Sunday, March 20, 2011

The Impact of Modified EU ETS Allocation Principles on the Economics of CHP-based District Heating Networks

Abstract: The economics of large-scale combined heat and power (CHP) generation for district heating (DH) applications are strongly affected by the costs and allocation mechanism of CO2 emission allowances. In the next period of the European emission trading system (EU ETS), from 2013 onwards, the allocation rules for CHP generation will be modified according to the principles announced in EU Directive 2009/29/EC. By means of a discounted cash-flow model we first show that the implementation of the modified allocation mechanism significantly reduces the expected net present value of large-scale CHP plants for DH. In a next step, by applying a spread-based real options model we analyze the decision-making problem of an investor who intends to invest in CHP generation. Our results provide some evidence that the modified EU ETS principles contribute to reducing the attractiveness of investments in energy-efficient large-scale CHP plants that feed into DH networks. In contrast, decentralized small-scale CHP, which is not subject to the EU ETS, may benefit from this development and could, therefore increasingly replace large-scale CHP assets. In other words, European legislation is indirectly promoting the further diffusion of decentralized CHP generation units."
For both technologies investigated, the expected mean of the NPV decreases from 126 €/kW (117 €/kW) to -806 €/kW (-456 €/kW) for coal-fired CHP plants (gas-fired CCGT-CHP plants) if the modified allocation rules are applied. For coal technology, the standard deviation of the NPV increases from 1,205 €/kW to 1,895 €/kW. Due to the reduction of freely allocated certificates, plant operators need to purchase significantly more emission allowances at the CO2 market. This increases the exposure to volatile EUA prices and, subsequently, the standard deviation of the NPV. For the CCGT-CHP technology, this effect is less significant, as the carbon intensity of natural gas is lower. Consequently, CCGT technology receives relatively to the output more free allowances and less EUAs need to be purchased at volatile market prices.

The dependence of the NPV on the market price for European emission allowances is also significantly increased after the introduction of the new ETS Directive.... Under the assumption that free allowances are allocated according to the double benchmark principle, the NPV at an EUA price level of 30 €/tCO2 is for both technologies in the range of 0 €/kW. If the modified allocation rules according to EU Directive 2009/29/EC are introduced, the NPV is highly negative at an EUA price level of 30 €/tCO2, an effect that is more significant for coal-fired CHP (-1,437 €/kW) than for CCGTCHP (-1,120 €/kW).
For coal-fired CHP units, ... the difference in the option value between an allocation according to double benchmark and an allocation according to EU Directive 2009/29/EC amounts to 6.56 €/MWh at the strike price of 18 €/MWh. For gas-fired CCGT-CHP plants, the difference in the option value amounts to 2.96 €/MWh at a strike price of 16 €/MWh.
by G√ľnther Westner and Reinhard Madlener
Institute for Future Energy Consumer Needs and Behavior (FCN) Faculty of Business and Economics / E.ON ERC
FCN Working Paper No. 4/2011; February 2011
Research Papers in Economics (REPEC)

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