Real Options as a Decision-making Tool in Climate Finance Evaluated with a Case Study on CCS

Abstract

Climate action is a challenging task and uncertainties in climate science make decision making extremely difficult. In this paper we evaluate the role that Real Options can play in helping decision making towards climate action. It also looks into whether evaluation via Real Options — keeping uncertainties in mind — will be a sensible choice from a broader macroeconomic viewpoint. While no single measure may alone be sufficient for climate change mitigation, Carbon Capture and Sequestration/Storage (CCS), along with energy efficiency improvements, renewable energy, enhancement of biological sinks, and other measures, may be able to achieve the emissions reductions needed to achieve climate stabilization. In addition, there will be important decisions in climate adaptation areas too, further adding to the complexities of decision making for climate action. In this paper, a normative case study is incorporated to determine the cost of CCS action in India. While arriving at the costs, a provision for the financial risk of storage has also been added. Given the costs, Real Options analysis is undertaken to arrive at a decision. The Real Options valuation is done using the Black-Scholes method. Ultimately, the Real Options framework is scrutinized from a broader macroeconomic perspective to understand its suitability for a more dynamic global economy as well as the effects of large climate funds on the framework, including how important a decision-making framework like Real Options is for a sustainable world.