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Burning wood pellets for US electricity generation? A regime switching analysis


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Applying a regime switching model under the theoretic framework of real options, we inspect the optimal timing boundaries for coal and coal mixed wood pellets as two alternative fuels for a power plant in Georgia, United States. Results indicate that cofiring wood pellets with coal is generally not a commercially viable option. However, lower-level (with wood pellets < 15%) cofiring could have been feasible during the infancy period (2009–2011) when wood pellet price was declining. Sensitivity analysis shows that our conclusions are robust and the most important factors are relative prices of coal and mixed fuel. Therefore, we reject the null hypothesis that cofiring is economically feasible and suggest using policy vehicles to stimulate the bioenergy market and meet the greenhouse gas emission reduction target. In particular, a subsidy of $1.40/mmbtu to the 10% mixed fuel or a tax of $1.50/mmbtu on coal would prompt the conversions of coal-only power plants to cofiring ones, and a subsidy of $0.45/mmbtu to the 10% mixed fuel or a tax of $0.50/mmbtu on coal would maintain existing cofiring power plants in the status quo.
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Burning wood pellets for US electricity generation? A regime
switching analysis
Bin Mei
, Michael Wetzstein
University of Georgia, Warnell School of Forestry and Natural Resources, Athens, GA 30602, USA
Purdue University, Department of Agricultural Economics, West Lafayette, IN 47907, USA
abstractarticle info
Article history:
Received 26 October 2015
Received in revised form 5 July 2016
Accepted 29 May 2017
Available online 09 June 2017
JEL classication:
Applyinga regime switching model under the theoretic framework of realoptions, we inspect the optimaltiming
boundaries for coal and coal mixed wood pellets as two alternative fuels for a power plant in Georgia, United
States. Results indicate that coring wood pellets with coal is generally not a commercially viable option.
However, lower-level (with wood pellets b15%) coring could have been feasible during the infancy period
(20092011) when wood pellet price was declining. Sensitivity analysis shows that our conclusions are robust
and the most important factors are relative pricesof coal and mixed fuel. Therefore, we reject the nullhypothesis
that coring is economically feasible and suggest using policy vehicles to stimulate the bioenergy market and
meet the greenhouse gas emission reduction target. In particular, a subsidy of $1.40/mmbtu to the 10% mixed
fuel or a tax of $1.50/mmbtu on coal would prompt the conversions of coal-only power plants to coring ones,
and a subsidy of $0.45/mmbtu to the 10% mixed fuel or a tax of $0.50/mmbtu on coal would maintain existing
coring power plants in the status quo.
Published by Elsevier B.V.
Greenhouse gas emission
Real options
1. Introduction
Historically, coal is the major fuel type for power plants. Electricity
generated from coal-red power plants accounts for N40% and 39%
globally and within the United States, respectively (EIA, 2016). On a
per-unit energy basis, coal is one of the largest emitters of carbon diox-
ide among all fossil fuels, and coal-red power plants represent a major
source of man-made carbon dioxide emissions. To reduce greenhouse
gas (GHG) emissions, most countries have set reduction targets. The
world-leader in this effort is the European Union (EU) with the United
Kingdom (UK) as an EU leader. In recent years, the EU in general and
the UK in particular have burned an increasing amount of biomass for
electricity generation. In 2015, the United States launched the Clean
Power Plan aimed to lower carbon dioxide emitted by electrical power
generation by 32% within 25 years relative to the 2005 level. The plan
is focused on reducing emissions from coal-burning power plants,
as well as increasing the use of renewable energy, and energy
Given the fact that electricity produced from renewable
resources is b7% in the US (EIA, 2016), there remains a great expansion
potential in the bioenergy market.
A typical coal-red power plant bears a huge capital investment
with a design life of 20 to 50 years. Therefore, it is usually not econom-
ical to totally abandon a coal-red power plant and replace it with
cleaner technology prior to the end of its useful life. Nonetheless, it is
feasible to substitute some portion of the coal by biomass (core coal
with biomass) so as to reduce carbon emissions. In particular, wood
Energy Economics 65 (2017) 434441
Corresponding author.
E-mail address: (B. Mei).
Specically, the Environmental Protection Agencyrequires individual states to imple-
ment theirplans by focusing onthree building blocks: increasing the generation efciency
of existingfossil fuel plants, substituting lowercarbon dioxide emitting natural gas gener-
ation for coal powered generation, and substituting generation from new zero carbon di-
oxide emitting renewable sourcesfor fossil fuel powered generation. Thisstudy focuses on
the last one.
0140-9883/Published by Elsevier B.V.
Contents lists available at ScienceDirect
Energy Economics
journal homepage:
are easily adaptable to automated combustion systems and the
cost to convert existing coal boilers to mixed fuel burning is less prohib-
itive than plant retirement (Zhang et al., 2010). The saving of GHG emis-
sions from wood pellets ranges from 72.6% to 82.4% for each kWh of
electricity (Dwivedi et al., 2011). Within the EU and specically in the
UK, many power plants are coring wood pellets with coal as a transi-
tion option toward a carbon-free power sector. This has created a rapid-
ly growing international market for wood pellets. Given the high
productivity of the forest sector in the US Southeast, much of this mar-
ket is supplied by southeastern wood pellet mills (Spelter and Toth,
2009). Forisk Consulting (2015) projects that US wood pellet produc-
tion could grow from about 5 million tons in 2009 to near
18 million tons by 2018, of which, 97% would be intended for export
Corresponding to the expanded supply, real wood pellet prices have
been generally declining from 2009 to 2012 and since stabilized (Fig. 1).
