The capacity for waste incineration in Swedish municipalities is increasing due to regulations aimed at decreasing landfill with waste. This has a large impact on the municipal energy systems, since waste is an important fuel for district heating production. The object of this study is a municipality, Skovde, which is planning to build a waste incineration plant to produce electricity and heat. The municipality is also planning to extend the district heating grid to include a large industrial heat consumer. The economic effect on the energy system of these measures is analysed as well as environmental effects in terms of carbon dioxide emissions. The consequences of two different policy instruments, green electricity certificates and a tax on waste incineration, are also studied. Economic optimisations show that the advantage of co-operation with industry is twofold: lower heat production costs and a considerable reduction of carbon dioxide emissions. It is economically feasible to invest in a waste incineration plant for heat production. An important measure to lower carbon dioxide emissions is to introduce combined heat and power production on the assumption that locally produced electricity replaces electricity produced by coal condensing power. (C) 2003 Elsevier Ltd. All rights reserved.