Distributed energy systems are gaining widespread popularity in recent times as they are capable of generating power with a minimum running cost. They are also highly effective since they are located close to the load which reduces the transmission losses to a significant extent. Energy starved countries have opened up business opportunities to industries which can generate electricity and export them to the grid. The purpose of this paper is to evaluate the economic feasibility of using a compressed air energy storage (CAES) system for distributed generation sources or captive power plants when it operates in islanded mode. This paper presents the application of CAES system as a viable energy storage method to be used as a dump load when the source operates in islanded mode. Based on the data of a sample case, cost analysis is being carried out to ensure the economic feasibility of implementing such a system for a captive power plant. The detailed cost analysis for implementing such a system is presented together with a simple methodology to be followed for selecting a compressor. Implementing an energy storage system always improves the performance of the system as it is capable of smoothing out the fluctuations. For plants which are exporting power to the grid, it also improves the operating profit of the plant by acting as a buffer in situations when there are minor disturbances in the grid and the plant is forced to operate in islanded mode. The sample case study is being done for the possible application and implementation of the suggested energy storage system, and the findings show that even though the initial cost of such a system is on the higher side, it can be helpful in the long run. The proposed system will be helpful to supply peak loads and also increases the profit of such sources who export power to the grid. The proposed system is applicable only to sources which are connected to the grid and it works well only when there is a sustained period of operation in islanded mode.