Evaluating the optimal timing and capacity of investments in flexible combined heat and power generation for energy-intensive industries

Dimitrios Zormpas and Giorgia Oggioni
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Giorgia Oggioni: University of Brescia

Annals of Operations Research, 2024, vol. 336, issue 1, No 38, 1133-1160

Abstract: Abstract Substantial R &D efforts are currently directed towards the development of combined heat and power (CHP) systems that automatically and seamlessly connect to the power grid. In this paper we develop a real options model to assess the impact that the operational flexibility characterizing such systems will have on the optimal timing and capacity associated with investments in CHP plants. We take the viewpoint of a manufacturer operating in an energy-intensive industry who contemplates investing in CHP. We discuss and compare investments in two types of CHP systems: a standard one that is operationally rigid and a technologically advanced one that is operationally flexible. The interaction between temporal and operational flexibility under uncertainty and irreversibility is central to our analysis. We show that operational flexibility guarantees earlier investment but has an ambiguous effect in terms of capacity. In particular, when operational flexibility is very valuable the potential investor is opting for investing in a plant with larger productive capacity. The potential investor chooses a smaller CHP unit if otherwise. A numerical exercise calibrated using data from the Italian pulp and paper and electricity industries complements our theoretical analysis.

Keywords: Combined heat and power; Optimal investment timing and capacity; Pulp and paper industry; Real options; Energy markets (search for similar items in EconPapers)
JEL-codes: D81 Q40 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s10479-023-05273-x

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