The impact of modified EU ETS allocation principles on the economics of CHP-based district heating systems

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 emissions 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. In this paper, we analyze the impact of the intended modifications on large-scale coal- and gas-fired CHP plants for DH in Germany. 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 the technologies considered. 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 large-scale CHP plants that feed into DH systems. If these effects are not compensated, this could lead to a situation where highly efficient CHP plants are gradually replaced by separate power and heat generation in boilers respectively fossil-fueled condensing plants.