Seeking Alpha Editor Michelle Carini recently asked for readers' thoughts about geothermal energy. I've been musing about geothermal energy as another low carbon source of not only power, but also heating. That article provided excellent background material, but it's hard to find investment opportunities in background information.
Here, I will give my take (still at a high level) on how one might consider investment in geothermal energy based on two new geothermal power projects in Indonesia. These projects highlight ENGIE (OTCPK:ENGIY) and Ormat Technologies (NYSE:ORA) as geothermal investment possibilities. However, before discussing the Indonesian projects, I think some introduction helps to set the scene.
General thoughts about geothermal power
Like any emerging technology area, there is a lot of uncertainty, including even what the term geothermal constitutes. And the technology has a long history which newcomers might not be aware of.
There are well established geothermal HVAC (Heating, Ventilating and Air Conditioning) systems, which efficiently heat or cool a house based on heat transfer between the house and the earth below (through a closed heat exchange piping system), and these have been recently been scaled up to include a few hundred houses. Geothermal HVAC systems require only a small difference in temperature between the dwelling and the underlying ground. They are interesting but generally not investable as larger facilities are required for investment purposes.
In some parts of the world, geothermal heating systems have been established city or even country-wide (e.g., Iceland) based on extracting hot water from underground aquifers and returning cooler water after some heat has been extracted to provide heating (through piped water systems) or hot water at a designated temperature. These are interesting, but often are developed by government authorities and therefore are not investable.
In tectonically active places with active volcanoes and lots of hot magma close to the earth surface, electricity generation is possible where steam is used to drive turbines. These are high temperature projects which have the scale to be interesting for investment.
Geothermal is renewable, but the rate of renewal varies from site to site
A key point about geothermal energy and heating is that the regeneration rate of the resource varies for different locations. Unlike solar PV and wind, which have defined output characteristics for a particular site, a geothermal project requires careful evaluation of the energy off-take if sustainable production is sought.
In the Iceland Government Master Plan, this critical feature of a geothermal project is summarized as follows:
For every geothermal area and every production method there is a definite maximum processing stage, E0, which is such that by way of a lower processing stage than E0 it is possible to maintain an unaltered level of energy generation from the system over a very long period of time (100-300 years). If the resource utilisation load is more than E0, it is not possible to maintain an unaltered level of energy generation for this long. Geothermal energy generation that is less than or equal to E0 is defined as sustainable energy generation but energy generation in excess of E0 is not sustainable.
This is a key difference between geothermal energy exploitation and other renewable energy resources, such as solar PV and wind power. Since the regeneration feature of a geothermal project is not easily predicted, a geothermal project is often developed in a stepwise manner to optimize capital expenditure. Production is commenced early in a drilling program to get a sense of the longevity of a field to avoid overcapitalizing on drilling at a site which loses production quickly.
Where does geothermal fit on the competitive landscape with other low carbon energy sources?
There has been such massive investment in first wind and more recently solar PV, that both of these technologies have moved dramatically down the cost curve to outcompete all other forms of energy generation (including fossil fuels). If geothermal was trying to compete "head to head" with power generation from solar PV or wind, I would argue that there is no case to invest in geothermal, as it has the disadvantage that substantial investment needs to be made before the size and longevity of the geothermal resource is clearly established. Solar PV and wind are not like this, as with good mapping of solar irradiation and wind speed, one has a clear view of the energy output of the resource before it is developed.
The reason that geothermal power is interesting is that it is dispatchable and hence it is attractive as a resource to complement intermittent wind and solar PV power. In effect it provides a substitute for storage by being able to "fill the gap" in a solar PV or wind powered grid. Of course the economics of this need to be sorted out in competition with batteries and pumped hydro, but I'm pretty sure that there are a number of geographies where geothermal power is interesting.
Indonesia is a good place to focus on geothermal energy
With 28 GW of estimated accessible geothermal reserves (and 40% of global geothermal reserves), Indonesia is attracting several major corporations to invest in substantial geothermal projects. Here I highlight two high temperature geothermal projects, which highlight companies worth considering for investment with a geothermal component.
Sarulla Geothermal power plant in Northern Sumatra
This is a $1.17 billion 330 MW project to be built in three equal stages. The first 110 MW unit commissioned by Toshiba (OTCPK:TOSYY) and Ormat Technologies has commenced operation. The plant is operated by Sarulla Operations, a consortium of 5 groups : Japanese trading company Itochu (OTCPK:ITOCY) (25%), Japanese electric power company Kyushu Electric Power (JP:9508)(25%), the largest listed energy company in Indonesia, PT Medco Power Indonesia (19%), Japanese oil company, Inpex (JP:1605)(18.25%) and Ormat International (12.75%).
Toshiba is supplying its flash technology, while Ormat is providing its binary technology. This combination provides high efficiency power with complete reinjection of the exploited geothermal fluid. Toshiba supplied the steam turbines and generators for the flash systems, while Ormat provided the design of the Geothermal Combined Cycle Unit and its Ormat Energy Converter, which act as condensing units for the steam turbines. Toshiba claims number one position in the geothermal sector.
It seems that the technologies provided by Toshiba and Ormat are highly complementary and both companies indicate a strategic collaboration to promote this package for other geothermal projects. They are working together in supplying Unit 2 of the Kizildere III Geothermal Combined Cycle Unit Power Plant in Turkey.
