Module 6Costing, assessing and selecting options and measures

Country-led environmental and climate change mainstreaming

Linking policy, costing and budgeting

Mainstreaming of environment and climate change in policies, strategies &

programmes

Identification of environmental integration and climate change adaption

& mitigation options

Costing, assessment and selection of options

Resource allocation: Integration of environmental and climate change

(adaptation & mitigation) measures in budgets

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Tools for costing and assessing

environmental and climate change options

Tools for costing and assessing

environmental and climate change options

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Common types of costs

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Reform measures

Management measures

Infrastructure measures

Transitional costs

Transitional costs

Operational costs

Operational costs

Capital costsCapital costs

e.g. removal of subsidiescosts e.g. training, recruitment, …

e.g. protected areascosts e.g. salaries, recurrent costs…

e.g. sanitation facilitiescosts e.g. construction, ongoing operations…

Valuing the environment: stated-preference methods

• Stated-preference approaches

- Contingent valuation

• Asking respondents how they would behave if a ‘market’ existed: ‘Willingness to Pay’ (WTP) and ‘Willingness to Accept Compensation’ (WTA)

- Choice experiment method

• Questionnaire based on choice over pairs of attributes

• Responses analysed with statistical model5

Valuing the environment: other approaches

• Revealed-preference approaches

- Hedonic pricing method

• Relationship between housing market prices and environmental attributes

• Production-function approaches

- Environment valued as an input to the production of a market-valued good or service, e.g. effects of increased ozone on agricultural crops

- Ecosystem service valuation models

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Many services are public goods

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Fiber

Food

Spiritual & religious

Freshwater

Genetic Resources

Climate regulation

Water purification

Disease regulation

Flood/Fire regulation

Recreation & tourism

Aesthetic

Economic Value ($)

Economic Valuation

Difficult or impossible

Easy

?

?

?

?

?

?

?

?

?

?

?

Classical economy

Source: Based on Mayaux (2006)

Environmental economy

Cost-benefit analysis: identifyingcosts and benefits

Environmental and CC adaptation/mitigation measures

Costs: extra costs incurred compared with the ‘business-as-usual’ scenario, reduced economic growth opportunities

Benefits: -Avoided damage and losses-Extra developmental benefits compared with ‘business-as-usual’ scenario-Energy cost savings-Sales of carbon credits-Positive environmental and related health/livelihoods outcomes (including health expenditures savings)-Strategic and competitive advantage (e.g. organic products)

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Can you think of some

examples?

For environmental measures, internalisation of externalities is a MUST, but can often be complex to achieve

[risk of simplification in detriment of environment]

For environmental measures, internalisation of externalities is a MUST, but can often be complex to achieve

[risk of simplification in detriment of environment]

Value (per hectare)

0

$2000

$4000

Mangrove Shrimp Farm

Coastal Protection (~$3,840)

Timber and Non-timber products ($90)

Fishery nursery ($70)

Net: $2,000 (Gross $17,900 less costs of $15,900)

Pollution Costs (-$230)

Less subsidies (-$1,700)

Restoration (-$8,240)

Mangrove Conversion

Private Net Present Value per hectare

Mangrove: $91

Shrimp Farm: $200019871999

Public Net Present Value per hectare

Mangrove: $1,000 to $3,600

Shrimp Farm: $-5,400 to $200

Source: Millennium Ecosystem Assessment; Sathirathai and Barbier 2001

Source: UNEP

Cost-benefit analysis (1)

• Cost-benefit analysis (CBA):• Quantifies all the costs and benefits (*) of an intervention

(with benefits including both ‘positive’ benefits and avoided losses) over the entire lifetime of the intervention

• A ‘discount rate’ is applied to all costs and benefits to represent ‘preference for the present’ or simply the opportunity cost of capital -> calculation of ‘present value’

• The higher the discount rate, the smaller the present value

• The further away in the future, the smaller the present value

• Significant controversies over the ‘right’ discount rate for assessing long-term options

(*) Actually the ‘incremental’ costs and benefits, i.e. the difference in costs/benefits between a ‘with intervention’ and a ‘no intervention’ scenario

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Cost-benefit analysis (2)

Outputs of cost-benefit analysis:

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Cost-benefit ratio (CBR)

Net present value (NPV)

Internal rate of return (IRR)

Ratio of costs to benefits calculated at their present value (the smaller,

the better – should be <1)

Benefits minus costs calculated at their present value (the larger, the

better)

The discount rate at which NPV = 0 A measure of the ‘benefit-generating power’ of the option or intervention

(the larger, the better)

CBA example: wind farm (1)

