Climate Resilience and Benefit–Cost Analysis: A Handbook for Airports (2019)

Below is the uncorrected machine-read text of this chapter, intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text of each book. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.

113 The federal government has published general guidelines for conducting benefit–cost and cost-effectiveness analyses for federal programs under Office of Management and Budget (OMB) Circular No. A-94 (U.S. Office of Management and Budget 1992). This document serves as a checklist to ensure that all relevant elements of a proper BCA (or cost-effectiveness analysis) have been addressed. It also provides specific guidance on discount rates that are to be used in evaluating programs where benefits and costs are distributed over time. (Appendix C of this circular is updated annually and provides current discount rates for cost-effectiveness, lease purchase, and related analyses.) The guidelines in this document are directly relevant to the current study because airports seeking to obtain AIP funds for investment projects must be in compliance with the guidelines. Circular A-94 contains specific guidance on a number of topics relevant to a public invest- ment project, including: • Identifying and measuring benefits and costs, • Treatment of inflation (real or nominal values), • Discount rates, • Treatment of uncertainty, including expected values and sensitivity analysis, • Incidence and distributional effects (i.e., who is affected), and • Special guidance for public investment analysis. The FAA’s BCA guidance document (FAA 1999b) is consistent with OMB Circular A-94 and is tailored to airport investment projects under AIP. The explicit purpose of this document is to “provide clear and thorough guidance to airport sponsors on the conduct of project-level benefit–cost analysis (BCA) for capacity-related airport projects” (FAA 1999b, p. 1). The FAA takes a broad view of what qualifies as a “capacity project,” which is determined via concur- rence with FAA’s Office of Airport Planning and Programming. The FAA identifies capacity projects as “development items that improve an airport or system of airports for the primary purpose of accommodating more passengers, cargo, aircraft operations or based aircraft” (FAA 2000). Currently, it is FAA policy that a BCA is required if the sponsor is requesting more than $10 million in discretionary funding over the life of the project, although the FAA may require a BCA for smaller projects as appropriate. As such, it is quite likely that most large climate adapta- tion investments being considered would require a formal BCA. The FAA document provides comprehensive guidance on how to perform a BCA and includes instructions for the following: • Defining project objectives, • Specifying assumptions, • Identifying the base case, A P P E N D I X G FAA Guidance on Benefit– Cost Analysis

114 Climate Resilience and Benefit–Cost Analysis: A Handbook for Airports • Identifying and screening reasonable investment alternatives, • Determining the appropriate evaluation period, • Establishing reasonable level of effort, • Identifying, quantifying, and evaluating benefits and costs, • Comparing benefits and costs of alternatives, • Performing a sensitivity analysis, and • Making recommendations (FAA 1999b). Certain elements of the guidance contained in OMB Circular A-94 and the FAA’s BCA guid- ance document are particularly relevant in the context of analyzing climate change effects, and these are discussed in the following. Description of the Project Defining the project base case and scenario case(s) correctly is important to developing technically correct BCAs. To do this, decision makers should be able to answer the following questions: 1. What is the primary objective of the proposed project? As noted in the FAA guidance document, the objective should be identified in the context of specific problems or needs at the airport (FAA 1999b). It is important not to mistake the objective with the proposed plans for meeting that objective. In the present case, there are several types of objectives that could arise in light of climate change risks and uncertainties: – Mitigate delays or closures, – Mitigate damage to existing infrastructure and property, – Improve efficiency of airport operations, and – Improve airport safety and security. Correctly identifying the objective makes it easier to identify the base and scenario cases as well as the benefits and costs of the adaptation. 2. What is the best way to project the future airport environment? The benefit–cost estimates of most airport projects will depend on the assumptions made about the future airport environment. The most important component of these assumptions is typically the projected growth in airport activity. However, in the present context, another important component is the exposure of specific airport infrastructure to climate risk. Answering this question requires working through the processes described in prior chapters, identifying likely climate stressors, listing vulnerable and critical exposures, quantifying potential impacts, and identifying potential adaptations and responses. 3. How should the base case be specified? The base case is a reference point representing what is expected to occur if the proposed project is not undertaken. It is important to correctly identify the base case. In particular, it is almost never correct to identify the base case as a do-nothing course of action. Assuming such a static base case will almost certainly lead to an overstatement of the net benefits of a proposed project. This is particularly true in the case of climate resilience analyses, where the relevant time period for analyzing benefits and costs may be quite long. As noted in the FAA BCA guidance document, the base case “must assume optimal use of existing and planned airport infrastructure . . . ; it must also incorporate reasonable expecta- tions of corrective actions by airport managers, users, and air traffic managers” (FAA 1999b) to mitigate identified airport problems or needs in the absence of a proposed project. In the present context, it will be important to identify existing or proposed adaptations (in opera- tions or infrastructure) that should be included in the base case.

