Download all Technical Policy Briefing Notes in a single ... - Mediation

Key Messages• There is increasing interest in the appraisal ofoptions, as adaptation moves from theory topractice. In response, a number of existingand new decision support tools are beingconsidered, including methods that addressuncertainty.• The FP7 MEDIATION project has undertaken adetailed review of these tools, and has testedthem in a series of case studies. It hasassessed their applicability for adaptation andanalysed how they consider uncertainty. Thefindings have been used to provideinformation and guidance for the MEDIATIONAdaptation Platform and are summarised in aset of policy briefing notes.• One of the tools recommended for adaptationis Real Options Analysis (ROA). Optionsanalysis derives from the financial markets,where it has been used to assess thevaluation of financial options and risk transfer.The same insights are also useful when thereis risk or uncertainty involved with investmentin physical assets, hence ‘real’ options• Real Options Analysis quantifies theinvestment risk associated with uncertainfuture outcomes. It is particularly useful whenconsidering the value of flexibility ofinvestments. This includes the flexibility overthe timing of the capital investment, but alsothe flexibility to adjust the investment as itprogresses over time, i.e. allowing a project toadapt, expand or scale-back in response tounfolding events. The approach can thereforeassess whether it is better to invest now or towait – or whether it is better to invest inoptions that offer greater flexibility in thefuture.• ROA has considerable potential foradaptation, and aligns with the concepts ofiterative adaptive (risk) management,providing a means to undertake economicappraisal of future option values the value ofinformation and learning, and the value offlexibility, under conditions of uncertainty. Itcan therefore justify options (or decisions) thatwould not be taken forward under aconventional economic analysis.• The application to adaptation has often useddynamic programming, which is an extensionof decision-tree analysis. This definespossible outcomes and decision points, andassigns probabilities and estimates expectedvalues.• The review has considered the strengths andweakness of ROA for adaptation. The keystrength of the approach is the information itprovides on large investment decisions,allowing economic analysis of the benefits ofinformation and flexibility under conditions ofuncertainty. The use of decision trees alsoprovides a useful way to visualise the contextof adaptive management. The maindisadvantage relates to the complexity of theformal economic approach, which is likely toneed expert application and significantresources, and the need to input probabilitiesand multiple risk points for climate change.• Previous applications of ROA for adaptationhave been reviewed, and adaptation casestudies are summarised. The majority ofapplications to date have been for largecoastal protection projects, though there isalso an application for large water projects.• The review and case studies provide usefulinformation on the types of adaptationproblem types where ROA might beappropriate, as well as data needs, resourcerequirements and good practice lessons. Thisidentifies that ROA is most useful for largecapital investments (project level), especiallywhere there is a large adaptation deficit or asignificant potential for learning or flexibility. Italso requires good quality data on climaterisks and cost/benefit components. Given thehigh resource requirements, the review alsoidentifies the potential for more informalapplication of ROA, e.g. through the use ofdecision trees and more qualitative analysis ofinformation and flexibility.