The Art of Geothermal – Investing in and Capitalizing on the Heat Beneath Your Feet

The lack of capital available to geothermal projects, especially during early development stages has stifled the growth of geothermal technology worldwide and poses a major challenge for this sector. Yet, with new prospects from technology innovations such as Enhanced Geothermal Systems (EGS) and low-temperature applications, investor’s interest is finally catching on and the number of those recognizing the huge geothermal potential to be tapped is ever increasing.

Nonetheless, knowledge and experience are an absolute requirement for any geothermal development. That applies not only to the developer but also to financial institutions and investors. Most geothermal power projects take 5 – 7 years to be completely operational, depending on permitting and other licensing issues. Each geothermal project phase, from site identification to operation and maintenance, has its own scheme, its own set of activities and requires different equity and financing solutions with very different risk profiles.

Financial applications depend greatly on the success of drilling, which is ultimately determined by the volume, temperature and pressure of the fluids discovered.

Yet, drilling is a very expensive part in any geothermal project, representing up to 60 – 70 percent of the overall geothermal project cost in Germany and 30 – 40 percent of the overall project cost in the United States. While the percentage varies greatly for other regions, in all cases the potential for unsuccessful drilling represents a high risk factor.

Given the high risk factor involved in drilling for geothermal resources, traditional debt is not available for financing this activity in the early stages of a geothermal project until the resource has been successfully proven. Government support and subsidies are helping projects to come off the ground in some cases. Public support schemes however differ from nation to nation and are never able to completely cover costs. In the end, all projects depend heavily on the open market for their financing needs. Options are limited, but specialized financial institutions have started developing alternative financing instruments. One example is Icelandic Bank Glitnir’s “resource verification loan,” a hybrid mezzanine vehicle that was used to cover the cost of drilling and testing the two initial production wells for a geothermal power plant in California.

While the risk reward balance prohibits developers from accessing most traditional sources of equity, there is evidence that the tide may be turning. In 2007, private equity firms invested more than US $400 million in geothermal energy. Large energy and utility companies are now moving into the industry, expanding collateral options for investors.

Mitigating Risks

All geothermal projects have to bear multiple risks until the resource has been proven: reservoir-related risks, risks from natural hazards, production-related risks, technical risks, financial risks and legal risks — and each has different probabilities and impacts and are more or less quantifiable. As exploration and drilling constitute major upfront investment components, reservoir risk is a veritable hurdle for the investor in a geothermal project. This is especially true for low-temperature projects in case the necessary flow rate cannot be reached, resulting in a high economic risk, i.e. a total failure of the project. Insurance exists for some of the risks but not for all, and not in all countries. As Ken MacLeod, CEO of WesternGeopower notes, proper risk assessment is key, “there is no exploration insurance available in the U.S. — a good and experienced team and thorough knowledge of the resource is our insurance.”

Yet, reservoir-risk transfer can be a viable instrument to mitigate the risk of lower than expected heat extraction. The insurance industry has, albeit faintheartedly, responded to the challenge by offering coverage for reservoir risks at locations that are geologically well-defined. Reservoir-risk insurance reduces the need for equity through partial coverage of costs should the project become uneconomical. According to Marcel Stäheli, Director of Weather and Energy Underwriting at Swiss Re, “Germany is currently the most mature insurance market for deep geothermal reservoir risks. With reservoir-risk transfer demand increasing (outside Germany), the insurance industry is further challenged to quantitatively assess the risks of lower than expected heat extraction in areas with little empirical data as geologically diverse as the East African Rift Valley or the Chilean Andes.”

Reservoir-risk insurance might be one vehicle that will further accelerate worldwide geothermal development. More and more, the huge geothermal energy potential in many regions in Asia, Africa and Latin America is starting to outweigh the prevailing risks in large part due to an increasing number of governments helping to bring foreign investors into the picture, particularly for renewable energy business.

Regulatory reforms and public incentives represent further stimulation for those ready to invest in geothermal projects and technology. The U.S. industry is buzzing with activity in all geothermal sectors. Australian companies are leading the way with major investments in EGS technology, with the first commercial power plants coming online soon. European project developers are demonstrating how combined heat and power can lead to economically viable projects in low-temperature regions.

Opportunities await all around the globe. Those ready to venture into the geothermal world can now refer to a new publication, edited and compiled by forseo GmbH with contributions from many international experts: The Investor’s Guide to Geothermal Energy. The guide provides comprehensive and market-driven insight into the art of geothermal business and project development. 

Kai Sametinger is a project manager at forseo GmbH.

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