, Volume 9, Issue 1, pp 109-138
Date: 16 Jun 2010

Real options analysis of investment in carbon capture and sequestration technology

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Abstract

Among a comprehensive scope of mitigation measures for climate change, CO2 capture and sequestration (CCS) plays a potentially significant role in industrialised countries. In this paper, we develop an analytical real options model that values the choice between two emissions-reduction technologies available to a coal-fired power plant. Specifically, the plant owner may decide to invest in either full CCS (FCCS) or partial CCS (PCCS) retrofits given uncertain electricity, CO2, and coal prices. We first assess the opportunity to upgrade to each technology independently by determining the option value of installing a CCS unit as a function of CO2 and fuel prices. Next, we value the option of investing in either FCCS or PCCS technology. If the volatilities of the prices are low enough, then the investment region is dichotomous, which implies that for a given fuel price, retrofitting to the FCCS (PCCS) technology is optimal if the CO2 price increases (decreases) sufficiently. The numerical examples provided in this paper using current market data suggest that neither retrofit is optimal immediately. Finally, we observe that the optimal stopping boundaries are highly sensitive to CO2 price volatility.

Siddiqui acknowledges the support of the ELDEV project in Trondheim, Norway. We would like to thank participants of the 2009 CMS conference in Geneva, Switzerland for their feedback. This paper has also benefited from the comments received from seminar participants at RWTH Aachen, the Center for Energy and Environmental Policy Research at the Beijing Institute of Technology, the Central Research Institute of Electric Power Industry in Tokyo, Japan, the Institute for Advanced Studies in Glasgow, UK, and the UCL Energy Institute. Finally, the reviews of two anonymous referees and guest editors have greatly enhanced this paper. All remaining errors are the authors’ own.