Enough to Make an Oilman Jealous

Grab your hard hats and lace up your steel-toed boots, dear readers, because this month we are going back out to the drilling rigs and construction sheds in search of a remarkable investment opportunity. But we are not drilling for oil or natural gas. There is a company I know of that’s leading the way vertically integrated companies in the fields of geothermal power, recovered energy generation (REG) and remote power. If you are interested in learning more about one of the cleanest, most abundant sources of energy on the planet, please read on…

A Heat-Seeking Energy Investment

What is it about an energy source that makes it useful, let alone valuable? One way to answer that question is to think in terms of thermodynamics and to look at how the potential energy of any substance is converted to heat energy. Ask yourself, for example, what is coal? First and foremost, coal is the carbonized remnants of ancient plant matter, stored up in the geologic column. Why is coal useful? It is, as the old saying goes, “the rock that burns.” One coal miner of my acquaintance calls coal a “portable climate.” Among other things, it offers the user the ability to release stored-up heat energy and thus to bring rapid warmth into a cold world. Yes, and so much more.

Or consider what happens when you are driving a car and burning up gasoline. What is it that you really want from your fuel supply? Do you care that gasoline comes from refined crude oil? Or are you more concerned with the fact that the gasoline combusts in the cylinders of your engine, via rapid, explosive release of heat when the gasoline is sparked? You probably learned in drivers’ education class that the basic, four-stroke internal combustion engine follows a cycle of intake, compression, power stroke and exhaust. When the gasoline combusts and explodes, it releases heat energy, which causes combustion gases to expand and push the power stroke. The power stroke, in connection with the well-timed power strokes of the other cylinders, turns the crankshaft. This is what allows you and your vehicle to move along. So gasoline is also, in essence, a form of stored heat.

Or consider nuclear power. What is the basic principle behind this particular energy source? Radioactive rods in a nuclear pile decay and give off heat, which in turn is used to raise the temperature of water or some other substance in a liquid phase. When the liquid phase gets hot enough, it vaporizes and its expansion turns a turbine. The turbine generates electricity. This is the case for almost all nuclear power plants in the world, whether on land or inside the confined hull of a submarine.

So the bottom line is that when we are looking for energy sources, we are basically looking for ways of obtaining heat energy in some form or another. In our Outstanding Investments portfolio, we hold shares in companies that drill and extract oil and natural gas, coal, uranium and even a company that manufactures windmill components. (Wind is just a manifestation of the differential thermal heating of air masses by the sun.)

Geothermal Energy

In this edition of Whiskey & Gunpowder, we are taking a look at another way to invest in heat. That is, we are looking at a company that is part of the industry that extracts stored heat energy from the crust of the Earth — namely, geothermal energy. Geothermal energy is heat (the “thermal” part of the word) derived from the Earth (the “geo” part). Geothermal energy is the energy contained in the hot rocks, and the hot fluids that fill the fractures and pores within the rocks, of the Earth’s crust. Under the right conditions, geothermal energy can be utilized to generate electricity, and this is why we are interested.

According to thermodynamic calculations performed by many a bleary-eyed graduate student over the decades, if the Earth had simply “cooled” from a molten state, it would have become a completely solid mass of iron and rock within a few hundred million years of its formation. But the Earth has been an active, dynamic planet for near 4.5 billion years, so something must be going on deep inside to keep the planet hot. The current belief is that the source of heat energy within the Earth is long-term radioactive decay occurring within the crust and mantle.

It gets so hot down within the Earth that much so-called “rock” is in a molten state, which we observe directly when some of that molten material erupts and forms volcanoes or mid-ocean ridges. In most other areas of the Earth, this heat reaches the surface in a very diffuse state. That is, you must use sensitive instruments to measure the heat flow from most parts of the Earth’s crust. But it is there. And due to a variety of geological processes, some areas of the Earth, including substantial portions of many western U.S. states, are underlain by relatively shallow geothermal resources with much energy potential. Here is a depiction, called the U.S. geothermal resource map, prepared by the U.S. Department of Energy:

The geothermal resource map of the U.S. shows the estimated subterranean temperatures at a depth of 6 kilometers (or just under 20,000 feet), which is considered relatively near the surface. This map is a synthesis of several types of data sets, including thermal conductivity, thickness of sedimentary rock, geothermal gradient, heat flow and surface temperature. These geothermal resources can be classified as low temperature (less than 150 degrees Celsius), moderate temperature (150-200 degrees Celsius) and high temperature (greater than 200 degrees Celsius). As the map makes clear, essentially all of the U.S. has some form of available, near-surface geothermal potential.

The uses to which these geothermal resources can be put are controlled by temperature. The highest temperature resources are generally used only for electric power generation. Current U.S. geothermal electric power generation totals approximately 2,800 megawatts (MW), or about the same as five large nuclear power plants. Uses for low and moderate temperature resources can be divided into two categories: direct use and ground-source heat pumps. I am not going to say that geothermal energy is infinite in scale, but the heat sources within the Earth are immense, and a well-managed program has the potential to be operational for many decades, if not centuries.

Geothermal Power Plants

There are two basic types of geothermal power plants used today: steam plants and binary plants.

