It is well known that conversion of energy gives rise to several environmental problems. The impact on the environment and human health can involve substantial indirect costs for society. These indirect costs are also known as external costs, since the market often does not consider them. However, they do exist and since the external costs may not be negligible they should be taken into account. The presence of environmental costs, not considered in the market, means that the real costs of the energy carriers are not reflected in the price. When prices fail to reflect the full cost, the market will misallocate available resources and some kind of intervention is needed to correct matters. If this is done, the decisions to produce and consume useful forms of energy will better reflect society's desire for environmental quality and it may substantially affect decisions regarding the design and operation of energy systems.

The purpose of this thesis is to study cost-effective technical changes of energy systems and the use of wood fuel when monetary values of external costs due to environmental damage are considered. A method based on optimisation is used and the energy systems studied are three regional energy systems, a district heating system and an industrial energy system. External costs included in the energy system analysis are those due to atmospheric emissions of CO₂, NO_x, SO₂ and particulates during the combustion of fuels to produce heat and electricity.

The analysis shows that taking external costs into account would lead to lower social costs due to the design and operation of energy systems. Hence, society would benefit from taking on investment costs to reduce environmental impact. The cost-effective technical measures would, in most cases, lead to an increased use of wood fuel and a reduced use of fossil fuel and electricity. With an open European electricity market, the emissions and the environmental costs could decrease substantially with the assumption that coal condensing power production is reduced with a lower use of electricity and that it is replaced by increased electricity production in cleaner production plants.