In the same period, coal prices have steadily declined, primarily because
of the competition from declining natural gas prices, resulting from the
advent of commercially viable hydraulic fracturing technologies and
horizontal drilling methods. In terms of price volatility, both wood pellet
and natural gas exhibit higher variations than coal. Therefore, an in-
triguing question for coal power-plant managers is how to make the op-
timal decision on fuel selection. In the energy economics literature, a
few studies have examined this issue. Specically, applying real options
analysis, Pederson and Zou (2009) evaluate ethanol plant investments;
Lee and Shih (2010),Lima et al. (2013),andMonjas-Barroso and
Balibrea-Iniesta (2013) study solar- and wind-energy projects; Song
et al. (2011), and Gazheli and Corato (2013) examine the conversion
option of traditional farmland for energy crops; Bednyagin and
Gnansounou (2011),Detert and Kotani (2013),andZambujal-Oliveira
(2013) investigate the investment decisions among combined-cycle,
coal-red, wind, solar, and nuclear power plants; Cheng et al. (2011)
assess the clean-energy mix policy; and Siddiqui and Fleten (2010) an-
alyze the staged commercialization and deployment of alternative ener-
gy technologies.
Past research on wood pellets mainly focuses on decentralized
household heating systems (e.g., Claudy et al., 2011; Hyysalo et al.,
2013; Michelsen and Madlener, 2012). Studies on wood pellets for elec-
tricity generation, however, have been limited. Steininger and
Voraberger (2003) employ a computable general equilibrium model of
the Austrian economyand demonstrate that fostering the use of coring
could lead to a decline in both gross domestic product (GDP) and em-
ployment. Ehrig and Behrendt (2013) assert that coring wood pellets
with coal represents one of the most cost-attractive ways to reach the
EU-2020 carbon targets. Dwivedi et al. (2014) reveal that the use of
wood pellets for electricity generation could reduce the UK's GHG emis-
sions by 5068% relative to fossil fuels. Xian et al. (2015) account for un-
certain energy markets and examinethe economic feasibility of coring
wood pellets with coal for electricity generation. In this study, we apply
a regime switching model under the framework of real options analysis
to investigate the economic boundary conditions between coal and coal
mixed with wood pellets as the fuel for power plants. We intend to con-
tribute to thecurrent literature by considering reciprocal switch options
between coal-only and coring for a power plant, and incorporating the
switch cost explicitly as a function of the energy prices.Considering the
shifting energy patterns in the US market (Fig. 1), we conduct analyses
on two distinct periods in addition to the whole sample period. One is
the infancy period (20092011), which is the early stage when coal
prices are relatively high and wood pellet prices are declining because
of initial rapid supply expansion. The other is the substitution period,
when cheap natural gas undermines coal's dominance as the fuel for
US power plants. The null hypothesis is that both coal-only and coring
are economically viable options for US power plants, which solely de-
pends on contemporary market situations but not government
2. Method
Based upon the classic real options approach proposed by Dixit and
Pindyck (1994),Adkins and Paxson (2011) examine the reciprocal
energy-switching options and provide a quasi-analytical solution for
the case of two competing energy inputs. Extending their analysis, we
adopt a general regime switching model, which incorporates price un-
certainty of two alternative fuels to investigate a power plant's optimal
choice of the fuel type. Consider an active, perpetual operating power
plant that turns the chemical energy in coal into electricity and has an
option to exchange the incumbent fuel (coal) with a substitute fuel
(coal mixed with wood pellets). The switch is reciprocal and incurs a
known sunk cost K
,i,j{c,m} and ij.
Gains from a switch include
the net cost saving from using cheaper fuel and the option value of
switching back.
Price for fuel X
,i{c,m}, is assumed to follow a geometric Brownian
dXi¼αiXidt þσiXidzið1Þ
where αis the drift rate, σis the volatility rate and dz is the increment of
a standardWiener process. Correlation between the two price variables
is described by ρ(|ρ|1), so that cov(dX
dt. To state the
valuation relationship in terms of one unit of output, price for each
fuel can be adjusted by a conversion factor.
The function F
), i{c,m}, denotes the plant value from using
fuel iand the embedded switch option, which depends on prices of
both the incumbent and substitute fuels. Using the dynamic program-
ming approach, the following partial differential equation can be
Wood pellets are small nuggets of compressed, sawdust-sized wood ber that have
higher energy density andlower moisture contentthan their raw input. The sustainability
of wood pellets as feedstock for energy is largely a matter of carbon cycle calculations,
which depends on the originand type of trees used for woodpellets. We believethat burn-
ing wood pellets locally for energy is more carbon efcient than burning coal, even after
accounting for the emissionsfor collecting and processing biomass.
Fig. 1. Weeklyreal energy prices ($/mmbtu) for 06/05/200904/25/2014. Deator: PPI for
crude material, base time period January 2013.
The EU biomass market is driven by government mandates. The same has not been
mirrored in the US.
Letter cfor coal and mfor mixed fuel (coal mixed with wood pellets). K
denotes the
conversion cost from coal to mixed fuel and K
denotes the conversion cost from mixed
fuel to coal. For example,for a coal-burningpower plant to burn wood and meet emission
requirements, some accommodations to facility operation and physicalstructure are nec-
essary, including ash and air emission control, hard coating cleaning, wood storage, and
grinding and blowing systems.
435B. Mei, M. Wetzstein / Energy Economics 65 (2017) 434441
where μis the discount rate, and Yis the output (electricity) price net of
operating costs. The generic valuation function F
takes the form
where A(A0), βand ηare unknown parameters of the product power
function. The rst term in Eq. (3) represents the option value of
switching fuel inputs, and the last two terms represent the value of op-
eration without any switch option. By applying the limiting boundary
conditions, it can be shown that
where β
N0, η
0, β
0, and η
N0. Using the value-matching con-
ditions, smooth-pasting conditions, and the two characteristic root
equations, a system of eight equations can be established and the switch
timing boundaries can be determined numerically. The price ratios
along the two discriminatory boundaries are given by
Wcm ¼Xc
N1andWmc ¼Xm
where W
designates the price ratio when fuel icurrently in use should
be replaced by fuel j. Imposing the property of homogeneity of degree
one on the value functions (i.e., β
=1 and β
=1) and
the conversion cost function, the value-matching and the smooth-
pasting conditions are
cm Wcm
cm 1
cm ð7Þ
mc Wmc
mc 1
mc ð8Þ
cm 1
cm ϕckcWϕc1
cm ð9Þ
mc 1
mc ϕmkmWϕm1
mc ð10Þ
where k
and ϕ
are parameters in the conversion cost function K
, and the implied characteristic root equation has closed-
form solutions for β
and β
where σ
.Eqs.(7)(10) can be solved numerically.
