Real options for adaptive decisions in primary industries

Abstract The long term sustainability of Australian crop and livestock farms is threatened with climate change and climate variability. In response, farmers may decide to (1) adjust practices and technologies, (2) change production systems, or (3) transform their industries, for example, by relocating to new geographical areas. Adjustments to existing practices are easy to make relative to changes to production systems or transformations of an industry. Switching between production regimes requires new investments and infrastructure and can leave assets stranded. These changes can be partially or wholly irreversible but hysteresis effects can make switching difficult and mistakes costly to reverse. ‘Real options’ is a framework to structure thinking and analysis of these difficult choices. Previous work has demonstrated how real options can be applied to adaptation, and extends traditional economic analyses of agricultural investment decisions based on net present values to better represent the uncertainty and risks of climate change. This project uses transects across space as analogues for future climate scenarios. We simulate yields from climate data and draw on data from actual farms to estimate a real options model referred to as ‘Real Options for Adaptive Decisions’ (ROADs). We present results for the transformation of wheat dominant cropping systems in South Australia, New South Wales, and Western Australia. We find that farmers’ decisions, as much as a changing climate, determine how agriculture will be transformed. Please cite this report as: Hertzler, G, Sanderson, T, Capon, T, Hayman, P, Kingwell, R, McClintock, A, Crean, J, Randall, A 2013 Will primary producers continue to adjust practices and technologies, change production systems or transform their industry – an application of real options,  National Climate Change Adaptation Research Facility, Gold Coast, pp. 93. The long term sustainability of Australian crop and livestock farms is threatened with climate change and climate variability. In response, farmers may decide to (1) adjust practices and technologies, (2) change production systems, or (3) transform their industries, for example, by relocating to new geographical areas. Adjustments to existing practices are easy to make relative to changes to production systems or transformations of an industry. Switching between production regimes requires new investments and infrastructure and can leave assets stranded. These changes can be partially or wholly irreversible but hysteresis effects can make switching difficult and mistakes costly to reverse. ‘Real options’ is a framework to structure thinking and analysis of these difficult choices. Previous work has demonstrated how real options can be applied to adaptation, and extends traditional economic analyses of agricultural investment decisions based on net present values to better represent the uncertainty and risks of climate change. This project uses transects across space as analogues for future climate scenarios. We simulate yields from climate data and draw on data from actual farms to estimate a real options model referred to as ‘Real Options for Adaptive Decisions’ (ROADs). We present results for the transformation of wheat dominant cropping systems in South Australia, New South Wales, and Western Australia. We find that farmers’ decisions, as much as a changing climate, determine how agriculture will be transformed