Industrial Utilization or Storage of CO2? A Compound Real Options Valuation for the Retrofitting of Coal-Fired Power Plants

Abstract We investigate the sequential investment in carbon capture and storage (CCS), i.e., the case of retrofitting a coal-fired power plant, and then in carbon capture and utilization (CCU) for methanol production. A (nested) compound real options model based on a backward recursive dynamic programming algorithm is used for the analysis. The options to invest in CCS and CCU are investigated individually first, and then sequentially, leading to a hybrid CCUS plant that enables both methanol production and CO2 storage. The prices of electricity, carbon and methanol are considered as stochastic and correlated with each other. Managerial flexibility exists regarding a postponement of the investment decision and the real-time optimization between selling methanol to the market or storing CO2 for earning carbon credits after establishing the CCUS plant. We find that at today’s relatively high CO2 prices CCS investment is economically rational, whereas CCU for methanol is not. Combining CCS with CCU increases the overall investment probability and potential for larger profits. Since methanol is more valuable than CO2, CCU can be expected to dominate the value of the compound option for the case of favorable market conditions (i.e., sufficiently high methanol and CO2 prices). JEL Classification Nos.: C61, G11