Port adaptation to climate change and capacity investments under uncertainty

Abstract

Seaports are crucial linkages in supply chains and account for over 80% of global trade by volume and 70% by value. They are also vulnerable to extreme weather events and sea level rise driven by climate change. Choosing the timing and scale of adaptation measures is challenging due to uncertainty about the rate of climate change, the frequency of disasters, and the irreversibility of investment in physical infrastructure. In addition to adaptation to climate change, ports must invest in throughput capacity to accommodate rising traffic volumes, reduce congestion, and maintain their long-term competitiveness. Ports also face uncertainty about shipping demand, which fluctuates with the business cycle, trade relations between countries, and other events. With this as background, we investigate the optimal timing and amount of port protection and capacity investments, as well as port charges, given uncertainty about climate-change-related threats and demand. The port gains better information over time, and thus has an option value to waiting. We show that the port charge is a decreasing function of capacity and an increasing function of protection. Capacity and protection are supermodular: a higher capacity warrants more protection, and better protection justifies higher capacity. If the disaster frequency rises, the port reduces its capacity and traffic volume but may increase or decrease protection investment. It prefers to postpone capacity investment if the disaster frequency can fall, but prefers to invest in advance if the climate is likely to get worse. It prefers to postpone protection investment if the disaster frequency changes a lot, or if the disaster frequency is currently low. The port also holds back on capacity and protection if future demand is highly uncertain. The results are largely the same for a landlord port, a service port, and a fully privatized port.