Decision tools for adaptation to climate change: Portfolio analysis of tea plantation investments in Rwanda

Climate change produces new challenges to the development strategies of the most vulnerable countries, where there is urgent need of effective adaptation policies. However, the uncertainty about the expected costs of climate change and about the benefits of adaptation hampers the design and the implementation of adequate measures. Alternative decision-support tools and decision strategies can be adopted by policy makers and the private investors. In this paper, we assess the effectiveness of Portfolio Analysis (PA) as a decision-support tool for adaptation strategies under different climate change scenarios. PA effectiveness is explored in the context of tea plantation investments in Rwanda. Tea is a key commodity for the Rwandan economy, and the agriculture sector is one of the most negatively affected by climatic changes, especially in developing countries. It is a perennial crop, for which investments have high sunk costs and economic returns are highly sensitive to changes in the average temperature and in rainfall distributions. Thus, returns on investments in new tea plants are affected by high climate-induced uncertainty. PA aggregates different investment options into portfolios, instead of considering a single option, and allows identification of an efficiency frontier of best portfolios in terms of tradeoff between economic efficiency (expected net present value) and risk (variance of the economic performance). In spite of its advantages, PA remains rarely used in climate change adaptation analysis. In this paper we show how PA can be performed in practice when evaluating adaptation investments against different climate change scenarios. The results show that, using PA, new possible allocations of resources emerge, identifying alternative investment solutions with a better trade-off between economic return and risk. PA here emerges as an effective tool in designing long-term investments in the agriculture sector, robust to the complex and uncertain effects of climate change. A Sensitivity analysis of the results to different social discount rates and different climate change scenarios suggests how these two factors can be relevant for the choice of investment portfolios.