Should district heating system owners embrace higher emission prices?

by Sebastian Wehrle (Doctoral researcher in reFUEL)

While the world is debating a 1.5°C global warming goal, greenhouse gas emissions in self-proclaimed climate pioneer states such as Germany turn out to retreat far slower than was pledged. As a result, calls for increasing the cost of greenhouse gas emissions are growing louder, supported amongst others by the OECD.

In a recent paper written together with Johannes Schmidt, I introduced the power system model medea, which I developed during my doctoral thesis. The model will also be used in the reFUEL project to study the impact of renewable fuels on the central European power system. We examined how an increase im CO2 emission prices would affect district heating systems. This is less straight-forward as it might seem at first sight, as higher emission cost would not only raise the cost of co-generating electricity and heat, but also increase the price of electricity, which is a key source of revenue for combined heat and power plants.

Whether higher emission costs are a net improvement for CHP profitability depends on technical characteristics and the CO2 intensity of the fuel burned in the CHP unit as well as on the amount of the emission cost increase that is passed-through to electricity prices.

In a nutshell, you are not going to benefit from increasing emission cost if you are operating a coal or lignite-fired CHP plant. If, however, your unit is fired by natural gas and at least moderately efficient, you can expect to be a net beneficiary of higher emission cost. In consequence, you have an interest in raising emission prices. This is particularly relevant when considering that many large district heating systems are fully majority owned by municipalities or federal states in Germany and Austria.

Higher emission prices improve district heating system profitability, because the units that are determining the electricity price in the German market are, at many times, more polluting and thereby stronger affected by the emission cost increase than your efficient natural gas-fired co-generation unit. To recover their operating cost, these emission-intense plants have to pass a considerable share, we estimate it in the range of 60% to 80%, of the (additional) emission cost through to electricity prices.

This should delight low emission generators as they can not only expect higher profit margins, but, due to increasing electricity prices, also more frequent dispatch and increased energy generation. Yet, this is bad news for consumers, as they have to pay for the larger part of the additional emission cost through higher electricity prices.

This finding is also quite robust to changes in the underlying assumptions. Variations in international electricity exchange or in fuel prices are not changing our pass-through estimates substantially. However, investments in low-emission energy generation technologies that are incentivized by higher emission cost, are likely to change the picture substantially. Increasing electricity generation from PV by 40% and from wind energy by 50% while shutting down 10% of the coal and lignite-fired power plant capacity would reduce the pass-through from emission cost to electricity prices by around 15 percentage points, according to our estimates (see RES2025 in Figure). Yet, consumers should not rejoice too quickly. Increasing system flexibility, which we modeled as reduced must-run requirement for the provision of ancillary services, could offset much of the reduction in the pass-through from emission cost to electricity prices. And increasing system flexibility is a top priority on the agenda of European policy makers. It seems as if the Energiewende will be paid for largely by consumers.

The paper, code, and data can be downloaded here.

Emission Pass-Through to Electricity Prices for a range of CO2-Prices.

Johannes Schmidt