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Drilling finance one of the key issues of the industry right now

Drilling finance one of the key issues of the industry right now Drilling rig by Iceland Drilling on site in Iceland (source: Iceland Drilling)
Alexander Richter 7 Aug 2011

Geothermal exploration risk is a hot topic these days with many developers being stuck ahead of drilling. Insurance, government support or specialized financial products are crucial to move development forward.

Over the last few years, exploration risk has been the topic of many talks at conferences, discussions and news articles. In the past there have been mentioned programs like the GeoFund by the World Bank (that provides some kind of drilling insurance in Africa), the Australians have provided financial assistance to actual drilling (and thereby increasing drilling costs), the German public/ private exploration risk insurance, private efforts by insurance broker Marsh, SwissRE and MunichRE, and other government incentives or programs.

All these programs have their pros and cons, but are necessary to move the industry forward – particularly in the current economic environment.

In the end it comes down to the point on how to finance geothermal drilling, that is supposed to confirm geothermal resources and power available for the building of a geothermal power plant. Without going into too much detail the issue comes to the point on how much risk an investor is willing to take investing into geothermal development. In the current financial environment, the willingness to take risk has dramatically decreased making it very difficult for developers to finance the most crucial element in the development of their projects.

Until you can actually build a geothermal power plant you have to prove that you have the necessary resource to run a plant with a certain capacity. In the past, it was sufficient to prove around 50-60% of the capacity for a certain size plant and turbine. Now this number is at more than 70%.  This might not seem much, but is in most cases a decision over the life and death of a project. If drilling can be up to 30-40% of the overal project cost, additional wells to be drilled need additional “early stage” financing that is currently hard to get.

Now German re-insurance firm MunichRE announced within a few weeks, that they have insured private geothermal power projects in Germany. Bloomberg just picked it up last week and talks to one of the projects that the company has insured. (article link)

The concept is essentially simple. The company insures three elements that are crucial in the geothermal drilling process. Number one is you find the necessary temperature, secondly you have water available and thirdly the water flow is sufficient for your planned power project. So in the case of an insurance  you pay an insurance premium that allows the investor, that is willing to invest in this phase of your project’s development, to secure his investment. How much of the actual investment would be insured and if it the actual threshold of the insured elements is enough to run an economical project is I guess a question of the individual policy.

But an insurance is pricy and cuts right into the return for both the overall project, but also for the investor. In the past Icelandic bank Glitnir (now Islandsbanki) provided a particular financial product that was tailored to directly finance part of the drilling.

So while primarily the industry is looking at governments to take over the exploration risk for geothermal development and thereby making geothermal projects more attractive for investors, in the U.S. and other countries this support has not arrived. Therefore private tools, like an insurance or a special financial product might provide the necessary hope to move the industry forward. This applies particularly to North America, where most of the development currently seems to be stuck ahead of the drilling phase. Low drilling rig counts show that there is currently not enough drilling going on.

So one can only hope that developers are able to tap into funds, or get help in doing so through either some insurance program, financial product or government support. The industry is in dire need.

MunichRE and Icelandic Islandsbanki will present and speak about these topics at the upcoming CanGEA Annual Conference & Investment Forum in Toronto, September 14-15, 2011.

Disclaimer: I worked in the past for Glitnir/ Islandsbanki and currently for the Canadian Geothermal Energy Association (CanGEA)