The conversion cost is an increasing function of ϕ
, which indicates
the relative importance of the two price levels in determining the
converting cost ϕ
. When ϕ
approaches one, the conversion cost almost
only depends on the price of the incumbent but not the substitute fuel.
That is, when ϕ
=1 the conversion cost is proportional to the price of
the incumbent, prevailing fuel but not the potential substitute because
of the lack of production using the latter during the transition period.
The optimal switch decisions can be illustrated in Fig. 2. The locus OA
denotes the optimal switching boundary from coal as the current fuel to
mixed fuel as the substitute, whereas the locus OB denotes that from
mixed fuel as the current fuel to coal as the substitute. If a price pair
falls into the region OAX and the incumbent fuel is coal, it is optimal
to switch to mixed fuel. Instead, if a price pair falls into the region OBY
and the incumbent fuel is mixed fuel, it is optimal to switch to coal.
Therefore, the continuance region is OAY if the incumbent is coal and
OBX if the incumbent is mixed fuel.
3. Data and variable description
All energy prices, expressed as of $/mmbtu, are of weekly frequency
and range from June 5, 2009 to April 25, 2014. Coal prices of US Central
Appalachian are used because N33% of total coal burned by power
plants in the Southeast is supplied by this region. Natural gas prices of
the Henry Hub are used because of its importance to the North
American natural gas market. Both coal and natural gas prices are ob-
tained from US Energy Information Administration (EIA, 2016). Wood
pellet prices (energy density 17 GJ/ton and free on board USsoutheast)
are from Argusmedia (2015). All prices are deated by the Producer
Price Index (PPI) for crude material and stated in January 2013 dollars.
A transportation cost of $1.15/mmbtu, which is the average railway
cost from Central Appalachian to Atlanta, Georgia in 2013 (EIA, 2016),
Fig. 2. Switching boundaries between two fuel types for a power plant.
Table 1
Summary statistics of real energy prices in $/mmbtu.
Fuel type Whole period Infancy period Substitution period
20092014 20092011 20122014
Mean SD Mean SD Mean SD
Coal 4.01 0.29 4.22 0.21 3.77 0.15
Natural gas 3.54 0.88 3.61 0.76 3.45 0.99
Wood pellet 9.89 1.09 10.47 1.18 9.23 0.40
WP10 4.67 0.31 4.92 0.17 4.38 0.14
WP15 5.01 0.34 5.28 0.19 4.70 0.15
WP25 5.70 0.41 6.01 0.28 5.34 0.16
Note: Price deator is PPI for crude material with January 2013 as the base. WP10, WP15,
and WP25 represent 10%, 15%, and 25% wood pellet coring with coal, respectively.
436 B. Mei, M. Wetzstein / Energy Economics 65 (2017) 434441
is added to the real price of coal to make it comparable to wood pellet
Mixed fuels are denedas 10%, 15%, and 25% of wood pellets coring
with coal. Their price series (X
) are weighted averages of wood pellet
) and coal (X
) prices, and adjusted for fuel efciency
Xmi ¼λiwwiXwþ1wwi
½ ð13Þ
where w
is the share of wood pellets in the coring and λ
is the ef-
ciency multiple dened as the ratio of coal-to-electricity efciency
over mixed-fuel-to-electricity efciency. The net efciency of coal-to-
electricity is 32.67% based on the average heat rate of 10,444 btu/kWh
of a coal power plant (EIA, 2016). The efciency loss for low level
coring is about 0.5% per each 10% of wood pellet input (Robinson
et al., 2003). Therefore, the efciency multiples for 10%, 15%, and 25%
wood pellet coring are 1.016, 1.024, and 1.040, respectively.
Summary statistics of energy prices are reported in Table 1.Overthe
whole sample period, wood pellet hasthe highest average price and vol-
atility, and natural gas has the lowest average price but a relative mod-
erate volatility. Blending more wood pellets with coal increases the
mixed fuel cost and volatility. Note that the impact on volatility is less
than proportional, given wood pellet prices are not perfectly correlated
with coal prices. Considering the overall evolvement of the energy mar-
ket, two sub-sample periods are investigated. In the infancy period,
20092011, US wood pellet production was primarily consumed do-
mestically for home heating (EIA, 2016). In contrast, during the substi-
tution period, 20122014, wood pellet exports from the United States
to the EU increased dramatically and relatively cheap natural gas
began to substitute coal in US power plants. Energy pricesin the substi-
tution period are lower than those in the infancy period resulting from a
more intense competition of alternative fuels in the energy market. In
addition, the volatility of mixed fuel in the two sub-samples is compara-
ble or even lower than that of coal due to the low correlations between
these two price series.
Parameters in Eq. (1) are estimated and calibrated as follows.
) be the continuously compounded re-
turn in the tth time interval, then ^
α¼r=Δþs2=2Δand ^
where rand sare the sample mean and standard deviation of the series
and Δis the equally spaced time interval measured in years (i.e., Δ=
1/52 year for weekly data). As indicated by the magnitudes of the drift
parameters (Table 2), all energy price series show a declining trend dur-
ing the whole sample and the substitution periods. In contrast, for the
infancy period, all energy price series except for wood pellets exhibit a
rising trend. Regarding the variation, coal prices have a fairly constant
volatility, whereas wood pellet prices stabilize over time and become
less volatile than coal prices duringthe substitution period. The correla-
tion coefcient estimates remain low at 0.3270.348 and therefore
volatilities of mixed fuel prices are generally lower than those of wood
pellets and coal. Because of the portfolio effect, the correlation coef-
cient decreases as the percentage of wood pellets in the mixed
fuels increases. Finally, the values of parameters k's and ϕ's in the
conversion cost function are based on Adkins and Paxson (2011),
where k
=0.5 means switch options are equally reciprocal and
=1 means the conversion cost merely depends on the price
of the incumbent fuel. Other key variables and their adopted values
are presented in Table 3, including a discount rate of 8% for US power
plants, an average retail electricity price of $0.050/kWh net of operating
costs, an average coal price of $0.014/kWh, and average mixed fuel
prices of $0.016/kWh, $0.017/kWh, and $0.019/kWh with 10%, 15%,
and 25% wood pellets, respectively.
