Real options analysis of investment in carbon capture and sequestration technology
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.
KeywordsReal options analysis CCS Geometric Brownian motion Mutually exclusive options
Unable to display preview. Download preview PDF.
- Adkins R, Paxson D (2008) Optionality in asset renewals, Working paper, Manchester Business School, Manchester, UKGoogle Scholar
- Dixit AK, Pindyck RS (1994) Investment under uncertainty. Princeton University Press, PrincetonGoogle Scholar
- Herbelot O (1992) Option valuation of flexible investments: the case of environmental investments in the electric power industry, PhD thesis, Department of Nuclear Engineering, Massachusetts, Institute of Technology, Cambridge, MA, USAGoogle Scholar
- Hildebrand AN, Herzog HJ (2008) Optimization of carbon capture percentage for technical and economic impact of near-term CCS implementation at coal-fired power plants. In: ‘9th International Conference on green house gas control technologies’, Washington, DC, USAGoogle Scholar
- IPCC: (2005) IPCC special report on carbon dioxide capture and storage. Cambridge University Press, CambridgeGoogle Scholar
- IPCC (2007) Climate Change 2007: Synthesis Report. IPCC, Geneva SwitzerlandGoogle Scholar
- Mattheij RMM, Rienstra SW, tenThije Boonkkamp JHM (2005) Partial differential equations: modelling, analysis, computation. Society for Industrial and Applied Mathematics, PhiladelphiaGoogle Scholar
- ORNL (2009) America’s 10 Energy Challenges. ORNL Review 42(2). http://www.ornl.gov/info/ornlreview/v42_2_09/v42_no2_09review.pdf
- Pindyck RS (1999) The long-run evolution of energy prices. Energy J 20: 1–27Google Scholar
- Reinaud J (2003) Emissions trading and its possible impacts on investment decisions in the power sector. IEA Information Paper, International Energy Agency, Paris, FranceGoogle Scholar
- Swedish Government Budget Bill (2008) Higher carbon dioxide tax for reduced traffic emissions. http://www.regeringen.se/content/1/c6/08/86/13/5e9ed088.pdf