The Ministry has a programme of work which seeks to improve the decision making frameworks we apply on transport issues. Previous publications of this type include a paper on our analytical framework, and strategy projects on future demand and on transport and the economy.

Investment in long-lived transport infrastructure such as roads, railways or ports is subject to uncertainty, especially on the demand side.  Failure to manage uncertainty can result in costly mistakes in either direction: white elephants or unacceptable levels of congestion.  The real options approach helps deal with this problem.

There is much to be uncertain about with the future of transport, and it has become imprudent to make decisions about investment in transport infrastructure based on past trends.

The real options approach aims to encourage decision makers to consider uncertainty during option development and to incorporate flexibility in the investment decision-making process. It helps planners reduce risk of a worse-than-expected outcome and take advantage of upside opportunities as they emerge.

The real options approach deals with the uncertainty problem by preserving the option to construct something that turns out to be needed, while avoiding most of the cost of constructing something that turns out to be a white elephant. It works by building flexibility into the investment decision making process, so that it is possible to change course as new information comes in.

An example is a road serving a port whose fortunes may or may not improve as ship sizes increase. We could decide to build or not build an improved access road to the port, and later regret having either (respectively) a white elephant or serious congestion. A real options approach points to preparing to build the road – e.g. planning, preservation of an easement, approvals – but delay the actual construction decision until demand information becomes firmer, in the meantime making small investments in chokepoints if necessary.

Real options are particularly relevant to investments in road, rail and port infrastructure. They are also relevant to decisions about preserving future opportunities and to deciding whether to mothball redundant facilities. They offer the potential to achieve good transport outcomes while spending substantially less than with the classic approach that is limited by the information available at the outset.