4. Empirical results and discussion
4.1. Base case results
Numerical solutions based on the system of four nonlinear equa-
tions, Eqs. (7)(10), are presented in Table 4. Parameters β's and A's
are of expected signs and all price ratios are greater than one. The
total value per kWh of a coal power plant and a mixed fuel power
plant can be calculated according to Eqs. (4) and (5) for a given coal
and mixed fuel price pairs. For example, the total value of a coal
(mixed fuel with 10% wood pellets) power plant using the whole sam-
ple parameter values and average energy prices is $0.7837/kWh
($0.8052/kWh) and the option value to switch to mixed fuel with 10%
wood pellets (coal) is $0.0014/kWh ($0.0081/kWh).
The threshold price ratios W
and W
dene the optimal switching
boundaries between coal and mixed fuel as fuel options for a power
plant for nine different scenarios. The boundaries together with histor-
ical mixed fuel and coal price ratios are plotted in Fig. 3.Inmostcases,
the price pairs fall into the switch-to-coal region, meaning that it is
noteconomicaltocore wood pellets with coal because the mixed
fuel cost increases with the share of wood pellets. Exceptions are 10%
and 15% coring during the infancy period, where some portion of the
price pairs fall into the continuation region. In these two exceptions, a
power plant should continue to use whichever is its incumbent fuel.
Consequently, a coring power plant could have operated efciently
during that time period. In general, Fig. 3 suggests that coring wood
pellets with coal is not economically feasible in the United States over
the 20092014 period with high wood pellet prices.
Next, we consider the impact of potential government interventions
on the renewable resource energy market (Fig. 4). First, we include a di-
rect subsidy of $1.40/mmbtu to the mixed fuel with 10% wood pellets,
which essentially cuts the input cost of a coring power plant. As
For completeness, we conducted unit root tests on the energy price series and nd
mixed results for or against the null hypothesis of unit roots. An alternative stochastic
model for price series is the geometric Ornstein-Uhlenbeck process. We also estimate
the parameters for the geometric Ornstein-Uhlenbeck processand nd low rates of mean
reversion and similar vo latility estimates. Therefore, we conclude that the geometric
Brownian motion well captures the short-run stochastic nature of the energy price series.
Table 2
Parameterestimates of the geometric Brownianmotion for real energy pricesin $/mmbtu.
Whole period Infancy period Substitution period
20092014 20092011 20122014
Coal 0.009 0.103 1.000 0.050 0.100 1.000 0.075 0.105 1.000
0.011 0.123 0.327 0.001 0.149 0.348 0.019 0.085 0.329
WP10 0.013 0.093 0.959 0.035 0.095 0.942 0.065 0.090 0.981
WP15 0.014 0.091 0.915 0.029 0.096 0.886 0.061 0.085 0.957
WP25 0.015 0.092 0.808 0.021 0.102 0.765 0.053 0.079 0.886
Note: WP10,WP15, and WP25 represent 10%,15%, and 25% wood pellet coring withcoal,
Table 3
Description of the variables used in the regime switch analysis.
Symbol Denition Value
μDiscount rate for US power plants 0.08
Parameter of the conversion cost function from coal to mixed fuel 0.5
Parameter of the conversion cost function from mixed fuel to coal 0.5
Parameter of the conversion cost function from coal to mixed fuel 1
Parameter of the conversion cost function from mixed fuel to coal 1
YElectricity price net of operating costs 0.050
Coal price 0.014
Mixed fuel price (10% wood pellets) 0.016
Mixed fuel price (15% wood pellets) 0.017
Mixed fuel price (25% wood pellets) 0.019
Note: Real prices are in $/kWh.
437B. Mei, M. Wetzstein / Energy Economics 65 (2017) 434441
such, all the energy price pairs move just under the coal-to-mixed-fuel
switch boundary. Second, we impose a tax of $1.50/mmbtu on a coal-
only power plant, which is equivalent to increasing the cost of coal.
Accordingly, all the energy price pairs fall just below the coal-to-
mixed-fuel switch boundary. In both scenarios, a coal power plant
should convert to wood pellets and coal coring. Therefore, a minimum
tax of $1.50/mmbtu on coal has a similar effect as a minimum subsidy of
$1.40/mmbtu on mixed fuel in triggering the investment in coring
power plants. Given an average cost of $0.12/kWh ($35/mmbtu) in
the United States, the mixed fuel subsidy or coal tax represents
about 4% of the electricity rate. Alternatively, a minimum subsidy of
$0.45/mmbtu on the mixed fuel or a minimum tax of $0.50/mmbtu on
the coal could maintain existing coring power plants in the status
quo, which represents about 1.3% of the electricity rate.
Table 4
Results of the regime switching model.
Symbol WP10 WP15 WP25
Whole period Infancy period Substitution period Whole period Infancy period Substitution period Whole period Infancy period Substitution period
20092014 20092011 20122014 20092014 20092011 20122014 20092014 20092011 20122014
11.022 2.809 46.028 8.293 2.276 32.430 6.097 1.894 22.703
19.057 28.428 10.787 13.048 20.325 7.448 8.289 12.983 4.564
0.372 10.684 0.0001 0.550 13.310 0.004 0.804 16.007 0.0013
1.100 1.051 1.178 1.121 1.064 1.211 1.157 1.090 1.268
0.040 0.002 0.190 0.088 0.005 0.359 0.205 0.018 0.750
1.138 1.199 1.102 1.164 1.244 1.110 1.201 1.302 1.121
Note: WP10, WP15, and WP25 represent10%, 15%, and 25% wood pellet coring with coal.