FAA Guidance on Benefit–Cost Analysis 115 4. How should the scenario case be specified? In its broadest form, the scenario case represents a range of one or more alternatives that could be undertaken to achieve the objective(s) identified by the sponsor. As written in the FAA guidance document, “a valid BCA must have at least one alternative identified for each possible course of action. Each alternative must be a reasonable, well-founded, and self- contained investment option” (FAA 1999b). Of course, it is important to keep in mind that the alternative(s) for the scenario case selected for analysis should be a product of the screen- ing and other potential constraints described in Chapter 6. Even if it seems clear that one particular alternative is the only reasonable way to proceed, the sponsor should not automatically exclude other possibilities. In the present context, rel- evant alternatives may be to delay the proposed investment for a certain length of time or to delay the decision itself about whether to make the investment. Appropriate Evaluation Period As has already been discussed, the latest science suggests that climate change is likely to con- tinue well into the foreseeable future, and it will become more pronounced the further out one goes. Some relevant climate measures for localized areas are available out to the year 2099. This suggests that a long evaluation period may be appropriate when analyzing a specific project meant to mitigate the effects of climate change. However, this may be at odds with FAA convention. The FAA’s BCA guidance identifies three different evaluation periods: • Requirement life. The period over which the benefits of the project will be greater than the costs. The guidance states that “from a practical point of view, requirement lives should not exceed 30 years” (FAA 1999b). • Physical life. The period over which the asset can be expected to last physically. • Economic life. The period over which the asset can be expected to meet the requirements for which it was acquired in a cost-effective manner. By definition, economic life is less than or equal to both requirement life and physical life (FAA 1999b). The guidance states that investment projects are usually evaluated over their economic lives. By implication, this suggests that the relevant time period for analysis should always be less than 30 years. In fact, the guidance specifically states that the “FAA generally uses an economic life span of 20 years beyond the completion of construction for major airport infrastructure projects” (FAA 1999b). However, the guidance also states that “longer life spans may be used if justified” (FAA 1999b). It is suggested here that investment projects designed to mitigate climate impacts are exactly the types of projects where a longer evaluation period may be justified since the largest climate impacts may well occur many years into the future. From a practical viewpoint, one important implication of using a long evaluation period is that the infrastructure being proposed may have to be replaced (at the end of its economic life) one or more times. In principle this can be directly handled in a BCA by specifying additional construction/rebuilding costs at appropriate points in the future. It should be noted that FAA guidance also recommends that the selected evaluation period be augmented by “at least” 5 years to accommodate the need to evaluate optimal timing of investment alternatives (FAA 1999b). This fits in neatly with the timing options discussed previously.

116 Climate Resilience and Benefit–Cost Analysis: A Handbook for Airports Level of Effort The FAA explicitly recognizes that the appropriate level of effort for a BCA may depend on many factors, and it suggests that the effort should be tailored to factors such as magnitude and complexity of the project, number of practical alternatives, availability of data, and sensitivity of benefits and costs to assumptions. In addition, FAA guidance recognizes that practical considerations include the availability of time and budget; this is obviously a major concern for many smaller airports with limited resources. However, the guidance also states that “while lack of budget or time may constrain the scope of a BCA, they cannot be used to justify an inadequate analysis where circumstances clearly indicate a need for more information” (FAA 1999b). In any event, airport sponsors should con- sult early with the FAA regarding appropriate levels of effort. As described earlier, it may be advantageous for entities with limited resources to consider a conventional BCA approach involving a few alternative scenarios with differing specified climate event assumptions. The discussion in Chapter 2 on conducting an initial screening analysis is particularly relevant. Those with more expertise or a larger budget could also consider the Monte Carlo simulation approach. The FAA has also published a document providing useful guidance and information tailored to smaller airports (FAA 2013). It covers topics such as forecasting future demand and aircraft operations, consideration of nearby airports as potential next-best alternatives, and identifica- tion of relevant benefits and costs. In addition, the document explicitly discusses the case where a full BCA cannot be completed due to budgetary or other constraints and identifies the minimum amount of information that can be provided to the FAA.38 This process is further discussed in the context of a less formal analysis when a full-blown BCA is not required (for example, during master planning or while vetting alternative projects). The document also refers to a “BCA Lite” analysis (FAA 2013), which may be relevant in the form of a cost-effectiveness study for many typical airport rehabilitation projects. As noted in the FAA’s BCA guidance document, the primary benefit associated with a reha- bilitation project typically would reflect the impact on the airport if the facility were allowed to fail completely (FAA 1999b). In most cases, the FAA expects that it will not be benefi- cial to allow a major airside facility to fail, so the concern focuses more on the most cost- effective way to complete the rehabilitation. A BCA Lite cost-effectiveness analysis typically would not be relevant for assessing the impacts of uncertain climate change because it focuses entirely on the direct costs of undertaking a project without formal consideration of the benefits. Measurement of Benefits and Costs The impacts of climate change—whether they be chronic (increased daily surface tempera- tures) or acute (increased likelihood of flooding events)—will typically be measured on the ben- efits side of a BCA in the form of avoided costs due to airport delay, closure, or other related significant impacts. Many of these impacts will not accrue directly to the airport. As such, they may be considered “social” impacts, reflecting costs to aviation stakeholders at large. In the case of a partial or com- plete airport closure due to, say, a storm surge, the relevant list of benefits from avoiding such an event might include any or all of the following avoided costs: • Aircraft, passenger, or cargo delay; • Airport and aircraft damage;