Ormat is a major vertically integrated player in the emerging geothermal and recovered energy generation industries. Their core technology is the Ormat Energy Converter, which converts low- medium and high-temperature heat into electricity. Ormat has similar numbers of staff in the US and in international sites, with ~1000 employees. It owns and has installed 2 GW of capacity, with its own 710 MW generating portfolio spread between the US, Guatemala, Guadeloupe and Kenya.
Muara Laboh geothermal project in Western Sumatra
ENGIE has a 60-year history in Indonesia, but this is ENGIE's first high temperature geothermal project in Indonesia. ENGIE, through its subsidiary Storengy, is using Indonesia as a key place to develop expertise that will be used elsewhere. ENGIE CEO Isabelle Kocher notes that the ENGIE teams have the skills to execute on the whole project cycle from scoping the area, to geothermal plant construction and operation. She indicates that these geothermal technologies are important for countries like Indonesia looking for low carbon electricity. This technology fits well within ENGIE's broader vision of participating in the energy transition and development of competitive renewable energies.
ENGIE works with Japanese companies Marubeni (OTCPK:MARUY) and Sumitomo (JP:8053) along with Indonesia's PT Supreme Energy to build up its geothermal skills. No doubt ENGIE's deep knowledge of gas exploitation is valuable for the geothermal projects.
Investment case for ENGIE and Ormat Technologies
Both ENGIE and Ormat Technologies are substantial companies with clear intentions to be significant players in a new push in geothermal energy exploitation.
ENGIE is interesting because it is a big company that is in the process of reinventing itself in the emerging low carbon energy world. It has a CEO with vision and the courage to make dramatic changes. Its commitment to geothermal is strategic and aligns with its commitment to becoming a low carbon energy company. You would not invest in ENGIE based just on its geothermal involvement, but geothermal is a sensible and likely to be profitable element of the business. It is worth discussing this company with your financial advisor.
Ormat Technologies has much more "skin in the game" of the geothermal industry, but it does have another major initiative in energy management, storage and demand management. The company has growing profits and international presence.
Like many companies in the renewable energy space, Ormat realizes that this is bigger than just substituting low carbon energy for fossil fuels. There is a massive opportunity for new decentralized ways of managing energy supply and consumption. Ormat recently acquired privately owned Viridity Energy (based in Philadelphia) to expand its business to include energy management and storage, including demand management. The Viridity acquisition will be will be cash positive in 2017. It's business involves proprietary software and solutions for retail energy providers, utilities, and large industrial & corporate clients. Viridity optimizes and monetizes client energy management, demand response and energy storage by interacting with system operators. Viridity has 850 MW of contracts over 3000 sites. Ormat will use Viridity technology to interact with customers in relation to demand response and energy storage. So this acquisition will allow Ormat to be more than a leading geothermal company.
In the geothermal area the Toshiba partnership seems powerful and complementary, but there are storm clouds around Toshiba and it could easily be that it will want to exit its geothermal business as it seeks to plot a new future that doesn't include nuclear power. So perhaps there could be an opportunity for Ormat to acquire the Toshiba business to provide a comprehensive solution?
Also lurking in the background is an Israeli shareholder discussion that could lead to significant change in shareholding. This could be good news for the company and might help thoughts about Toshiba.
On the other hand it is not clear what, if anything, is really happening within Ormat. There is a suggestion that two Ormat investor groups have been approached by a strategic supportive investor concerning acquisition of their stock. But on the other hand it could involve an investor who wants to play games with the company. So there are qualitative risks in investing in Ormat in addition to the usual number crunching.
Ormat has had a good run recently (52-week high/low $59.63/$41.12 and it is trading close to year high at $57.39) and it reported record revenue of $663 million (up 11.4%) and gross profit up 24% over the previous year. It is worth keeping an eye on.
Geothermal investment isn't straightforward, as it is a more complicated renewable asset than solar PV or wind, although it is 24/7 and can be modulated to complement intermittent power. There are some similarities between a geothermal and a gas project, except that with gas, once it is gone it is gone, while a geothermal project will, given time, rejuvenate. With gas you maximize extraction to minimize capital exposure, while with geothermal you seek a capital investment that will deliver long term energy supply. The trick is to find the appropriate level of heat extraction to make the project sustainable over the long term.
In geologically active places like Iceland, Japan and California, there is a long history of exploitation of geothermal energy, often pioneered by public sector activity. The new corporate opportunities lie in less exploited places such as Indonesia, which has 40% of the world's geothermal resources.
Companies like Ormat Technologies, ENGIE and Toshiba are doing the hard yards of working out how to develop these geothermal resources. Because of the complexity of site-variable renewal times, I suspect that geothermal energy has less generalization than solar or wind power generation, but there are locations where there is considerable commercial opportunity. Both ENGIE and Ormat are worth considering, but they are bigger stories than just geothermal exploitation.
I'm not a financial advisor. I'm interested in the technologies that are contributing to the transition from a fossil fuel based energy system to one based on low carbon renewable energy. Geothermal energy has a place and the companies I mention here are worth thinking about in this context. If my commentary is helpful to your evaluation of energy investment, please consider following me. I thank Henry Miles who knows a lot about geothermal energy and who suggested I take a look at Ormat Technologies.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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