Fig. 3. Optimalswitching boundaries for nine different wood pellet and coal coring scenarios for electricity generation. All prices are in $/mmbtu.
438 B. Mei, M. Wetzstein / Energy Economics 65 (2017) 434441
Fig. 4. Impactof the subsidy on mixed fueland the tax on coal on optimal switch decisions.A subsidy of $1.40/mmbtu to the 10% mixedfuel or a coal tax of $1.50/mmbtuwould trigger the
conversions of coal-onlypower plants to coringones, and a subsidyof $0.45/mmbtu tothe 10% mixed fuel ora tax of $0.50/mmbtuon coal would maintainexisting coringpower plants
in the status quo.
Fig. 5. Sensitivity analysis on key variables in the regime switch model.
439B. Mei, M. Wetzstein / Energy Economics 65 (2017) 434441
4.2. Sensitivity analysis
Sensitivity analysis is conducted on the discount rate, drift and vola-
tility parameters of coal price, correlation coefcient, and wood pellet
price for the whole sample period and the case of 10% wood pellet
coring (Fig. 5). When the discount rate is reduced from 8% to 6%, the
major impact is on the switch boundary from coal to mixed fuels. A
lower discount rate yields higher cost mixed fuels more affordable and
thus shifts the switch boundary up. When the drift parameter of coal
price is reduced from 0.009 to 0.020, both coal price and mixed
fuel price tend to fall over time, so that the wait region narrows and
both switches are more likely to occur. When the volatility parameter
of coal is lowered from 0.103 to 0.050, the volatility of mixed fuel de-
creases as well. With less uncertainty in the mixed fuel cost, a coal
power plant is more willing to switch to mixed fuel. When the correla-
tion coefcient is reduced from 0.959 to 0.800, the portfolio effect be-
comes more signicant. Hence, the impact is quite similar to that of a
reduction in the volatility of mixed fuel. In summary, when values of
the key variables in the switch regime model change by a signicant
amount, the optimal decision for a power plant does not change appre-
ciably. Specically, coringwood pellets with coal is not an economical-
ly viable option.
At the plant level, heat rates and delivered fuel prices can deviate
from the industry averages. A lower heat rate implies higher
operation efciency and thus reduces fuel input cost, all else equal.
This means that the price pairs in Fig. 3 fall more into the switch
to coalregion. Similarly, the same would occur if a plant can
negotiate a lower coal delivered price. In other words, plants with
lower heat rates or better control of delivered coal prices are less
willing to switch to wood pellets coring and larger incentives are
needed to induce the conversion.
5. Conclusions
Using the regime switching model under the theoretic framework of
real options, we examine the optimal timing boundaries for coal and
mixed fuel astwo alternative fuels for a US power plant. Results indicate
that coring wood pellets with coal is not a commercially viable option
in most cases. However, lower-level (with wood pellets b15%) coring
could have been feasible during the infancy period when wood pellet
price is declining. Sensitivity analysis indicates that our conclusions
are robust and the most important factors are relative prices of coal
and mixed fuel. Therefore, we reject the null hypothesis that coring
is economically feasible and suggest using policy vehicles to stimulate
the bioenergy market and meet the GHG emission reduction target.
Specically, a subsidy of $1.40/mmbtu to the 10% mixed fuel
or a
coal tax of $1.50/mmbtu would trigger the conversions of coal-only
power plants to coring ones, and a subsidy of $0.45/mmbtu to the
10% mixed fuel or a tax of $0.50/mmbtu on coal would maintain
existing coring power plants in the status quo. Given the total
electricity of 1596 billion kWh generated from coal (EIA, 2016), the
estimated government spending is about $8 billion to prompt the
conversion to mixed fuel and $2.7 billion to retain current coring
power plants. This spending will increase as the share of wood
pellets in the mixed fuel enlarges. These numbers are roughly
comparable to the subsidy levels of $0.030.20/kWh or $8.8258.82/
mmbtu to solar energy (Fthenakis et al., 2009), and the production tax
credit of $0.019/kWh or $5.59/mmbtu toward wind energy
(Greenblatt et al., 2007). Therefore, renewable energy policies should
give equal priorities towood pellets coring as to solar and wind energy
in the US.
Unlike most countries in Europe, where domestic cost of
manufacturing wood pellets is not competitive with the import price,
the US Southeast has a productive forest industry and well-established
infrastructure. Hence, producing wood pellets from intensively man-
aged timberland in this region is likely to increase local employment
as well as GDP. For example, a 500-megawatt coal power plant takes
about 2540 jobs, whereas a same-sized power plant with mixed fuel
is estimated to take 3480 jobs, or a 37% increase in employment
(Strauss, 2014). In addition, a long-term demand for wood pellets can
help preserve existing working forests and attract more investments
in commercial forests, which in turn increases carbon sequestration.
Thus, the government expenditure on boosting wood pellet usage by
power plants does not simply represent a cost but has some benets
and can potentially improve the rural economy.
The authors thank Dr. Hui Xian for her help on the data collection.
McIntire-Stennis GEOZ-MS-0173 funded part of this research.
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... Additionally, many of these biomasses are low in nitrogen and sulfur, reducing the amount of oxides of both species emitted during plant operation (Darvell et al., 2010;Mami et al., 2018;Robinson et al., 2003). However, current lignocellulosic biomasses are limited in the tonnage that can be utilized each year due to competition with and/or dependence on other industries (Mei and Wetzstein, 2017;Milledge et al., 2014;Piwowar and Dzikuć, 2016;Robinson et al., 2003). Deforestation issues add to the concerns regarding increased usage of woody biomasses, as attempting to meet the world's growing energy demands could lead to total deforestation of the Earth in as little as nine years (Dolisca et al., 2007;Kautto and Peck, 2012). ...
