Introduction

With the importance of meeting net-zero targets growing, decarbonising industrial process heat has become a pivotal challenge for policymakers and industrial stakeholders alike. However, investment in low-carbon heat technologies is still timid. This is hindered by risk aversion, the irreversibility of investment, and the fragmented nature of industrial heat demand, among other factors.

This paper explores the potential role of Small Modular Reactors (SMRs) in supplying decarbonised heat and electricity to industrial sites. These technologies offer high-temperature capabilities of decarbonized heat production at stable cost, yet face significant economic and infrastructural barriers. In the context of a possible deployment of such technology to supply heat and/or electricity to an industrial firm, emerges the issue of agreements on bilateral contracts between SMR developers and industrial firms, which may offer a viable pathway to overcome investment hurdles and align supply with demand.

To investigate this, we develop a coupled investment model within a Real Options framework, capturing the strategic decision-making processes for both an industrial firm and a SMR developer.

Methodology

The model considers five investment or contracting options for the industrial firm and three for the SMR firm, incorporating the irreversibility of capital expenditures, uncertainty on market fundamentals, and risk aversion from both agents. We expand the classical one-agent real options framework by incorporating a Nash bargaining stage to model the coupled decision making process between the two firms. We quantify the different investment and contracting probabilities for both firms, and evaluate their sensitivity to investment costs and price parameters.

The model is solved with dynamic programming, using a refined version of the Least Square Monte Carlo where we add an inner backward induction loop to keep the two-agent model time consistent. We use 100k Monte Carlo branches, with 16 timesteps representing a 2035 - 2050 time horizon where investment and contracting decisions are made annualy.

Results
We consider the application case of a high temperature reactor on the SMR firm side, and an industrial firm from the chemical industry sector. These type of reactors, although anticipated to be more expensive to build than light water reactors, are able to supply heat at higher temperature and pressure than the latter, allowing them to supply steam to a wider range of industrial processes. Our results indicate that, under our numerical assumptions, the probability of an agreement between the industrial and SMR firms on a bilateral contract for heat supply in 2040 drops from 70% to around 10% when irreversibility is accounted for, and from 75% to 20% in 2050. Sensitivity analyses are led to quantify the effet of SMR investment costs, and commoditiy prices initial values and volatilities. Simultaneously higher gas and electricity prices increase the probability of agreement, while higher electricity prices with stable as prices push the SMR firm to invest in a purely electrogenous setting. Finally, it is interesting to note that, in some scenarios (e.g, low capital expenditures) in which the classic NPV analysis yielded a probability of agreement close to 100%, the real options model on the contrary exhibits opportunities for making optimal investment decisions separately for on-site capacity at the industrial site and for pure electrogeneous capacity at the SMR.
So far, firms have been modeled as risk-neutral agents. Further analysis will examine how both firms' degree of risk aversion influences these outcomes. Economic intuition suggests that risk-averse agents exhibit a stronger preference for bilateral contracts as a means of hedging against uncertainties arising from volatility in electricity, gas, and CO2 prices.