Is it still economic to build a new coal-fired power plant in the U.S.? A real option analysis

ABSTRACT

In the U.S., virtually no new coal-fired power plants have been built in recent years. Both industry experts and academics seem to believe that no rational firm will build a new coal-fired plant. Will such a trend continue in the future? To provide insights into this question, we investigate the optimal decision of an electricity company with an irreversible and deferrable opportunity to build either a new coal-fired or natural gas-fired power plant as its new base-load resource. According to our real option analysis, the optimal decision depends on the location. In the case of the eastern U.S., it is optimal to choose a natural gas plant if a firm is given a choice among a new natural gas plant, a new coal plant and deferring the investment. However, contrary to the common sentiment in the industry and academia, building a new coal plant in the western U.S. is still more economical than building a new natural gas plant in the absence of emission pricing. Furthermore, introducing carbon pricing to western U.S. states, as California did, can substantially increase the probability that a firm will optimally choose a natural gas plant over a coal plant.

KEYWORDS:

• Real option
• green policy
• emission market
• coal plant
• natural gas plant

JEL CLASSIFICATION:

• G12
• G31
• Q40

Acknowledgements

We thank Di He, Jingqi Zhang and Ameya Shirwadkar for their service as research assistants. These three research assistants are affiliated with the Illinois Institute of Technology. All errors are strictly ours. A summer research grant from the University of Wisconsin at Whitewater supported this research.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ According to the EIA’s Form 860 Data (EIA 2017), new coal-fired plants added to U.S. grids in the years 2014, 2015, and 2016 amount to only 106, 3 and 62 MW in terms of nameplate capacity.

² We gather the building cost data from PacifiCorp (2007), given that the EIA’s Assumptions for the Annual Outlook do not include such information for a coal plant with zero CCS any longer.

Additional information

Funding

This work was supported by the summer research grant from the University of Wisconsin at Whitewater.