Both energy supply and waste treatment give rise to negative effects on the environment, so-called external effects. In this study, monetary values on external costs collected from the EU's ExternE project are used to evaluate inclusion of these costs in comparison with an energy utility perspective including present policy instruments. The studied object is a municipal district heating system with a waste incineration plant as the base supplier of heat. The evaluation concerns fuels used for heat production and total electricity production, for scenarios with external costs included and for a scenario using the present policy instrument. Impacts of assumptions on marginal power producers (coal or natural gas power plants) are investigated, since locally produced electricity is assumed to replace marginal power and thus is credited for the avoided burden. Varying levels of external costs for carbon dioxide emissions are analysed. The method used is an economic optimisation model, MODEST. The conclusion is that present policy instruments are strong incentives for cogeneration, even when external costs are included. Waste is fully utilised in all scenarios. In cases where coal is the marginal power producer, more electricity is produced; when natural gas is the marginal power producer, less is produced. There are several uncertainties in the data for external costs, both methodological and ethical. In the ExternE data, not all environmental impacts are included. For waste incineration, ashes are not included, and another difficulty is how to treat the avoided burden of other waste treatment methods. (C) 2007 Elsevier Ltd. All rights reserved.