Emissions trading and investment decisions in the power sector

A case study in Finland

Harri Laurikka (Corresponding Author), Tiina Koljonen

Research output: Contribution to journalArticleScientificpeer-review

90 Citations (Scopus)

Abstract

Organizations, which consider investment in or divestment of power production licences/capacity within the European Community, are exposed to the impacts of the European Union Emission allowance Trading Scheme (EU ETS). In this paper, the consequences of the EU ETS on investment decisions are explored in a country-specific setting in Finland. First, we review the general mechanisms through which the EU ETS influences size, timing and cashflows of an investment. Next, we discuss the projected changes in Finnish power producers’ investment environment and examine the financial impacts due to the EU ETS on a case investment decision, a hypothetical condensing power plant (250 MWe). The standard discounted cash flow (DCF) analysis is extended to take into account the value of two real options: the option to wait and the option to alter operating scale. In a quantitative investment appraisal, the impact of emissions trading not only depends on the expected level of allowance prices, but also on their volatility and correlation with electricity and fuel prices. The case study shows that the uncertainty regarding the allocation of emission allowances is critical in a quantitative investment appraisal of fossil fuel-fired power plants.
Original languageEnglish
Pages (from-to)1063-1074
Number of pages12
JournalEnergy Policy
Volume34
Issue number9
DOIs
Publication statusPublished - 2006
MoE publication typeA1 Journal article-refereed

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emissions trading
European Union
power plant
Power plants
decision
Fossil fuels
fossil fuel
allowance
electricity
Electricity

Keywords

  • emission trading
  • investment
  • power generation

Cite this

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title = "Emissions trading and investment decisions in the power sector: A case study in Finland",
abstract = "Organizations, which consider investment in or divestment of power production licences/capacity within the European Community, are exposed to the impacts of the European Union Emission allowance Trading Scheme (EU ETS). In this paper, the consequences of the EU ETS on investment decisions are explored in a country-specific setting in Finland. First, we review the general mechanisms through which the EU ETS influences size, timing and cashflows of an investment. Next, we discuss the projected changes in Finnish power producers’ investment environment and examine the financial impacts due to the EU ETS on a case investment decision, a hypothetical condensing power plant (250 MWe). The standard discounted cash flow (DCF) analysis is extended to take into account the value of two real options: the option to wait and the option to alter operating scale. In a quantitative investment appraisal, the impact of emissions trading not only depends on the expected level of allowance prices, but also on their volatility and correlation with electricity and fuel prices. The case study shows that the uncertainty regarding the allocation of emission allowances is critical in a quantitative investment appraisal of fossil fuel-fired power plants.",
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Emissions trading and investment decisions in the power sector : A case study in Finland. / Laurikka, Harri (Corresponding Author); Koljonen, Tiina.

In: Energy Policy, Vol. 34, No. 9, 2006, p. 1063-1074.

Research output: Contribution to journalArticleScientificpeer-review

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AU - Laurikka, Harri

AU - Koljonen, Tiina

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AB - Organizations, which consider investment in or divestment of power production licences/capacity within the European Community, are exposed to the impacts of the European Union Emission allowance Trading Scheme (EU ETS). In this paper, the consequences of the EU ETS on investment decisions are explored in a country-specific setting in Finland. First, we review the general mechanisms through which the EU ETS influences size, timing and cashflows of an investment. Next, we discuss the projected changes in Finnish power producers’ investment environment and examine the financial impacts due to the EU ETS on a case investment decision, a hypothetical condensing power plant (250 MWe). The standard discounted cash flow (DCF) analysis is extended to take into account the value of two real options: the option to wait and the option to alter operating scale. In a quantitative investment appraisal, the impact of emissions trading not only depends on the expected level of allowance prices, but also on their volatility and correlation with electricity and fuel prices. The case study shows that the uncertainty regarding the allocation of emission allowances is critical in a quantitative investment appraisal of fossil fuel-fired power plants.

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