Research Team: Mark C Bohm, Ram C. Sekar, Howard Herzog, Henry D. Jacoby, and John Parsons
Sponsors: MIT Carbon Sequestration Initiative
Summary:
Should investors in new coal-based power generation pre-design their facilities so as to be carbon dioxide “capture-ready”? Is it commercially viable to pay an upfront premium to pre-engineer the power plant such that the investor has the option - i.e. the right, but not the obligation - to retrofit carbon dioxide capture equipment in the future? The research seeks to address these questions, giving the investor three choices:
- Build a pulverized coal-fired power plant today (lowest initial investment, but highest cost to retrofit with CO2 capture).
- Build a standard Integrated Coal Gasification Combined Cycle (IGCC) power plant
- Build an Integrated Coal Gasification Combined Cycle (IGCC) power plant with pre-investment to ease retrofit to CO2 capture (highest initial investment, but lowest cost to retrofit with CO2 capture).
The research looks at investment valuation of “capture-readiness” using the modern asset pricing approach, where the uncertainties in underlying parameters are treated at source. The decision to retrofit capture equipment can be made at any time. The combination of such dynamic decision making and treating stochasticity in the underlying parameters at source reduces the problem to an “option valuation problem”.
The valuation entails the following three steps for each case:
- Development of a one-factor (carbon price) stochastic cash flow model for each power plant option.
- Expert elicitation of carbon prices and uncertainties.
- Options valuation of capture readiness using risk-adjusted state pricing and dynamic programming.
An additional goal of this research is to illustrate the value gained by adopting a combination of dynamic decision making and Modern Asset Pricing (MAP) compared to traditional Discounted Cash Flow (DCF) valuation with deterministic decision making.
Publications to date:
Bohm, M.C., H.J. Herzog, J.E. Parsons and R.C. Sekar, "Capture-ready coal plants - Options, technologies and economics," International Journal of Greenhouse Gas Control, Vol 1, pages 113-120, (2007). <PDF>
Sekar, R.C., J.E. Parsons, H.J. Herzog and H.D. Jacoby, "Future carbon regulations and current investments in alternative coal-fired power plant technologies," Energy Policy 35: 1064–1074 (2007).
Bohm, M., H. Herzog, J. Parsons, R. Sekar, "Capture-Ready Coal Plants - Options, Technologies and Economics," presented at the 8th International Conference on Greenhouse Gas Control Technologies, Trondheim, Norway, June (2006). <PDF>
Bohm, M.C., "Capture-Ready Power Plants - Options, Technologies and Economics," M.I.T. Masters Thesis, (2006). <PDF>
Sekar, R.C., J.E. Parsons, H.J. Herzog & H.D. Jacoby, "Future Carbon Regulations and Current Investments in Alternative Coal-Fired Power Plant Designs," MIT Joint Program on the Science & Policy of Climate Change Report # 129, December (2005). <PDF>
Sekar, R.C., "Carbon Dioxide Capture from Coal-Fired Power Plants: A Real Options Analysis," MIT LFEE 2005-002 RP, May (2005). <PDF>