• Small-scale wind farm in scenic area• Initial construction costs: $750,000• Construction time: 1 year• Annual maintenance costs: $5,000• Life-span on project: 15 years• Dismantling and site restoration costs: $35,000• Market value of electricity produced: $150,000/yr• Results of contingent valuation study (visual impact):

• Mean annual compensation demanded: $25/household• 2,000 households affected

• Discount factor: 6%• Annual costs: $55,000 ($25 x 2000 + $5000)

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Source: Hanley et al (2013)

Year Discount factor (1.06)-t

Benefits ($)

Present value of

benefits ($)

Costs ($)

Present value of costs ($)

0 1 0 750,000 750,000

1 0.9433 150,000 141,495 55,000 51,881

2 0.8899 150,000 133,485 55,000 48,944

3 0.8396 150,000 125,940 55,000 46,178

4 0.7921 150,000 118,815 55,000 43,565

5 0.7472 150,000 112,080 55,000 41,096

6 0.7049 150,000 105,735 55,000 38,769

7 0.6650 150,000 99,750 55,000 36,575

8 0.6274 150,000 94,110 55,000 34,507

9 0.5918 150,000 88,770 55,000 32,549

10 0.5583 150,000 83,745 55,000 30,706

11 0.5267 150,000 79,005 55,000 28,968

12 0.4969 150,000 74,535 55,000 27,329

13 0.4688 150,000 70,320 55,000 25,784

14 0.4423 150,000 66,345 55,000 24,326

15 0.4172 150,000 35,000 14,602

Total discounted benefits/costs

1,394,130 1,275,77913

Source: Hanley et al (2013)

Cost-effectiveness analysis

• Costs valued in monetary terms, and benefits quantified in ‘physical’ units over the entire lifetime of the intervention; a discount rate is applied to both

• Allows calculating unit costs, as the ratio of total discounted costs to total discounted benefits obtained

• The obtained unit costs support:

• comparison of several options

• comparison with ‘benchmark costs’ for similar interventions

• CEA suitable where difficult to assign monetary value to benefits• But requires identifying a single, all-encompassing measure of benefits

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Illustration of CEA: Global GHG abatement cost curve

Source: McKinsey (2009), Exhibit 8, p. 17

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Example: land-based mitigation options

Forests

Net sink (tree biomass + soil organic matter)

PeatlandsLargest & most

efficient terrestrial store

of carbon biomass

Grasslands

Net carbon sink if not degraded

Cultivated systems

Both a sink and a source of GHGs,

net balance depends on cultivation methods

Atmosphere

CO2

CO2

CH4

N2O

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Significant mitigation potential

for developing countries

Typically cost-effective and requiring low

upfront investment

Improved ecosystem management also supports adaptation

Basis for public sector decision

making

Basis for private sector

decision making

Financial and economic analysis

• Both CBA and CEA support:

• financial analysis: considers the ‘monetary’ costs and benefits (or equivalent) accruing to parties directly concerned by a project or programme, at their ‘face value’

• economic analysis: broadens the analysis to more accurately reflect costs and benefits to society

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Complementary tools

• For the assessment of robustness and the integration of uncertainty, CBA/CEA can be combined with:• the use of multiple scenarios (e.g. ‘no change’ scenario

and various climate change and development scenarios)

• sensitivity analysis (i.e. testing of the effect of changes in scenario assumptions on the CBR, NPV, IRR or unit costs)

• risk analysis (-> risk probability analysis includes the probability of occurrence of various cost and benefit outcomes in calculations... assuming probabilities are known) 18

Tools for prioritising and selecting measuresTools for prioritising and selecting measures

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Supporting decision making

• CBA/CEA support the financial and economic assessment of options• They help identify measures that offer the best ‘value for

money’ – a key aspect in situations of budgetary constraints

• Other types of assessment and other criteria (e.g. technical, social, environmental) are required to fully inform decision makers

• Must take into account pro-poor implications

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Multi-criteria analysis (MCA) helps integrate various criteria

Multi-criteria analysis (1)

• An approach to decision support that uses more than one criterion to assess performance and rank various options or interventions

• The term actually covers a wide range of methods• Typically:

• various options or interventions are assessed against a pre-determined set of criteria

• qualitative ratings or quantitative scores are given• rules are then applied to rank options/interventions

• Numerical scores can be added up to calculate a total score (with the possibility of applying different weights to different criteria)

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Multi-criteria analysis (2)

• MCA is a useful complement to CBA/CEA• Allows combining financial/economic criteria with

technical, environmental and social ones• It can be used on its own, or in combination with

CBA/CEA:

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MCA before CBA/CEA

MCA after CBA/CEA

Allows reducing the number of options to which CBA/CEA is

applied

CBA/CEA helps eliminate financially or economically unviable options, then MCA

allows for final selection based on extra criteria

Multi-criteria analysis: example

• How to analyse environmental consequences of integrated farming vs organic farming

• Possible criteria:• Emissions of NH3 at air causing acidification

• Losses of NO3- causing groundwater pollution

• Losses of biocides causing toxicity issues

Potatoes (hypothetical ex)

Nitrates(kg/yr)

Ammonia(kg/yr)

Biocides(kg/yr)

Integrated farming 4.1 0 0.4

Organic farming 5.3 1.0 0

We need weighing and criteria to make a decision!

