Integrating climate change and natural disasters in the economic analysis of projects: a methodology for stress testing climate disasters and risks – World
To maximize development gains, World Bank projects must take climate change and disaster risk into account in their design and appraisal. Buildings could be exposed to heat waves, roads could be vulnerable to flooding, and farming practices could be prone to drought and pests. Although projects can be simultaneously vulnerable to many of these risks, in most cases it is possible to design and implement projects that are resilient to future climate change and natural hazards. To do this, however, these risks must be considered at every stage of the project cycle.
With increasing attention and awareness of climate change, an increasing share of project documents provide information on the exposure of projects (and the assets they build or upon which they are based) to risks, including through ‘selection exercises. For example, all World Bank projects are subject to a “disaster and climate risk review” to identify possible threats early in project design. However, even when projects identify risks, the economic analysis provided to support the economic viability and desirability of a project does not always take into account the presence of natural hazards. To select the best projects and ensure that they meet expectations, it is important to ensure that all project appraisal and appraisal processes, including economic analyzes, properly take into account all risks. .
This guidance note offers a simple methodology for doing this by adding a stress test for climate change and natural disasters to the economic analysis of a project. Given the uncertainty about future climate change and its impacts, the lack of data (especially in low-income or fragile environments), and the complexity of the many interaction channels through which risk can affect a project, the methodology proposed here is not intended to predict or forecast the effects of climate change and natural disasters. If anything, it could create a false sense of certainty and overconfidence. Instead, it uses ranges for various impacts of climate change and disasters on a project’s costs and benefits and identifies plausible risks to its viability and timeliness. The aim is to help estimate the possibility and consequences of a project failure due to climate change or disaster in order to improve the quality of the project design and provide important information for help decision-makers to assess the attractiveness and economic feasibility of the project.
This stress test methodology was designed to highlight the risks to the long-term project results, taking into account the risks in three dimensions:
Changes in average climatic conditions
Impacts of natural disasters, with current frequency and intensity
Changes in the frequency of disasters due to changes in average climatic conditions.
The stress testing methodology described in this note relates to the World Bank’s Resilience Assessment System (RRS) methodology and provides a tool (see RiST tip 1) and approach to achieve an A rating. for the resilience of a project, the first of the two dimensions covered by the RRS (see World Bank Group 2021).
The results of this analysis should be seen as a stress test of the robustness of the project to ensure that future impacts of climate and natural disasters do not render the projects economically unviable. The purpose of the analysis is to assess whether, under stressors related to climate and natural disasters, the net present value (NPV) of a project or other indicators, such as the benefit-cost ratio ( RAC) or monetary or non-monetary parameters related to poverty or health above an acceptable threshold. The stress testing methodology presented in this guidance note helps work teams identify possible risks to the project, incorporate risk mitigation measures where necessary, provide a template for reporting residual risks, and to inform decision-makers about the robustness of the project.
This methodology can be applied to any project involving an economic analysis, but with a few important caveats. First, it was developed primarily to estimate the risks that climate change and disasters create for a project; for projects whose primary objective is risk reduction, other tools and methodologies may better capture the benefits and co-benefits of risk reduction (Tanner et al. 2018).
The stress testing methodology explained in this note is intended to provide a simplified quantitative analysis to complement the existing economic analysis of a project and highlight important considerations for better resilience. However, it cannot replace detailed technical analysis when catastrophic failure is possible. In particular, projects whose failure could lead to catastrophic losses, such as a large hydroelectric dam, should be subject to a more sophisticated analysis than that proposed here. Finally, the tool is designed for projects that do not already integrate the impacts of climate and disasters in their economic analysis. If a project is already taking into account certain impacts, the tool can be used to improve consideration of climate change and disasters, as long as the impacts are not double counted.