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.

Keywords: Combined heat & power, Emission trading system, Investment under uncertainty, Spread, Real options

JEL Classification: C61, D81, Q41, Q43