There is a need to be considerably more sophisticated with the conduct of economic analysis (e.g. Monte Carlo simulation) to estimate not only the expected NPV of a project but to estimate the probability distribution of that NPV, and assess the risk (the probability) and circumstances under which the project NPV may be negative.

38. Thought 4 We should not confuse the economics of climate-proofing with the financing of climate-proofing. Economics of climate-proofing: Is it good for society to invest in climate-proofing? Financing of climate-proofing: If it is good for society, then where will the money come from?

39. Thought 5 There is a great temptation to increase the capital costs of infrastructure projects to account for climate change by some standardized “climate change adaptation coefficients” (for example, 10%). This temptation should be avoided. Adaptation options and costs are specific to local circumstances and technologies.

40. Thought 6 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).

41. Outline of Presentation 1. On the meaning of “climate-proofing” 2. Costs of climate change vs. benefits of climate-proofing 3. Climate-proofing investments 3.1 Assessing exposure and vulnerability 3.2 On the economics of climate- proofing 3.3 Types of decisions 4. Some thoughts on the nature of the economics of climate proofing investment projects 5. Further resources

46. Further Information All reports available at: http://www.adb.org/climate-change For more information, please contact Mr. Charles Rodgers: crodgers@adb.org

47. On the Economics of Climate-Proofing Infrastructure Investment Projects Presentation by Dr. Benoit Laplante Environmental Economist Consultant Asian Development Bank March 12, 2013