From Drought to Ice Roads To Sea Ice: A New Approach to Assessing and Pricing the Combined Costs of Climate Trend and Variance

Abstract: Both climate trend and variance affect costs and decisions associated with a warming climate, but the majority of analyses to date focus on trend. This focus on trend may be due to the limited tools available for assessment of their combined impact. Using the business concept of “expected costs,” I demonstrate a way in which their interrelated impacts can be assessed. I first use an statistical approach that requires long (50 to 100 years) climatic time series, but since such series are often unavailable, we show how the Black- Scholes Option Pricing formula (widely used in finance) can be adapted for the same purpose and used with climate series of more limited length. I then demonstrate the method by applying it to the problem of the on-going California drought, pricing the cost of run-off variance and the economic value of increased reservoir capacity, given current climatic trends. Next I apply the method to the question of building ice roads in the Northwest Territories of Canada, where a strong negative (warming) trend is underway. I then discuss how this technique can be applied using climate modeling in the Arctic waterways.  Finally, I will provide a few other options around the globe to demonstrate the broad applicability of this approach. Using this new approach it is possible to generate quantitative and actionable information of practical use, particularly in cases where both the mean state and variance are changing.