Integrating Climate Change and Natural Disasters in the Economic Analysis of Projects: A disaster and climate risk stress test methodology – World

Stephane Hallegatte
Rubaina Anjum
Paolo Avner
Ammara Shariq
Michelle Winglee
Camilla Knudsen

1. Introduction

To maximize development gains, World Bank projects must consider climate change and disaster risks in their design and appraisal. Buildings could be exposed to heat waves, roads might be vulnerable to floods, and agricultural practices may be subject to drought and pests. Although projects can be simultaneously vulnerable to several such risks, in most cases, it is possible to design and implement projects that are resilient to future climate change and natural risks. Doing so, however, requires these risks to be considered at each step of the project cycle.

With growing attention to and awareness of climate change, an increasing share of project documents provide information on the exposure of the projects (and the assets they build or rely on) to risks, including through screening exercises. For example, all World Bank projects undergo a “disaster and climate risk screening” to identify possible threats at the early stages of project design. However, even when projects identify risks, the economic analysis provided to support a project’s economic viability and desirability do not always consider the presence of natural risks. To select the best projects and ensure they deliver as expected, it is important to ensure that all project appraisal and assessment processes—including economic analyses—properly consider all risks.

This guidance note proposes 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 on future climate change and its impacts, the lack of data (especially in lowincome or fragile environments), and the complexity of the many interacting channels through which risk can affect a project, the methodology proposed here does not aim to predict or forecast the effect of climate change and natural disasters. If anything, doing so could create a false sense of certainty and overconfidence. Instead, it uses ranges for various impacts of climate change and disaster on a project’s costs and benefits and identifies plausible risks for its viability and desirability. The goal is to help estimate the possibility and consequences of a project failing due to climate change or disaster to improve the quality of project design and provide important information to help decision makers assess project attractiveness and economic feasibility.

This stress testing methodology has been designed to highlight risks to project outcomes over long time horizons, accounting for risks along three dimensions:

1. Changes in average climate conditions

2. Impacts from natural disasters, with current frequency and intensity

3. Changes in the frequency of disasters due to changes in average climate conditions.

The stress testing methodology described in this note is linked to the World Bank’s Resilience Rating System (RRS) methodology and provides a tool (see RiST tool tip 1) and approach to obtain an A rating for resilience of a project, the first of two dimensions covered by the RRS (see World Bank Group 2021).

The results of this analysis should be considered a stress test of project robustness to ensure that future climate and natural disaster impacts do not make projects economically unviable. The purpose of the analysis is to assesses whether, under climate and natural disaster stressors, a project’s net present value (NPV) or other indicators—such as benefit-cost ratio (BCR) or poverty or health-related monetary or nonmonetary metrics— remain above an acceptable threshold. The stress testing methodology presented in this guidance note helps task teams identify possible risks to the project, incorporate risk mitigation measures where necessary, provide a template for reporting on residual risk, and inform decision makers on project robustness.

Caveats

This methodology can be applied to any project that has an economic analysis, but with some important caveats. First, it has been developed primarily to estimate the risks that climate change and disasters create for a project; for projects with risk reduction as their primarily objective, 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 meant to provide a simplified quantitative analysis to complement a project’s existing economic analysis and highlight important considerations for improved resilience. It cannot, however, replace detailed engineering analysis when catastrophic failure is possible. In particular, projects whose failure could lead to catastrophic losses—for example, a large hydropower dam—should conduct a more sophisticated analysis than the one proposed here. Finally, the tool is designed for projects that do not already incorporate climate and disaster impacts in their economic analysis. If a project already accounts for some impacts, the tool can be used to enhance consideration of climate change and disasters, as long as impacts are not double counted.