Real options analysis of decarbonization investments in the chemical industry

The industrial sector is a major contributor to greenhouse gas emissions. While models exist to explore transition pathways, they often fail to adequately account for managerial flexibility in making critical decarbonization investments. Our approach explicitly considers the impact of uncertainty and flexibility on the timing and choice of industrial decarbonization investments, using process heat generation in the Swiss chemical industry as a case study. Introducing a bespoke real options valuation (ROV) model that accounts for the options to wait and for follow-on investments, we examine four decarbonization pathways: electrification, sustainable biogenic fuels, green hydrogen, and carbon capture and storage (CCS). Key uncertainties analyzed include allowance prices in the European Union Emissions Trading System (ETS), industrial electricity prices, and the capital expenditure for CCS. Based on plant-level data from 68 chemical plants in Switzerland, the model reveals that a mix of electrification, biomass, and CCS is deployed. Plants operating at low temperatures tend to transition to heat pumps, while those at high temperatures invest more in biomass and CCS. Results showcase how including real options in decarbonization models can delay modeled investments to a limited extent but that a diligent representation of uncertainty will likely have a much greater impact. Our case study further shows that the existing ETS-driven policy setup can lead to substantial decarbonization. In case of increasing electricity prices and stagnating ETS emission allowance prices, however, plants might stick to gas-based heat generation until 2050. Further policy interventions targeting the uncertainties could safeguard (and even speed up) investments, contributing to a timely decarbonization of industrial heat.