Sought After Base-Load Power.

With rising electricity consumption, it is expected that by 2015 there will be a shortage of base load capacity in the world energy market. The energy gap will come as coal plants are closed down (coal plants generate roughly 50% of U.S. electricity; about 22% globally) due to toughening pollution controls. Since 2007, 95 proposed coal plants in the U.S. have been cancelled or postponed, which represents nearly half of the 200 plants proposed for construction since 2000. The Energy Information Administration (EIA) reports that more than 600 coal-fired plants still produce about half of the power in the U.S. The government has pledged to reduce greenhouse gas emissions by 80% by 2050 – with coal-fired plants being to represent a good portion of those emissions.

There are ambitious energy plans but not all renewable sources of energy can meet base-load demand. Base-load power is considered the minimum power that must be made available to consumers, and represents a stable and steady source of power. While the output of a wind or solar plant varies with climatic conditions, geothermal power plants boast average operating rates of 98% (i.e. the plant is producing electricity for 98% of the year), making geothermal a potential substitute for coal and nuclear plants and a highly coveted source of baseload power.

Exhibit 1: % of U.S. Electricity Generation from Coal:  Source: U.S. Department of Energy

Attractive costs

Levelized Cost of Energy (“LCOE”) represents the “all-in” cost of generating electricity for a particular system. It is usually represented per MWh or KWh and is a normalized value based on all costs over the lifetime of a project including the initial investment, O&M, fuel and financing expenses. According to the National Renewable Energy Laboratory, the LCOE for a geothermal plant, when including the value attributable to PTCs, is approximately US$0.059/KWh (US$59.00/MWh) versus US$0.0875/KWh for a coal plant and US$0.085/KWh for a conventional gas plant. The PTC reduces the LCOE for a geothermal plant by approximately US$0.02/KWh. Conversely, carbon credit costs increases the LCOE for a coal plant by roughly US$0.035/KWh.

Capital costs for a geothermal plant can range between US$2 million and US$4 million per MW of capacity, which is equal to or much higher than a traditional fossil fuel power plant. Geothermal facilities on the other hand, have a capitalized lifetime supply of fuel in the form of their production and injection wells, and hence do not require fuel to generate electricity. Consequently, over the lifespan of a geothermal project, the LCOE of geothermal energy is expected to be materially lower than traditional electricity generating technologies and lower than or comparable with other renewable energy sources (including the PTC).

Geothermal Awareness Is Not As High As Solar And Wind But Rates of Return Are Better

While geothermal awareness and publicity currently pales in comparison to other ‘green’ technologies (i.e. solar, wind), we find geothermal projects, on average, carry higher IRR compared to wind projects and much higher IRR’s compared to solar projects. The economics of geothermal plants make it a realistic alternative to traditional power plants. However, cash grants and other incentives only make the attractiveness that much greater.

Exhibit 2:  Comparison Internal Rate of Returns (IRR’s)

Renewable Portfolio Standards (RPS)

In addition to incentives, policy support at the state and federal levels, in the form of Renewable Portfolio Standards (“RPS”), will propel growth in renewable energy in the US. RPS requires utilities and other retail electricity suppliers to produce or purchase a minimum quantity or percentage of their power supply from renewable sources. Currently, 30 states and the District of Columbia have mandatory RPS requirements. Mandatory RPS policies are backed by compliance enforcement mechanisms. Most states have a cost containment provision (a cost cap) limiting renewable energy procurement to those below the benchmark price. This could arguably turn RPS compliance into a “best effort” basis. However, we believe the utilities are taking their RPS targets seriously.

The impact is evident. Since the introduction (in 2002) of California’s RPS renewable energy projects totaling 7,300 MW of capacity have been approved by the state’s regulatory body including 1,285 MW (17.6%) of geothermal capacity. While online production has in fact grown slower than expected mainly due to unanticipated project delays and difficulties the number of project proposals has shown robust growth. Looking ahead, given these mandatory RPS targets, an additional 25,000 MW of electricity is estimated to be required in the western U.S. from renewable sources and as a base load producer, geothermal energy is expected to play a critical role in filling the current shortfall.

Exhibit 3: Renewable Portfolio Standards by State- Pew Center on Global Climate Change

Rising Oil Prices

Energy price volatility has been a critical driver behind the rapid adoption of alternative energy. The rise of  oil to a peak of $147 in May 2008 coincided with a wave of global policy changes in support of alternative energy. Rising oil prices  make renewable energy sources like geothermal increasingly more attractive. With a barrel of oil  approximately “equal” to 0.49 MWh of energy and  the LCOE of a geothermal plant at about $0.08/Kwh,  geothermal energy is equivalent tooil at about  $40 per barrel. PTCs make it even more compelling as the LCOE of a geothermal plant decreases to $0.059/Kwh – equivalent to about a $30 per barrel. Oil prices are trading much higher than that level.

US Government Incentives

Government support for clean energy initiatives has traditionally come in the form of tax credits and accelerated depreciation deductions for tax purposes. The Production Tax Credit (“PTC”), first implemented in 1992 to support wind and bioenergy resources and recently renewed provides geothermal energy producers with an inflation-adjusted US$21/MWh tax credit for ten years for projects placed into service before 2014. Projects eligible for the PTC are also eligible to instead receive an Investment Tax Credit (“ITC”) equal to 30% (formerly 10%) of a project’s qualifying cost, although projects which do avail of the ITC are required to reduce the base for depreciation by 50% of the ITC.

The Recovery Act, signed in February-2009, also provides the U.S. Department of Energy with the authority to issue loan guarantees totaling US$ 6.0B up until September 30, 2011 for renewable energy projects that generate electricity or thermal energy.  Additionally, US$ 350M was allocated specifically to fund development and increased commercial usage of geothermal power. This represents the U.S. Government’s largest ever fund allocation dedicated solely to geothermal technology reflecting an aggressive support for energy independence and environmental sustainability through clean energy initiatives.