The Economics of Adoption of Industrial Cogeneration: A Deterministic Model in Continuous Time

We conceptualize and model the decision-making problem of an industrial investor having the choice to adopt either some cogeneration or some heat-only generating technology, or a combination of the two. The deterministic model suggested is specified in continuous time, takes a lifetime perspective, and explicitly accounts for the impact of technical change and variations in other parameters on the optimal timing to adopt a cogeneration system and the optimal capacity choice/mix. The firm is flexible in postponing the investment decision. Uncertainty is incorporated by varying energy prices and base load duration. In a sensitivity analysis we show that the optimal capacity decision can change discontinuously due to regime shifts caused by changes in key variables, making investment decisions risky (risk of a suboptimal capacity choice) and optimal policy design very challenging. In numerical simulations, we provide evidence that technical progress and other changes in other important parameters can affect the optimal timing of adoption and the optimal capacity mix in important ways. Hence, if adopters are heterogeneous, this also has important implications on the optimal diffusion path of CHP technology. At the energy policy level, our findings of discrete jumps in the optimal cogeneration capacity level call for tailored cogeneration policies according to the specific characteristics of the firms, or industrial branches. At the more general level, the model could be useful for any kind of co-production where by-products can either be sold in the market or, alternatively, used as an input in some other production process of the firm concerned.