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

We investigate sequential investment in carbon capture and storage (CCS), i.e., the case of retrofitting a coal-fired power plant, and then invest 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, which seems helpful for decision-makers who have to make capital-intensive irreversible investments under high uncertainty regarding electricity and CO price. The options to invest in CCS and CCU are investigated individually first, and then sequentially, leading to a hybrid CCUS plant that enables both CO storage and methanol production. 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 CO for earning carbon credits after establishing the CCUS plant. We find that at CO prices of around 40 €/t, 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 CO, 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 CO prices).