Title: Transition from coal to natural gas power plants under CO₂ consideration: a real options approach

Authors: Chung-Hsiao Wang; K. Jo Min

Addresses: LG&E and KU Energy LLC, 220 West Main Street, Louisville, KY 40202, USA ' IMSE Department, Iowa State University, 3004 Black, Ames, Iowa 50011, USA

Abstract: As a way to alleviate global warming, there have been major initiatives to reduce carbon dioxide (CO₂) emission amount across the world. In Western Europe as well as in California, market-based permits for CO₂ emission have been a major enabler of such initiatives. In this paper, under the assumption of such market-based permits where permit price is inherently uncertain, we model and analyse a transition process from coal-based to natural gas-based power plants with less CO₂ emission based on a real options approach. Specifically, we apply existing real options approach to derive closed-form analytical solutions for such a transition. Subsequent managerial insights and policy implications are provided in the context of CO₂ emission reduction and environmental ramifications.

Keywords: electric power; CO₂ prices; real options; geometric Brownian motion; GBM; closed-form solutions; power plant transition.

DOI: 10.1504/IJSE.2020.112310

International Journal of Sustainable Economy, 2020 Vol.12 No.4, pp.344 - 363

Received: 01 Jan 2020
Accepted: 11 Jul 2020
Published online: 07 Jan 2021 *

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