FAA Guidance on Benefit–Cost Analysis 117 • Airport cleanup/restitution costs; • Costs due to personal injury or death; and • Loss of local business activity. Some of these impact categories reflect social costs not incurred directly by the airport itself. Regardless of what specific entities are affected, determining a method of measuring them can be difficult. For example, it is not necessarily an easy matter to estimate how many hours of delay would be caused by surface temperatures rising above some specified threshold. Generically, temperatures above the threshold would cause an aircraft’s minimum required takeoff speed to exceed what is possible on the available runway, and the operator would have to either cancel the flight or remove passengers or cargo to decrease its weight and thus lower its required takeoff speed. Such weight restrictions are fairly common in some locations, obviously depending on local temperatures and the specifics of the aircraft involved. While the specifics of quantifying the expected incidence and impact of high temperatures on aircraft performance are well beyond the scope of this handbook, some recent work has been done on this exact subject using CMIP5 projections (see Coffel and Horton 2015; Coffel et al. 2017). While limited to an analysis of four large U.S. airports (Phoenix, Denver, LaGuardia, and Washington-National), the results suggest significant increases in the incidence of high tem- peratures causing either a 10,000-lb or 15,000-lb weight restriction for a Boeing 737-800 aircraft. Combined with projections of scheduled aircraft activity, such impacts could be translated into passenger or cargo values in order to estimate total delay quantities and dollar values for a given threshold temperature occurrence in a given year. Generally speaking, if the quantities can be reasonably estimated, then in many cases their overall valuation in dollar terms can be projected using FAA guidelines. Unit valuations are available directly from the FAA’s Economic Values publication (FAA 2016b), which is updated periodically and includes recommended values for passenger time, life and injury costs, aircraft capacity and utilization factors, aircraft operating costs, replacement and restoration costs of damaged aircraft, and labor cost factors. On the investment cost side, FAA guidance also provides valuable information related to life- cycle costing. Interested readers should consult the FAA BCA guidance document for details on topics such as planning and research and development costs, investment costs, operations and maintenance costs, and termination costs. Appropriate Discount Rate A particularly important factor to consider in a BCA is the appropriate discount rate for the project. The FAA has traditionally followed OMB guidance on this subject. There are two alternative rationales for discounting. One is investment-based, which says that the rate should reflect the prevailing rate of capital productivity [i.e., the opportunity cost (or pretax average return) of capital]. Under Circular A-94 (U.S. Office of Management and Budget 1992), OMB has set this rate at 7% in real terms (net of inflation), and that is the rate that is conventionally used in most BCAs considered by the FAA. An alternative rationale for discounting is consumption-based, which reflects the rate at which society is willing to trade consumption today for future consumption (this is sometimes called the social rate of time preference). A reasonable approximation of this rate is the real rate of return on long-term government debt. Over the past 50 years or so this rate has averaged under 3%. If there were no tax or other distortions, then in principle the consumption-based discount rate would equal the investment-based rate. However, there are many practical reasons why the

118 Climate Resilience and Benefit–Cost Analysis: A Handbook for Airports two might diverge.39 In 2003, OMB issued additional guidance via Circular A-4 suggesting that for projects involving regulatory analysis, separate estimates should be presented using both 7% and 3% real discount rates (U.S. Office of Management and Budget 2003). Note that use of a 7% discount rate in the present context implies that the increasing effects of climate change felt many years into the future would not likely have significant present value impacts. For example, discounting a $1 million impact occurring 50 years from now by 7% annually would result in a present value impact of under $34,000. By contrast, discounting at 3% gives a present value impact of about $228,000. While OMB has not issued formal updates to its 7% guideline, it is suggested that airport sponsors proposing to undertake climate resilience investments with a long time horizon discuss this issue with the FAA. A separate though related topic concerns whether the use of a declining discount rate might be preferred for projects with long time horizons. In particular, it is difficult to know for sure what the average or median return on investment might be many years into the future. In general, it can be shown that using a single mean discount rate will lead to a lower net present value of a given cash flow compared to using values above and below the mean that are con- sidered equally likely; the effect is magnified the longer is the time horizon. This suggests that use of a declining discount rate may be economically justified for projects with very long-term impacts (Arrow et al. 2012).