ESMAP Report – early stage fiscal incentives

Los Azufres geothermal power plant, Mexico (source: Alstom)

Parker O'Halloran 1 Jun 2017

This review is the last of four excerpted from The World Bank’s Energy Sector Management Assistance Program covering the Comparative Analysis of Approaches to Geothermal Resource Risk Mitigation. This will be a summary of mitigating the risks of geothermal energy development with “Early Stage Fiscal Incentives.”

As highlighted in the previous entries with the focus of Government as Developer, Cost-Shared Drilling, and Resource Risk Insurance it is obvious that greatest hindrance to developing geothermal energy is the initial costs of surface reconnaissance and exploration drilling. Private companies in particular need incentives to support capital outlay for investment. The use of early stage fiscal incentives are another technique that governments can implement to reduce the cost of exploration and encourage risk capital towards exploration and drilling.

The risk mitigation method of early-stage fiscal incentives is similar to a partial cost sharing scheme and can be just the impetus needed to mobilize risk capital, particularly during the early stages. The main incentives of such a scheme are to reduce certain taxes and import duties that can reduce the amount of risk capital required for surface reconnaissance, exploration and confirmation drilling. These exemptions may include reduction of taxes on drilling equipment and construction materials. This lowers the overall investment costs for the exploration phase by decreasing the amount of early stage risk capital needed to fund a project. Furthermore, these incentives may be perceived favorably by the public, as there is no “perceived” up-front financial support from them.

Although these incentives are somewhat modest in contrast to the others in the ESMAP Report, they can reduce the financial losses to developers if the early stages of exploration are unsuccessful. These types of incentives are often used in combination with the other risk mitigation schemes to enhance their appeal as well. Early Stage Fiscal Incentives have been used in Mexico, Turkey, the Philippines, Indonesia, and the United States with success. Although this method has certainly facilitated many geothermal development projects, the method cannot be singled out as the impetus for a geothermal project, and has had limited impact on pace of geothermal power production.

There are two disadvantages of early stage fiscal incentives that must be considered. The scale of the geothermal project will directly impact the fiscal imposition, and may have little overall impact toward the project’s costs. Additionally, to implement such fiscal incentives may require change in a country’s fiscal architecture in order to put it into effect.

Overall, this mitigation scheme has the least impact of those previously discussed. Essentially national governments are willing to make a cut in tax revenues temporarily, in the hope that the future project will be profitable and generate tax revenue. These tax breaks are generally easy to implement and monitor through existing financial structures that make them ideal to “sweeten” the deal for other mitigation measures.

Source: World Bank Group, ESMAP, Washington, DC, worldbank.org March 2016.