Geothermal Energy - Investment Case
Financing geothermal is more difficult the earlier the development stage of the project. This reflects the risks of geothermal projects until the resource has been proven. The further the project develops the more the risk decreases, making its financing easier. Knowledge and experience are therefore key for any geothermal development and that applies not only to the developer but also to financial players, such as banks or investors. The industry gained some valuable support through financial players with a unique interest in geothermal, which will help to increase overall interest in this important energy segment of the future.
Geothermal development has always been tied to and grown with increases in price developments on electricity markets. So it is not surprising that today in times of increasing discussion about global warming and rising energy prices, geothermal is again gaining interest as a base-load energy resource.
To draw an overview picture of how capital is and can be raised for a geothermal project is difficult as projects differ greatly with regards to location, market conditions, geological potential, water flows, political environment and developer specifics. Capital flows into geothermal development have also depended greatly on local energy markets, public and political support. But first and foremost, geothermal projects and investors face strong risks that decrease over time of a project.
It is not uncommon for geothermal power projects to take around 7 years until the actual operation of the installation. This can also be 1-2 years more or less depending on permitting and other licensing issues. Projects for direct use of geothermal heat need less time. Both applications depend greatly on the success of drilling and the resources available. Clearly, like in any other industry depending on a drilling success raising capital can be difficult. Here the drilling success is the proven resource - in volume, temperature and pressure of the fluids.
Generally a geothermal project can be divided into 5 different phases. Each phase requires different equity and financing solutions, with very different risk profiles at each stage in the development cycle. Traditional project and debt financing can often not be drawn upon in the early stages of the development of a geothermal project.
In the "Exploration Phase", geophysical surveys and collected geochemical and geological data are being analyzed and temperature gradient drilling provides an overview of where the geothermal potential lies for further development. In this early phase of a geothermal project the risk is high and only development equity can provide necessary financing, mostly through own financing provided by the developer or outside seed capital. To attract any financing at this stage is extremely difficult and the overall geothermal potential for this particular area/ region needs to favorable in order to attract investors at this stage.
In the "Pre-Feasibility Phase", a focused exploration on most favorable resource areas is being conducted with sufficient exploration data being collected and analyzed.
At this stage, the risk is still relatively high and financing can only be provided through development equity, see above. But venture capital and early stage private equity can also help driving the project further. Still the developer will find it rather difficult to raise necessary financing and only equity can be of help at this point in time of a project.
The "Exploration" and "Pre-Feasibility"-phase take each about one year.
In the "Feasibility Phase", which normally takes around 2 years, the first full-sized production well and additional confirmation wells are being drilled. The successful drilling here proofs the resource and significantly reduces the risk for project. It also allows the preliminary design of the planned plant.
Given the clearer picture on the resource, the financing possibilities improve and can attract additional financial resources. The drilling in this phase is mostly financed through drilling equity, provided for by private equity, financial partners, even public markets in some cases. Few banks, e.g. Glitnir also provide tailored solutions to already provide debt financing at this rather early stage.
In the "Detailed Design & Construction" phase, that takes round 2-3 years, the remaining production and re-injection wells are being drilled and tested, necessary civil works are being finished and the final design and testing of the plant can be processed. This phase sees traditional project equity possibilities coming into the picture. The resource is proven and clearer estimates about the output are allowing for construction financing for the project. At this stage, strategic partners, e.g. suppliers and/ or utilities can come into the picture providing further private equity to the project, either in form of cash or the provision of technology in exchange for a share in the equity of a project.
After those 7 years, the plant can be operated and maintained, with a potential extension of the plant as well, all depending on the experience with the resource of the field. Project finance and production tax credits now allow the opportunity for the exit of early stage and strategic investors.
As described above the development cycle with its different risk profiles proofs to be a challenge of geothermal project development globally. This applies particularly in regions where the geothermal energy potential has not been discovered and quantified as it has been in countries, such as the Philippines, Indonesia and the United States.
In the past the development of geothermal projects has been driven by big size utilities in many regions, most of them in state ownership, such as in the Philippines. There the political support for geothermal as an energy resource that provides independence from outside energy resources has been particularly strong, but so has been the potential for geothermal energy utilization. Other examples are New Zealand and Iceland, two island states that have started to develop geothermal in times of scarce and pricy energy supply, New Zealand already in the early 1950s, Iceland with its big push for geothermal in the 1970s.
Today the dependencies on political support has decreased, but in regions where the development of geothermal energy is more capital intensive, such as e.g. in Germany, it still depends heavily on government incentive programs, such as feed-in-tariffs (Germany) or renewable portfolio standards (in many states of the U.S.).
But the picture is changing and so a number of companies, financial institutions, utilities and investors are looking into financing geothermal projects. But they all face the same problem that basically until the resource, here the hot water, is proven and production estimates can be made, any capital allocation faces various levels of risks. For any investor and/ or financial institution this is a risk that many believe that they cannot take.
Knowledge and experience in geothermal project development can therefore play an important role in any activity in this sector as it can help determine levels of risk and possible financing at various stages a lot earlier. Unfortunately this experience is scarce.
The geothermal industry is very fragmented making the bargaining power towards e.g. the oil sector with which the industry is competing with for equipment and people very difficult. To develop geothermal projects any developer needs a strong financial muscle and this has also been a big issue for the industry. But the picture is changing.
The different levels of risk also require a profound knowledge and experience for evaluating the resources on which any geothermal project builds upon. For many traditional financiers this is a difficult task even though the general value of geothermal as an energy source is being seen.
While governmental support and/ or subsidies in form of risk insurance for e.g. the drilling risk, or so-called feed-in-tariffs (with higher electricity price/ kWh than market price for non-renewable electricity generation), as well as production tax credits can help project to come off the ground, all those projects depend heavily on the open market for their financing needs.
Glitnir has learned from the experiences of the industry and works closely with experienced partners in this sector having established its own geothermal team of experts providing geothermal financial services world-wide. The bank also experienced that the lack of an experienced and geothermal-focused investment company made it difficult to drive even projects with lesser risks. The result was the founding of Geysir Green Energy, a dedicated financial player with holdings in the whole value chain of the geothermal industry and this globally.
Both Glitnir and Geysir Green Energy have been welcomed in the geothermal community with open arms. The efforts of both players have awakened the interest of a large number of financial players, such as banks, investment funds, private equity boutiques and firms, hedge funds and other to team up with the experience and knowledge built up in this sector by these two committed geothermal players. There are further plans to build up funds to combine geothermal projects in various locations and at various stages of development to cover drilling and project risks, but also further strengthening the financial muscle of geothermal developers. There is also strong support by players like the World Bank and IFC to provide regional, sovereign and political risk insurance.