Assessing the cost-effectiveness of Nature-based Solutions under climate change uncertainty and learning

While ongoing climate change requires effective adaptation strategies, decision-making on the scale, timing and location of adaptation measures remains challenging, as the extent and pace of climate change is uncertain. In particular, uncertainty surrounds the success of mitigation strategies and economic and demographic developments. While 'grey' measures, such as dikes and pumping, have been the dominant form of adaptation in the past against inland flooding, Nature-based Solutions are receiving more attention. However, evidence on their cost-effectiveness compared to grey alternatives is still limited. In this article, we develop a real options model that integrates climate change uncertainty as well as flexibility of the timing of investment. We expect that the uncertainty falls over time due to an increase in climate data that becomes available to the decision-maker. The decision-maker learns about climate change from two types of events: inland flooding and meteorological drought. The model is calibrated with data from the Oldambt-Eemskanaal-Dollardboezem water system in the Dutch Province of Groningen. Our results show the potential for Nature-based Solutions to become a viable alternative to dike heightening and pumping in addressing both extreme events. Moreover, we observe that the cost-effectiveness of Nature-based Solutions depends on the maturing time of the ecosystem, the value of land on which the measure is being implemented, and the type of information considered in the investment decision. We show that maturing times of up to nine years make a Nature-based Solution the preferred measure to invest in, even under strong beliefs of severe climate change. When maturing times exceed nine years, the option takes too long to become effective and pumping is preferred. Furthermore, our results show that an increase in the value of land on which a Nature-based Solution is being constructed may substantially reduce its cost-effectiveness. Finally, decision-making flexibility becomes valuable if expected damages from floods and droughts are sufficiently low and the decision-maker learns quickly about climate change.