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Optimal Abandonment of EU Coal-fired Stations

Abstract:
Coal-fired power plants face potential difficulties in a carbon constrained world. The traditional advantage of coal as a cheaper fuel may erode in the future if CO2 allowance prices increase. When would it be optimal to abandon a coal station and obtain its salvage value? We assess this question following the Real Options approach. We consider the case of a coal plant that operates in a deregulated electricity market where natural gas-fired plants are the marginal units. We assume specific stochastic processes for the fundamental uncertainties in our model: coal price, natural gas price, and emission allowance price. The underlying parameters are derived from actual futures markets. They are further used in a three-dimensional binomial lattice to assess the decision to abandon. We draw the optimal exercise boundary. Sensitivity analyses (regarding fuel prices, allowance price, volatilities, useful life, residual value, thermal efficiency, safety valves in carbon prices, time step) are also undertaken.

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Energy Specializations: Natural Gas – Policy and Regulation; Coal – Policy and Regulation; Electricity – Generation Technologies; Electricity – Policy and Regulation

JEL Codes:
E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General
Q53 - Air Pollution; Water Pollution; Noise; Hazardous Waste; Solid Waste; Recycling
Q2 -

Keywords: power plants, coal, natural gas, emission allowances, futures markets, stochastic processes, abandonment option, real options.

DOI: 10.5547/ISSN0195-6574-EJ-Vol32-No3-7


Published in Volume 32, Number 3 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.