Environment Agency: Water Resources Management Planning -- Real Options Analysis

Fri Mar 30 16:24:38 EDT 2012
By Dr. William Baker, Thomas Ash, and Nanthawit Sukthaworn with Dr. Gregory Hamm

This NERA paper, developed for the UK Environment Agency, provides an overview of real options analysis, an approach to decision-making that formally recognizes uncertainty and examines how current decisions limit or expand our ability to learn and react in the future. The authors demonstrate that there are many water supply demand decisions in England and Wales which exhibit the flexibility, uncertainty, and learning characteristics necessary to make real options thinking valuable above and beyond deterministic and probabilistic single-plan approaches. They explain how real options thinking  may be applied in optimising at least three types of decisions in water-planning in England and Wales: in the formation of water company long-term supply demand plans, as documented in the Water Resource Management Plan (WRMP) and the Supply Demand Balance (SDB) submissions; in the examination of the merits of undertaking an individual scheme, within the prevailing WRMP context; and in decisions on water operations, such as optimizing control curves for use of stored water, or for instigation of a hosepipe ban. The paper includes examples showing the benefits of real options thinking using water company data in hypothetical situations involving demand and/or uncertainty over the costs of new resources. Although the costs, public and regulator unfamiliarity, and lack of staff skills and experience are all significant potential barriers to the adoption of probabilistic methods and, specifically, real options analysis, the authors believe that these barriers can be addressed through training and communications, and demonstration projects.