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Geothermal Energy Risk Management

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Geothermal Energy Risk Management

  1. 1. Geothermal energy risk managementThe current industry and political landscape has opened opportunities forcleaner energy options, while investors and government regulators endeavorto provide the essential infrastructure, services and legal framework todevelop and deploy new energy technologies. Before considering some of thekey risks,which have an impact on renewable energy projects and thegeneral approach to proper assessment, it is useful to identify barriers thatare preventing the uptake of RE projects. Foremost of these are barriers,which relate to the low level of awareness, understanding and attention,afforded to the complex array of policy, regulatory, technical financing andorganizational factors affecting RE projects. Geothermal project financing isnot the typical boilerplatescheme with pro forma agreementsutilized in otherresource project development.Geothermal Developer ProfileInvestors areeither large and traditional energy service companies that havethe ability to finance RE investments in technology or projects funded on anon-recourse finance basis, orsmaller but entrepreneurial geothermaldevelopers seeking investors for technology R&D and/or project finance.Forthese entrepreneurial geothermal development firms, there are differentbusiness models and balance sheet sensitivities to consider.While financial institutions carefully evaluate developer qualification andtrack record, being a major and well-known developer is not requiredbecause financiers recognizesinvestment opportunities having considerableexperience in developing energy projects by providing equity. However, newgeothermal developers are required to demonstrate their competency byselecting experienced and well-respected consultants, and specifying andusing equipment with proven track record.Most if not all capital prior to the geothermal project’s proven feasibility isdone through equity and not debt. Financing of exploration andconfirmation drilling usually comes from company equity or risk capitalprovided by investors. Generally, investment is sourced from seed capital,venture capital, or equity financing for a geothermal developer.Due to thehigh risk involved with geothermal exploration, banks do not providefundingthrough loans until the later stages in the development process.Risk IdentificationDuring the critical resource identification phase, the developer aims toobtain as much information as possible about potential resources whileinvestor costs are low providing the developer with a stronger foundation fordecisions on actual exploration and project development. Information andknowledge increase resource certainty and reduce risk, which allows betteraccess to capital. For this reason, the government can help mitigate risks byestablishing a well-documented geothermal database that is readily availableto potential investors.The government must also develop a standardclassification system that addresses the probability of risk based on astandard set of geothermal resource criteria and attributes.
  2. 2. Key indicators of success from geothermal exploration wells are hightemperatures and permeability combined with production of a high-enthalpyfluid that is not acidic and does not produce scaling over and above that isnormally expected for geothermal fluids.The highest risks for the implementation of geothermal energy projects areresource availability risks.Risk management challenge is magnified in thecontext of geothermal development due to the extremely high risk of lossduring the identification, exploration, and delineation drilling phases ofproject development where the probability of drilling a dry hole is high.Other identified risks can be further categorized into: operational risks(failures in planning, etc.), economic risks (increasing operating costs, etc.)and political risks (licenses, etc.). Risks that cannot be realistically avoidedcan increase the cost of capital or raise the required rate of return.In Europe and North America, the insurance industry has been providingmany of the traditional risk management products for the petroleumindustry to geothermal, such as property damage, business interruption,machinery breakdown and construction.Contract StructureGeothermal project financing is initially dependent on a “bankable” reservoirreport, which is based on the complete and thorough documentation of theexploration and drilling data as independently evaluated by a disinterestedthird-party’s technical analysis and recommendation report. Engineering,Procurement, and Construction (“EPC”) contracts typically pass allgeothermal plant facility design, development and construction risks fromthe developer who acquires a “bankable” turnkey energy project,to thecontractor who ispaid a premium for the assumption of the risks. In an EPCcontract, the contractor agrees to deliver the keys to a commissionedgeothermal energy plant to the developer for an agreed price, on a fixedschedule with performance guarantees and liquidated damages for thefailure of acceptance tests and timely commissioning.Project finance is also highly dependent on the Power Purchase Agreement(“PPA”) executed between the developer and purchasing end user, typicallyan electrical utility.The PPA provides for the sale of capacity and energy atan agreed price, price structure, and specified time period. In addition, thefinancial institution will include a careful analysis of the interconnectionstudies and transmission agreements.From the risk perspective however, itis preferable that economics and demand for power drive projects ratherthan contract provisions. Also, contracts negotiated with either side being ata disadvantage, is a cause of concern for lenders.ConclusionNeedless to say, streamlining the permit process by government regulatorswill have an impact on geothermal development, as shorter project periodswould reduce uncertainty for policy and market dynamics when modelingeconomic returns.
  3. 3. Geothermal projects are characterized by significant upfront capitalinvestment for exploration, well drilling, and the installation of plant andequipment. But once the geothermal projects are placed in commercialoperation the fuel source is secure for the tens of years of expected lifetimewith a steady revenue stream.It is good to note that traditional insurance products are now becoming moreavailable to the RE industry while new financial risk managementinstruments are evolving. Nevertheless, there is a need for customization ofcoverage and linked products that provide a total solution for the risksinherent in geothermal development. While geothermal energy will continueto face obstacles to gain investment market acceptance and application,there is room for optimism as the use of this energy source is onlybeginning.Fernando “Ronnie” Penarroyo is the Managing Partner of Puno and PenarroyoLaw Offices (www.punopenalaw.com). He specializes in Energy andResources Law, Project Finance and Business Development.

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