Economics of Making Roads Resilient to Climate Change: Use of Discounted Cash Flow and Real Options Analysis

An increase in the number of extreme weather events and gradual shifts in climate parameters due to a changing climate pose a serious threat to the nation’s roadway infrastructure. A systematic approach is needed to define risks and assess consequences of climate change, consider the uncertainties, rank priorities, and initiate an adaptation strategy in a cost effective manner. The objective of this study is to develop a framework that could be used to assess the impact of climate change on pavements in a rational way using either the Net Present Value (NPV) or the Real Option (RO) approach, to compare several options and to make the most prudent decision regarding selecting an option, and the time of adopting that specific option. The NPV approach will generally go against investment for cases with high uncertainty, even if they are very promising, and does not take into account the flexibility or decisions that could be implemented on the basis of changing conditions. In contrast, the RO method offers a flexible deferment option when the uncertainties regarding outcomes are resolved to a certain extent. A framework with a step-by-step method for evaluating the feasibility of building roads that are resilient to a changing climate is presented, along with an example. The worked out example shows that there could be considerable value in using RO analysis, and this value can be leveraged to develop better economic policies for building roads that are resilient to a changing climate