... Deforestation issues add to the concerns regarding increased usage of woody biomasses, as attempting to meet the world's growing energy demands could lead to total deforestation of the Earth in as little as nine years (Dolisca et al., 2007;Kautto and Peck, 2012). As a result, this competition increases the price (on a per kWh basis) of energy generated using woody biomasses (Mei and Wetzstein, 2017). Thus, researchers are investigating other possible biomass sources for use as dedicated energy crops. ...
Freshwater macroalgae are an underutilized group of ubiquitous algae with greater yield potentials than most terrestrial energy crops, but whose combustion characteristics are not thoroughly understood. This effort compared the combustion of pelletized 100% pine and macroalgae-containing solid fuel mixtures (90%/10% and 75%/25% pine/macroalgae) using a fixed bed co-current reactor. Macroalgae increased pellet density as its protein and calcium content promoted hydrogen bonding and cross-linked the carboxylic acid functionality of polysaccharides. In addition, higher concentrations of freshwater macroalgal biomass required a greater air flow rate to achieve the mixing required for combustion. Since the macroalgae had a higher level of fuel nitrogen and fuel sulfur, emissions of nitrogen and sulfur oxides largely grew with an increasing proportion of this fuel. Overall, pelletized macroalgae can be co-combusted with woody biomass and its pre-treatment (water-rinsing and modulating cultivation conditions) can reduce or eliminate drawbacks found in the harvested naturally-occurring algal material.
... Wood pellets may be used as solid fuel for cooking in households and small-medium enterprises. Wood pellets, MSW pellets and also RDF (refuse derived fuel) are also adaptable to cofiring with coal as an option toward a carbon-free energy intensive industries [3]. Gasification is one of three main thermochemical conversions of biomass to gaseous fuel [4,5,6]. ...
... For scenario A (electricity from PLN), the calculated CO2 emission was the highest, i.e. 81.8 kgCO2/ton woody biomass. The use coal as fuel in power plant has been known as a source of CO2 emission [3]. Pellets production using scenario-B generated CO2 emission of 45.6 kg CO2/ton biomass. ...
... Its 2019 Climate Package does not promote biomass co-firing [29]. For the US, Mei and Wetzstein [30] argued that the cost of domestic wood pellets was competitive with the import price but that it was too high to make co-firing commercially viable. Solar, wind and natural gas dominate biomass as energy sources to produce electricity in the US [31 table 7.2a]. ...
As governments forced electricity producers to use more renewable energy sources, over a hundred thermal power plants in high-income countries turned to biomass as a partial or complete replacement for coal. Is the co-firing technology appropriate for Vietnam? To assess the technology we build an integrated model simulating the economics, environmental and social implications of blending 5% of rice straw in two existing coal power plants in Vietnam. The business value of co-firing is positive –straw is cheaper than coal– but not large enough to motivate the stakeholders. The external social benefit of co-firing –reduced air-borne pollution– are several times larger than the business value. Within that external benefit, the social value of avoided PM2.5 and NOx emissions dominates the social value of avoided CO2 emissions. The net job creation effect is positive: collecting straw creates more employment than using less coal destroys. This is the first technology assessment of co-firing biomass in coal power plants in Vietnam and one of the first for a subtropical middle-income country. The study only considers rice straw, and it does not address the role of government nor the biomass market functioning. The price of coal is the primary determinant of co-firing business value. There is an empirical economic justification for a public intervention to promote co-firing biomass in Vietnam, mainly as a way to reduce open-field straw burning. Local air quality goals, rather than greenhouse gas reduction policy, can justify such regulations.
... More research, however, is needed on the optimal design of such contracts. Meanwhile, utilizing wood pellets to replace fossil fuels in power generation deserves more attention (Dwivedi et al., 2019;Kline et al., 2021;Mei and Wetzstein, 2017), and the economics of forest carbon offsets needs to be better understood (van Kooten and Johnston, 2016;van Kooten and Sohngen, 2007). (4) Acquisition and disposition strategies of TIMOs and REITs. ...
Timberland ownership in the world, especially in the United States, has experienced significant changes in the past few decades. In this commentary, I reviewed a recently published book by Daowei Zhang under this theme. The book examined the driving forces of institutional timberland investment by compiling a number of landmark events through corporate reports and interviews with major parties involved. This helps us better understand the motivation, synergy, corporate strategy, competition, financing structure, organizational arrangement, broad impact of the ownership shift. The book also compared returns of timberland investment management organizations and real estate investment trusts, and provided an outlook of future research in timberland investment. As a summary, I positioned the book in the current literature of timberland investment and elaborated some lines of subsequent research.
... Sensitivity analysis shows that the conclusions are robust, and the most important factors are the relative prices of coal and blended fuel. Therefore, the authors reject the null hypothesis that co-incineration is economically possible and suggest the use of policy instruments to stimulate the bioenergy market in the form of subsidies or tax adjustments [44]. ...
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This paper deals with the state and perspectives of bioenergy development in the context of exploiting the potential of available natural resources. We analyse the economic benefits of tran-sitioning to alternative biofuel within the research task in cooperation with the Vojany black coal power plant. Within the applied methodology, a non-parametric data envelopment analysis method was used to confirm the most economically efficient types of fuels used in the combustion process. The assumption of fuel efficiency was confirmed by testing fuel combustion combinations directly in the power plant. The transition to 100% combustion of solid recovered fuel creates the potential for sustainable production of the analysed power plant and compliance with the current emission values of basic pollutants and new stricter limits, which will be binding in the EU from August 2021. The proposed solutions were analysed by Monte Carlo simulation. An estimate of the economic results achieved by the power plant was simulated, assuming a complete transition to solid recovered fuel. The results of the study support the feasibility of creating a circular waste management market, with the Vojany black coal power plant as the largest user of solid recovered fuel in Slovakia and abroad.
... Data for other fuels were based on mean values of real energy prices in the industrial sector. [58,71] Logistics are taken to be same for all cases. The maintenance benefit of PE due its low ash-content offsets sales of ash obtained from other fuels. ...