Source: Kroeze and Fortuin (nd)

• Criteria have different dimensionse.g. cost, deposition levels, area of damage

• Criteria differ in weighte.g. critical loads for acidification may be exceeded to a larger extent than targets for eutrophication

• Weights depend on ‘vision’e.g. some problems may be prioritised over others

• Qualitative and quantitative information

Multi-criteria analysis: example (2)

Source: Kroeze and Fortuin (nd)

Example of MCA grid

Option Effective-ness

Cost Technical feasibility

Social & cultural

acceptability

Env’l impacts

Total score

Option 1

Option 2

Option 3

Option 4

Scores: from 1 (poorest performance) to 4 (highest performance). As far as cost is concerned, a scale should be established, with scores corresponding to a given cost range or cost/unit range.

Adapted from USAID (2007), Exhibit 12, p. 1825

Example of MCA grid (2)

Objective Weights Project option 1

Project option 2

Project option 3

Reducing flood damage

x3 4 3 5

Reducing extension of flooded area

x2 5 3 0

Gaining land for agriculture

x1 3 2 -2

Maintaining groundwater level

x1 -3 -2 0

Securing livelihood of fishery communities

x1 -4 -3 2

Preserving biodiversity x2 -3 -2 -1

Total score 2 1 4

Turning words into action

Costing, assessing and selecting environmental and climate change adaptation & mitigation options and measures

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What can be done and what are the institutional and capacity needs in

your country/sector of responsibility?

Recap – Key messages

• Cost-benefit analysis and cost-effectiveness analysis support the identification of financially and economically viable adaptation and mitigation options/measures• Help prioritise actions based on financial/economic

criteria

• Multi-criteria analysis, used alone or in combination with CBA or CEA, supports the assessment and prioritisation of options based on multiple criteria• Technical, environmental and social criteria can be

considered alongside financial/economic ones

• Pro-poor implications must be taken into consideration when prioritising measures 28

Key references

• Economics of Climate Adaptation Working Group (2009) Shaping climate-resilient development: a framework for decision-making. Climate Works Foundation, Global Environment Facility, European Commission, McKinsey & Company, The Rockfeller Foundation, Standard Chartered Bank & Swiss Re. Available from: http://www.mckinsey.com/clientservice/Social_Sector/our_practices/Economic_Development/Knowledge_Highlights/Economics_of_climate_adaptation.aspx

• MDG Needs Assessment Tools:http://www.undp.org/

• World Bank – Economics of Adaptation to Climate Change web pages: http://climatechange.worldbank.org/content/economics-adaptation-climate-change-study-homepage

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References

• Hanley, N; Shogren, J and White, B (2013) Introduction to Environmental Economics. 2nd edition, Oxford University Press: Oxford.

• Kroeza, C and Fortuin, K (nd) Multi Criteria Analysis. Environmental Systems Analysis presentation, Wageningen University, The Netherlands.

• Mayaux, P (2006) Millennium Ecosystem Assessment: overview of findings. Institute for Environment and Sustainability, Joint Research Centre; Ispra, Italy. Presentation made at AIDCO, Brussels, 26 June, 2006 (Dejeuner su l’herbe conferences).

• McKinsey & Company (2009) Pathways to a Low-Carbon Economy: Version 2 of the Global Greenhouse Gas Abatement Cost Curve. Available from: http://www.mckinsey.com/globalGHGcostcurve

• MillenniumProject (2004) Millennium Development Goals Needs Assessment Methodology. Available online from: http://www.unmillenniumproject.org/ [Accessed 20 February 2013]

• UNDP MDG Needs Assessment Tools, available from:

http://www.undp.org/content/undp/en/home/librarypage/poverty-reduction/mdg_strategies/mdg_needs_assessmenttools/mdg_needs_assessmenttools.html

• USAID (2007) Adapting to Climate Variability and Change: A guidance manual for development planning. United States Agency for International Development, Washington, DC. Available from: http://pdf.usaid.gov/pdf_docs/PNADJ990.pdf

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