HRN: Where do you see oil prices in the next few years?
Rule: I think oil prices will move up dramatically in the next 5 years. The transition from a hydrocarbon economy to some other type of economy will require massive investment in new technologies and I don’t think we will adapt quickly enough to avoid an escalation of oil and gas prices. Hydrocarbons, oil and gas, are extremely efficient energy sources. They are extremely dense and there is an incredible installed capacity to utilize them in various forms. They seem ideally suited for use as motor fuels. Whatever replaces them will be long in coming and involve enormous expense. I suspect that the next 10 or 15 years will involve a transition away from the widespread use of oil and gas in applications other than motor fuel. As a consequence, increasing per capita consumption of hydrocarbons around the world with an increasing number of capita, and without a viable alternative in the near term means that higher oil and gas prices are inevitable.
HRN: How do you see alternative energy playing out versus oil and gas?
Rule: I differentiate economic alternative energy and uneconomic alternative energy. The alternative energy investments that intrigue me are geothermal and hydroelectric which are, by and large, industries that could exist and thrive without subsidy but, because they are green energy, receive subsidies at any rate. Juxtapose those with wind and solar, which do not, given their current stage of technology and status of deployment, generate an economic return without subsidy. I am not, for the most part, an investor in wind or solar, although I have made a couple of small wind investments as a consequence of extraordinary feed-in tariffs. Solar has, in my opinion, an insurmountable problem, which is night. It’s highly interruptible power. It’s not baseload and it’s devilishly difficult for utilities to incorporate into their demand curves. Wind is similarly difficult. People don’t like to live in windy areas and the energy has to be transported to where people want to consume it, and the wind doesn’t necessarily blow when people want to consume the power that’s being generated by it. Geothermal power is baseload. It’s very highly deliverable, about 95% efficient, and it is in certain areas of the world, such as the Western United States, highly economic. Hydro, although it relies on precipitation and drop, has been utilized for 100 or 150 years and is highly competitive even though it doesn’t have the same baseload characteristics of geothermal.
HRN: Would you say that geothermal power is the most promising area for investors?
Rule: What all forms of alternative energy have, and what no other forms of energy have, is social and political acceptance. Most elements of society are solidly in favor of increasing utilization of non carbon generating power. I was involved, as an investor, in the drilling of a new geothermal well in the Geysers of Northern California, which is, by the way, the largest installed geothermal facility in the world. What struck me about it was that we were drilling this well using typical oil and gas equipment. It was a fairly large drilling rig and a fairly noisy, messy operation and it occurred to me that if we had been drilling an oil well on the Napa-Sonoma county line there would have been popular outrage and political opposition—pickets, protests and that kind of thing—but, because we were drilling a geothermal well, we received orders of commendation from both the Napa and Sonoma county councils. What’s important about that is that it’s power that is (a) needed, and (b) can be built due to a level of political and social support that other forms of energy do not enjoy.
HRN: I understand that there are US Department of Energy grants and other government programs designed to encourage alternative energy.
Rule: The current US administration has done two extraordinary things. They have offered grants to the geothermal industry of up to 30% of project expenses. We calculated that the government would give companies as much as 27% of the capital budget with no equity interest. At the same time, they will guarantee up to 80% of allowable project expenditures. Now that’s interesting because if you add up 27% and 80% it produces a rather exquisite fraction. What is more interesting is that, in the Western United States, the government has instituted feed-in tariffs that require utilities to pay premium prices for alternative energy versus other sources of energy. As a result, unleveraged internal rates of return on select geothermal projects can exceed 20%. The industry’s cost of capital, as a function of subsidies, could be around the 5% level. The idea of a 15% financial margin in an operation that is effectively offering a utility risk is extremely attractive. I don’t know how long the federal subsidies will last. They’re slated to last about 3 ½ years and I wonder, given budget constraints, if the popularity of geothermal projects will allow them to continue with this level of subsidy in the face of competing needs for money, but it certainly makes for a very, very attractive investment opportunity.
HRN: I’ve noticed that the market does not seem to be rewarding geothermal junior companies.
Rule: It’s my belief that, 2 or 3 years from now, alternative energy investments will enjoy the same kind of spike in popularity that we saw in uranium speculation 5 years ago. I think there’s going to be a true mania surrounding alternative energy investments and I think a lot of money will be lost because newbies to alternative energy investments won’t understand the characteristics of the various industries. There’s quite a disconnect between the market and geothermal energy, because most of the speculators in geothermal have come to it from the mining side rather than the power side. These people are exploration and excitement oriented rather than process oriented. I was speaking at a conference in Vancouver a few weeks ago about geothermal power and the fact that news wasn’t reported in grams per tonne confused people. They were trying to apply mineral exploration parameters to a very different business.
HRN: When do you think the value of these growing companies will be recognized?
Rule: What I learned in the uranium business in 1998, 1999 and 2000, when I was pounding the podium at conferences explaining why these stocks would do very well, was that thinking people would understand the story but had no relevance to them because it hadn’t been demonstrated by one stock that had worked. In 2003, Paladin Energy moved from about $0.05 to about $2.00 and that move—a 40 bagger—really kicked off the uranium frenzy. What happened was that a story that was understandable, relevant and true became validated by a single company. The first time that a geothermal company gets taken over by a major utility with a nice premium, the geothermal story will suddenly be validated and important. I think that will happen, maybe, as early as this calendar year.
HRN: What companies are in the running?
Rule: There are 5, soon to be 4, entrants on the junior side in North American geothermal stocks: Ram Power Corp, which is a leader; and Magma Energy, which is also a leader based on the extraordinary career of its founder and chief executive, Ross Beaty; and there are three smaller junior geothermal companies, Sierra Geothermal Power, US Geothermal and Nevada Geothermal Power. The smaller companies are really a paradox because they are all selling at substantial discounts to the value of their assets but they are arguably too small to exist as public companies. It’s difficult for some of the smaller companies to attract institutional capital because of the relative lack of experience in geothermal of their management teams and the bulk of their assets are so small that attracting capital dilutes shareholders at the same time that they’re selling at large discounts, so the risk adjusted net present value of their assets is unattractive. Sierra Geothermal, I think, has made the right decision to amalgamate with Ram Power because Ram’s management team has the skill set to attract institutional capital. I suspect that both US Geothermal and Nevada Geothermal will be taken over either by Magma or Ram or by one of the big US coal-fired electric utilities, such as AES, Southern Company or Duke Energy. The utilities have been circling the geothermal space long enough that they are going to get into the act. I think the theme was set when Canadian Hydro was taken over by TransAlta. The theme being that large coal-fired utilities take over well-run alternative energy entities with large development pipelines because they want to control the carbon offsets from alternative energy against their coal operations without having to buy those carbon offsets in the market, and also because they see the ability to grow in alternative energy as a consequence of the political will and support of alternative energy, which is a set of circumstances that the coal industry no longer enjoys. I think, ultimately, we will see all of the North American geothermal entities taken over either by international power generators or by American coal-fired generators. I think it’s one of the easiest themes to play for the next 5 years because, like uranium, it’s an absolute certainty.
HRN: Thank you for being so generous with your time.
Rule: It was my pleasure.
Disclosure: Long Ram Power Corp. (TSX:RPG) and Magma Energy Corp. (TSX:MXY). The author is personally a client of Global Resource Investments, Ltd.