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Literature lacks data on the performance of waste plastics in controlling NOx emissions in practical combustors operating typically in the temperature window of 1000 - 1200 °C, under a range of fuel-oxygen equivalence ratios, preventing recycling of plastics in this application. In this contribution, we demonstrate that waste plastics, in particular polyethylene, can serve as a reburning fuel for converting nitrogen oxides (NOx) into environmentally-benign combustion products, in practical large-scale combustors such as pulverised coal power plant, circulation fluidised bed combustion plant, entrained flow boilers, and incinerators. The experiments involved a high-temperature vertically-entrained reactor operating in the range of 600 – 1200 °C, in conjunction with online infrared spectroscopy, chemiluminescence and gas chromatography. Chemical kinetic modelling, supported by DFT calculations with DMol³ package revealed the underlying chemistry of the NOx mitigation reactions, especially the importance of C2H5 and C2H3 radicals. We modelled the process kinetically and performed a techno-economic assessment of the new technology, to prove its financial feasibility. The reaction of pyrolytic fragments with NOx yields excellent removal efficiency of nitrogen oxides of up to 82 % and selectivity to N2 up to 85 %, within the temperature range of 1000 °C – 1200 °C, and fuel-oxygen equivalent ratios of Φ = 0.8 – 1.2. While we observed the formation of HCN, the overall nitrogen selectivity shifts towards the formation of N2. Both the conversion of NOx and the selectivity to N2 can be improved further by increasing the residence time. The economic assessment indicates that, the use of waste plastics is comparable to other mainstream solid fuels and becomes less expensive when considering renewable benefits.
... Some coal-fired power plants have converted to gas-firing instead of adopting cofiring biomass. Cofiring biomass at coal-fired power plants could become feasible with governmental support in the form of subsidies or tax credits.Also using a ROA model,Mei and Wetzstein (2017) examined two distinct time periods for coal and mixed fuel as alternatives for a US power plant. One is the 'infancy period'(2009)(2010)(2011), when coal prices were relatively high and wood pellet prices were declining because of initial rapid expansion of supply. ...
Technical Report
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Supporting policies
... The United States, in contrast, does not have the same mandates as in Europe but cofiring wood pellets with coal could be a solution. Along this line, Xian et al. (2015) and Mei and Wetzstein (2017) used the real options approach to examine the economic feasibility of low percentage cofiring wood pellets with coal for a power plant under cost uncertainty. Both studies concluded that cofiring was not a viable option without subsidies or carbon taxes. ...
n this study, 68 peer-reviewed journal articles in timberland investments in the United States published after 1980 are reviewed. Prior to the synthesis, the history of modern timberland investments, investment vehicles and return indices are summarized. Then, the literature is categorized into four groups, i.e., role of timberland in a portfolio, pricing of timberland assets, public timber real estate investment trusts and other relevant topics, and discussed respectively. The analysis suggests that timberland is a risk diversifier in a portfolio whether standard deviation or value-at-risk is used as the risk metric, that classic asset pricing models have difficulty in pricing private-equity timberland assets resulting in significant alpha, that timber REITs have some risk-reduction ability but no excess returns, and that bioenergy market and contractual rights and obligations on the properties may affect cash rewards from timberland investments. At the end, some concluding remarks and potential future research issues are presented.
At the Paris Agreement in 2015, Iran pledged a 4% reduction in greenhouse gas emissions by 2030 and bio-fuels like wood pellet are an option. To estimate the volume of waste woody biomass the International Energy Agency model was employed and results show that a total opportunity of 754,840 m³ of woody by-products. An economic feasibility study of wood pellet production was performed by calculating the economic indices and analyzing their sensitivity using COMFAR III software for three scenarios in annual capacities of 48,000, 75,000 and 120,000 tons. The costs of wood pellet production for each plan are 104.29, 107.63, and 106.92 €/Mt, respectively. Acceptable IRR (45%–124%) and NPV (7–14 Million Euro) support the feasibility of wood pellet production in Iran. Standard VDI 2067 used to calculate specific cost of generating energy with wood pellet fuel against domestic water boilers using diesel and natural gas fuels. Results showed that the cost of generating energy is higher by wood pellet (43.5 €/Mwh, against gasoline, 25.9 €/Mw, and natural gas, 22.3 €/Mwh) due to the high initial investment in the wood pellet-fired boilers compared to established fossil fuels and the low price of diesel and natural gas in Iran.
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In contrast to EU, U.S. electric utilities are not employing the bioenergy technology of co-firing wood pellets with coal. This difference in employment patterns is explored within a real options analysis (ROA) for possible U.S. utilization of wood pellets, considering fuel-price series from 2009 to 2014. For analysis, these series are divided into two sub-periods based on different market conditions: Infancy (2009–2011) and Substitution (2012–2014). ROA indicates co-firing wood pellets with coal is feasible considering adoption during wood pellets' infancy, under low discount rates, and long power-plant lifespans. A portfolio effect of employing multiple fuels underlies this result. However, co-firing is not currently economically feasible. The different adoption decisions are likely a consequence of recent cheap and abundant U.S. natural gas. For co-fired wood pellets to be feasible, government incentives and/or a market increase in natural gas prices appear necessary.
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Power utility companies in the United Kingdom are using imported wood pellets from the southern region of the United States for electricity generation to meet the legally binding mandate of sourcing 15% of the nation's total energy consumption from renewable sources by 2020. This study ascertains relative savings in greenhouse gas (GHG) emissions for a unit of electricity generated using imported wood pellet in the United Kingdom under 930 different scenarios: three woody feedstocks (logging residues, pulpwood, and logging residues and pulpwood combined), two forest management choices (intensive and non-intensive), 31 plantation rotation ages (year 10 to year 40 in steps of 1 year), and five power plant capacities (20–100 MW in steps of 20 MW). Relative savings in GHG emissions with respect to a unit of electricity derived from fossil fuels in the United Kingdom range between 50% and 68% depending upon the capacity of power plant and rotation age. Relative savings in GHG emissions increase with higher power plant capacity. GHG emissions related to wood pellet production and transatlantic shipment of wood pellets typically contribute about 48% and 31% of total GHG emissions, respectively. Overall, use of imported wood pellets for electricity generation could help in reducing the United Kingdom's GHG emissions. We suggest that future research be directed to evaluation of the impacts of additional forest management practices, changing climate, and soil carbon on the overall savings in GHG emissions related to transatlantic wood pellet trade.