Steam plants use very hot (greater than 200 degrees Celsius) steam and hot water resources, such as are found at The Geysers complex of plants in Northern California, which is the largest geothermal electricity producer in the world and has been going strong for about 40 years with no sign of letup. Either the steam comes directly from the underground geothermal resource or the very hot, high-pressure water is depressurized (or “flashed”) to produce steam. The steam then turns turbines, which drive generators that generate electricity. The only significant emission from these plants is water vapor, in the form of steam. But there are very minute amounts of carbon dioxide (CO2 ), nitric oxide (NO) and sulfur emitted as well, which are natural products from the underground fluids, usually less than about one-fiftieth as much as come from a traditional, fossil-fuel power plant. Currently, electric power produced this way costs about 4-6 cents per kilowatt-hour (kWh).

Here is a pair of schematics that illustrate the process:

Binary plants, on the other hand, use lower-temperature, but much more common, hot water resources (100-200 degrees Celsius). And because these lower-temperature reservoirs are far more common, binary plants are the more prevalent. The hot water is passed through a heat exchanger in conjunction with a secondary fluid (hence, “binary plant”) with a lower boiling point, such as isobutane or isopentane. The secondary fluid vaporizes, which turns the turbines, which drive the generators. The remaining secondary fluid is simply recycled through the heat exchanger. The geothermal fluid is condensed and returned to the reservoir. Because binary plants use a self-contained cycle, there are essentially no emissions. Currently, electric power produced by binary plants costs about 5-8 cents per kWh. Here is a schematic to illustrate this process:

More on Geothermal Power

Now that we have looked at the basic geology and engineering of geothermal power, let’s look at the business and policy sides of things. First, you should understand that extracting the Earth’s heat and selling geothermal power is subject to the same regulatory structures as are almost all other energy generation and transmission entities in the country. So the 50 state-level public utility commissions (PUCs), or whatever else they call them in any given state, control much of the destinies for geothermal producers.

Also, geothermal energy is capital intensive; hence, it takes time to pay off any major investment. At the same time, geothermal power competes against the rest of the electrical grid, within the PUC-dictated regimes of rate setting and tariffs for transmission. This means that the cost basis for a geothermal power plant has to be competitive against plants that produce electricity by burning coal, natural gas or even oil (such as in Hawaii), as well as the recently growing solar-thermal energy industry.

Still, there is plenty of good news for geothermal energy. Once a plant is up and running, geothermal power is quite reliable. Geothermal plants offer a continuously available (24/7) base-load power source, with historic reliabilities in excess of 90%, which is comparable to the reliability of many nuclear plants. Compare this with wind-generated power with 25-40% reliability (the wind does not always blow when you need it), or solar-generated power with 22-35% reliability (the sun sets each night, among other drawbacks). And reliability is a critical issue in terms of operations, because plant owners usually bear the risk of getting charged back by utility customers for what is called shortfall energy, meaning the power that a utility has to go out and purchase on spot market if the designated source is not operating on schedule or up to capacity or promised load.

There is more good news for geothermal, in the form of what the regulators call policy support. That is, there are certain things called pivot points within government policy, which tend to swing investment trends in a positive or negative manner. Of late, geothermal has been on the receiving end of many very positive government actions and pivots.

Geothermal energy does not deplete like an oil or natural gas deposit. Many hot springs of the world have been bubbling warm water or steam since prehistoric times. So geothermal power is considered a renewable form of energy production, and in our own era, it benefits from the renewable energy “production tax credit.” This tax credit has been extended by the U.S. Congress through 2008, and is expected to receive further extensions in the future. The production tax credit, plus five-year depreciation schedules, mean that there is an effective U.S. government subsidy of over 63% of the capital cost of renewable energy projects. (Think of it as spending dollars that cost only 37 cents.) So right away, renewable energy projects, and geothermal projects in particular, are beneficiaries of significant investment tax breaks that would make any oilman jealous.

In addition, many states (22 plus the District of Columbia as of this writing) have adopted renewable portfolio standards. These are legislative mandates for utilities to meet specific numerical targets for renewable energy or other environmental criteria by certain dates. My home state of Pennsylvania, for example, has a target that mandates 18% renewable, non-polluting electricity generation by 2020. And last fall, California Gov. Arnold Schwarzenegger signed into law a bill that, as of the beginning of 2007, all but prohibits utilities in the state from signing long-term contracts for power unless the sources emit less than 1,000 pounds of CO2 per megawatt-hour (MWh) of electricity produced. While the law does not specifically ban coal-fired electric power (also called “brown power”) from sale or use in California, it sets a CO2 limit that is so low as to effectively rule out coal plants as a future source for electricity sales into the West Coast market. Take another look at that U.S. geothermal resource map, and then think about what this means for geothermal power sales to the California marketplace. The Terminator has all but terminated brown power in the Golden State.

So the policy tide of recent years is shifting in favor of geothermal, and in the future, things might be even better for the industry. In particular, any future carbon tax, or so-called “cap and trade” regime for CO2 , will doubtless benefit the geothermal industry, what with its miniscule CO2 footprint.

And there is one more bit of background that you ought to understand about geothermal power. The last major geothermal “exploration” effort was about 30 years ago, during the energy price spikes of the 1970s. There has been next to no significant geothermal exploration program in three decades. So much of the knowledge of the resource base is grounded on older data, gathered with older instrumentation. Future efforts in the field of exploration and development will undoubtedly refine the older knowledge base and expand the resource base.

Until we meet again…
Byron W. King

July 3, 2007