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National Adaptation Plan (NAP) Country-level training

Supported By In cooperation with

Session 7Appraising Adaptation Options

Presented by Nat Pinnoi, Ph.D.Private Sector Finance Specialist

UNDP Bangkok Regional Hub

Slide 2

Overview of this module

The module will:

• Inform stakeholders on the role of cost benefit analysis (CBA) in the appraisal of adaptation options (or projects)

• Introduce policy makers to the usefulness of cost benefit analysis

• Highlight the limitations of CBA in the appraisal of adaptation options

• Provide resources and references that can serve as a reference point

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What can you expect to learn from this session?

• Reflect on the need for ranking and prioritizing adaptation options that emerge as equally plausible form in the NAP process

• Understand the steps involved in carrying out a Cost Benefit Analysis (CBA) of options (at the project level)

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What can you expect to learn from this session?

• Reflect on the potentials and limits of CBA for appraising adaptation options

• Learn how you can use CBA practically in the context of the core elements of the NAP process

• Understand that the choice of the discount rate and the expected climate damage significantly influence the result of a CBA 

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The role of CBA in the NAP process

The NAP process typically involves four elements: (A) Laying the groundwork and addressing gaps (B) Preparatory elements (C) Implementation strategy (D) Reporting, Monitoring and Review.

CBA is an important tool in helping countries at (B) and (C) stages and helps to narrow down gaps in (A), especially the stocktaking

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The role of CBA in the NAP process

Some of the areas where CBA becomes valuable in the process include:

• Assessing climate vulnerabilities and identifying adaptation options at different levels

• Prioritizing adaptation options in national planning

• M&E – theories of change and impact evaluation

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Economic tools for ranking and prioritization of adaptation options

Source GIZ (2013)

Slide 8NAP country-level training

CBA in Action

01/05/2023

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Objective ways to know we are maximizing benefits

• Evaluating distinct but equally plausible adaptation options (or measures) requires a CBA of each alternative option

• This will allow an objective comparison to be made between the options. This module will focus on comparisons on a project basis.

• For adaptation options that have implications on entire sectors, more complicated analysis such as Input-Output and/or General Equilibrium Model is required to see how entire economic systems are affected. This can be done at many levels – a sector by sector, an inter-sectoral approach or a sub-sector by sub-sector

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Objective ways to know we are maximizing benefits

Example of project analysis under uncertainty: • Under Business as Usual, suppose a low dam costs $1 billion, a high

dam costs $1.5 billion and with current climate, a low dam has benefits of $1.2 billion and high dam of $1.6 billion low dam is better with $200 million net gain vs. $100 million net

gain from high dam [B/C of low vs. high dam under Business as Usual = ??]

• Because of CC, more intense precipitation is expected, suppose benefit of low dam rises to $1.3 billion and benefit of high dam rises to $2 billion high dam now better option with $500 million net gain vs. $300

million net gain form low dam [B/C of low vs. high dam under CC scenario = ??]

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Cost benefit analysis: intro - I

• When making a decision, esp. in the public sector, trade-off analysis is inevitable. Costs and benefits of an action and / or inaction need to be understood for policy decisions.

• Add up costs and add up benefits; if net benefits are positive: do the project!

• Simple, right?

• Not quite! Issue of measurement of costs and benefits.

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Cost benefit analysis: intro - II

• Often times, costs are simpler to figure out – tend to be one-off and are market transactions e.g. one time cost of constructing an irrigation system

• Benefits can be trickier e.g.: How do we calculate the market (e.g. wealth) and non-market (e.g. health) benefits over time?

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CBA: 8 suggested steps

1. Define the scope of analysis

2. Identify all potential impacts of the project

3. Quantify the predicted impacts

4. Monetize impacts

5. Discount rate to find present values of costs and benefits

6. Calculate the net present value (NPV)

7. Perform expected value and/or sensitivity analysis

8. Make recommendations

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Time preference and discounting – I • When determining the optimal allocation of resources over

time, one must deal with time preferences.

• CBA requires consideration of stream of benefits over time against costs which incur largely today (e.g. install irrigation system that is expected to be useful over x years).

• The problem is that the value of money does not stay constant over time. Do you want to get $100 today or $110 in ten years from now?

• Also, most individuals prefer to receive benefits now as opposed to receiving the same level of benefits in future (i.e. they have positive time preferences).

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Time preference and discounting – II

So, we need a system:

• The discount rate (value between 0 and 1) is a product of society’s time value of money (composed of the pure rate of time preference and the goods discount rate) [closer to 0: future is more important; closer to 1: today is more important].

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Discounting: How do we do it?

• Use this formula to convert all future values to present values:

• PV = FV(t) / (1+r)t

Where

• FV is expected future value• r is the discount rate (value

between 0 and 1)• t is time.

• Example: How much is $100000 in 30 years worth today? Try it using different values for r!

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

$80,000

$90,000

$100,000

The impact of a discount rate on present value estimates

Year

Valu

e

15%

12%9%

6%

3%

Source GIZ (2013)

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Potentials and limits of CBA within the NAP process – I

• CBA works best when it is possible to estimate both the market and non-market values of all benefits that accrue.

• It is a systematically estimated analysis that provides a key piece of information to facilitate a decision. It is not meant to be used as the sole decision-criteria.

• If properly executed, CBA enables comparison, in equal terms, the investments that have to be made today with benefits that accrue over time.

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Potentials and limits of CBA within the NAP process - II

• The major limitations of a CBA is that not all costs and benefits can be quantified in monetary terms.

• The discount-factor can matter in the final analysis.

• Need to also account for uncertainty over time. Can use sensitivity analysis to capture some uncertainty.

• Within the NAP process, results from CBA can be used as one of the ways of evaluating and ranking adaptation options after they have been identified. Political, social and other considerations will also matter along with economic considerations.

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Exercise: CBA

• The case developed for the exercise is the construction of a new irrigation scheme including a dam construction for agricultural production. This is considered a measure for adapting to increasing water scarcity from climate change.

• The CBA accounts cost and benefits of the project over a period of 25 years. • The CBA is conducted under certain assumptions. Discount rate (value between 0 and 1): A product of society’s time value of money (composed of the pure rate of time preference and the goods discount rate) [closer to 0: future is more important; closer to 1: today is more important].

Climate damage: The reduction of benefits through damages from CC. In the case construction of the exercise it is assumed that the total agricultural benefits are reduced through negative impacts on the yields despite the irrigation measures.