This paper aims to perform a real options valuation of fusion energy R&D programme. Strategic value of thermonuclear fusion technology is estimated here based on the expected cash flows from construction and operation of fusion power plants and the real options value arising due to managerial flexibility and the underlying uncertainty. First, a basic investment option model of Black-Scholes type is being considered. Then, a fuzzy compound real R&D option model is elaborated, which reflects in a better way the multi-stage nature of the programme and takes into account the imprecision of information as one of the components of the overall programme uncertainty. Two different strategies are compared: "Baseline" corresponding to a relatively moderate pace of fusion research, development, demonstration and deployment activities vs. "Accelerated" strategy, which assumes a rapid demonstration and massive deployment of fusion. The conclusions are drawn from the model calculations regarding the strategic value of fusion energy R&D and the advantages of accelerated development path.
An extension of the Guerrero et al. (2010) net present value (NPV) analysis using real options analysis (ROA) is offered to improve machinery replacement decisions. Specifically, the feasibilities of replacing natural gas irrigation systems with either electric or hybrid (electric/wind) systems are evaluated. Results indicate NPV and ROA criteria can yield opposite decisions depending on the stochastic nature of the parameters, reversibility of the investment, and flexibility of investment timing. For policy, NPV results indicate that replacing natural gas with a hybrid is on the cusp of being optimal. However, ROA indicates this NPV implication may not hold.
Many energy source switching opportunities – such as using palm or rape oil in biodiesel production, or using bio, coal, gas, hydro, nuclear or wind in elec-tricity generation – are reciprocal energy-switching options. We provide a quasi-analytical solution for a general switching model for two alternative energy inputs with fixed switching costs. We also consider easier analytical solutions for a sin-gle switching opportunity that are appropriate for national decisions regarding energy capacity (nuclear or natural gas) and for perpetual energy alternatives with variable switching costs. We provide illustrations and a sensitivity analysis for these models, along with comments on the computational ease of proposed solutions and suggestions for model extensions.
The use of trade or firm names in this publication is for reader information and does not imply endorsement by the United States Department of Agriculture (USDA) of any product or service. The USDA prohibits discrimination in all its programs and activities on the basis of race, color, national origin, age, disability, and where applicable, sex, marital status, familial status, parental status, religion, sexual orienta-tion, genetic information, political beliefs, reprisal, or because all or a part of an individual's income is derived from any public assistance program. (Not all prohibited bases apply to all programs.) Persons with disabilities who require alternative means for communication of program informa-tion (Braille, large print, audiotape, etc.) should contact USDA's TARGET Center at (202) 720–2600 (voice and TDD). To file a complaint of discrimi-nation, write to USDA, Abstract The North American wood pellet sector is profiled in this paper. A small pellet industry has existed since the 1930s, but its main growth occurred in the wake of the energy crisis in the 1970s. Its current spurt is even greater, growing from 1.1 million metric tonnes in 2003 to 4.2 million 2008. It is set to reach 6.2 million in 2009. Most plants are small, relying on sawmill residues for fiber and thus are limited to 100,000 tonnes or less per year. A number of new mills have been built to process chipped roundwood and have capacities three to four times as large. Most pellets made in the United States are consumed domestically, but a growing offshore market is boosting exports. By contrast, most Cana-dian pellets are shipped overseas. The reliance on sawmill residues led to imbalances between supply and demand for fiber as the sawmilling sector retrenched in the 2008–2009 recession. This has led mills to turn to roundwood or other non-sawmill sources of fiber. The wood pellet industry and use of wood pellets as energy are in their relative infancy in North America and the recent growth of both has been fueled by increases in the cost of fossil energy. However, policies aimed at reducing carbon dioxide emissions into the atmosphere could loom as bigger factors in the future.
Purpose – In this paper, a real option model is developed to examine the critical factors affecting the decision to lease agricultural land to a company installing a PV power plant. Subsidies introduced by governments for the production of renewable energies have increased the investments in this sector. Since ground-based solar cells need land for energy production, then potential trade-off with agriculture in terms of land exists. The paper aims to discuss these issues. Design/methodology/approach – The paper uses the real option approach in order to take into account for uncertainty and irreversibility of the farmer's decision. Findings – By applying the model to the province of Bologna (Italy), the paper illustrates the possible land-use change scenarios in this area. The paper concludes by discussing the importance of PV energy production as a source of income for farmers and its implications from a social perspective. Originality/value – The research is applied to the province of Bologna (Italy) where investments in ground-based solar cells are becoming quite common. The originality lies in the fact of considering the investment as irreversible, since it is a 20-year commitment from the farmers. The paper also takes into account the uncertainty in agricultural commodities' prices.
This comparative study evaluates an investment project on renewable energy based on wind power. We have conducted the study in three European Union countries: Denmark, Finland and Portugal. We have modelled the main uncertainties that affect this kind of project, such as the cost and production of electric power, investment costs and consumer price index. For each of these countries, we have analysed the mechanisms of public support for wind energy. We have identified the real options included in the regulatory frameworks of these three countries and assessed how they affect the expanded net present value of the project. To this end, we have used two different methods of option valuation: the Monte Carlo method and the binomial method. We have proved that the obtained results using both methods are quite similar. Finally, we have evaluated the public incentives for wind energy offered in each of these three countries and concluded that, in economic terms, Finland is the country with the strongest support for this kind of energy, followed by Denmark and, in the last place, Portugal.