Geothermal energy investment and its risks

In an interview last month, “North America Clean Energy Magazine asked Craig Dunn with Borealis Geopower to discuss geothermal energy development and some of the current issues moving forward.

Generally risk, so Craig, is defined as 1. The possibility of suffering harm or loss; danger; and 2. A factor, thing, element, or course involving uncertain danger; a hazard. Financial risk is then the “quantifiable likelihood of loss or less-than-expected returns”

Risk. The word immediately brings up the feeling associated with walking across a rope bridge over a deep canyon—for some there is only dread, but for others, sheer exhilaration. Many feel dread because the bridge could fail, but others see it as an opportunity to cross the canyon. The key to understanding risk is to not just see the danger or loss, but also the uncertainty and possibility.

In the geothermal energy industry, there is a problem with risk. This problem is not necessarily tied up in the danger or loss side of the equation—both developers and project investors are keenly aware that some projects may never produce a single electron worth of electricity. The problem is in understanding and quantifying the uncertainty. How much of a chance is there that a project will fail? For any financial investment, and specifically for any energy project to get funded, investment professionals need to “run the numbers.” What is my risk and potential reward? And, one key question: “what is the possibility of a zero return on my investment,” or, in the above analogue, a bridge failure?
Say there was a million-dollar reward at the other side of the canyon and the bridge had a one-in-a-million chance of failing…would you cross? Likely, most people would “risk it” and cross the bridge. How about a $100 reward and a one-in-a-hundred chance of bridge failure? Now, people are starting to re-assess the risk-to-reward ratio; they are “managing their risk.” So, here’s where it gets tricky. What if there was no confidence in the odds of a bridge failure? Meaning the bridge could fail at any time. How could someone assess the risk to reward?

As much as they might like you to believe otherwise, institutional investors do not risk their lives when they invest in projects, but there is significant financial risk when one considers the number of zeroes involved with any major energy project.

Here is where the predicament lies for geothermal energy development, as the reward for geothermal energy development is high. According to the US Department of Energy, geothermal energy has one of the lowest levelized costs (average cost of power production over the life of a power plant) of any power supply. Unlike wind or solar, geothermal energy does not rely on variable sources of energy; the earth’s heat provides baseload power without fuel costs. Geothermal energy development has one of the smallest environmental footprints for land use and CO2 production, and can be a source of both power and heat. When this cost-effective, clean, renewable energy is needed most, investors should be more than interested in “crossing the bridge.” So, why then is geothermal energy not the investor’s first choice for energy investment dollars?

The answer comes back to quantifying risk to reward. Like any energy development, geothermal projects have an element of risk. Any honest energy developer will admit that not everything goes according to plan and not everything stays on budget. A big issue for geothermal energy is the vast majority of capital risk on the front-end, including: exploration risk, drilling risk, and power facility construction risk, just to name a few. It is not unreasonable to assume that a geothermal energy developer will spend almost 95% of its capital budget before putting electrons on the grid and beginning to recover the reward. Although this is a distinct disadvantage for geothermal energy development, comparably to fossil fuels and other renewable energy sources for power generation, this is still not the key problem. Successful investors do not avoid risk, they manage it. The real issue is correctly quantifying the risk by identifying all the potential pitfalls. If the investor understands the risk, they could put a number on it (the bridge fails one in 100 times), and then they could decide what a reasonable reward should be and “manage their risk.”

If a developer downplays the risk or overstates the reward, they create uncertainty and mistrust for the investment community. “You are saying the bridge only fails one-in-a-million times, but it failed last week. What are the odds of failure today?” If the developer cannot honestly answer the question, then the unknown or uncertain risk can make quantifying the risk-to-reward ratio next to impossible. However, with every “bridge failure,” developers learn how to build a better bridge and improve the odds of success.

This is where the geothermal industry can be proactive and think like the investor. Developers need to provide sound numbers for things like exploration drilling success, resource recovery, and capital costs. “Yes, there is a one-in-100 chance the bridge will fail, but the reward is still a million.” If these numbers are well-researched and accurate, it allows investors to make informed decisions.

With no misconceptions, the benefits for developers are twofold:

* The investor and the developer are well-informed of the actual risk they are taking.
* The investor is comfortable with their reward for taking that risk.

At the end of the day, the developers have already decided that it is worth crossing the bridge for geothermal energy development, and they have already invested or risked their own time and energies. Now is the time to help the investment community understand where the pitfalls are and why the reward is worth the risk. More than ever, the industry needs investors to cross the bridge with them for clean, renewable, geothermal power.”

Craig Dunn is a geologist with Borealis GeoPower.

Source: North American Clean Energy