Studies have shown that separate actors can benefit from co-operation around heat supply. Such co-operation, for example, might be between an industry selling waste heat to a districtheating system or two district-heating systems interconnecting their respective systems. Cooperation could also be expected to reduce the environmental impacts of the energy systems by choosing the plants with the lowest emissions. It is widely accepted that the production of heat and electricity causes damage to the environment. This damage often imposes a cost on society, but not on company responsible. In general, using a broader system perspective when analysing local energy systems results in a lower total cost, more e.cient use of plants and a greater potential for producing electricity in combined heat-and-power (CHP) plants. Internalising the externality costs in the energy system model facilitates the study of what cooperation can mean for reducing emissions. This study shows that co-operation between the two systems is on the whole cost-effective, but the benefits are greater when external costs are not included in the calculation. Considering externality costs in combination with current electricity prices would lead to a higher system cost, but the quantity of emission gases will be lower. If, on the other hand, the calculation is made taking externality costs and corresponding adjusted electricity prices (the adjustment being necessary to compensate for the additional cost due to externality costs) into consideration, the quantities of emission gases will rise because more heat-and-power will be generated by one of the CHP plants. © 2002 Elsevier Science Ltd. All rights reserved.