Geothermal Frustration, Part II

Yesterday in Part I, I discussed how the publicly traded geothermal companies are not delivering what we hoped for as returns.

I described how geothermal power is the beneficiary of a lot of government benefits, from renewable-energy mandates to tax breaks. Thus, the geothermal companies (including five companies in the ESI portfolio) should be doing better in the stock market. But that’s not the case, even though the deck is stacked in favor of green power, especially geothermal. Where’s the return?

The Geothermal Business Model

Let’s ask a question of almost all of the current geothermal players. Is SOMETHING WRONG with much of the current geothermal business model?

Actually, WHAT IS THE BUSINESS MODEL for the typical geothermal energy pure-play company? Let me summarize in a general fashion.

  • The typical geothermal pure-play starts with one or a very few visionary people, often engineers. These guys (almost always guys) have an idea. They do some prospecting and find a couple of sites with steam vents or mud volcanoes. Very often, the site is something that other players looked at or even drilled back in the 1970s. The sites are usually out in the middle of nowhere, like some gulch in Nevada or similar jurisdiction
  • Then the players acquire relatively small acreage positions — a few thousand aces here and there — often from the Bureau of Land Management (BLM) or private parties. They try not to pay big money for big acreage. Indeed, many of the current geothermal guys have a $3 per acre mentality. For overseas projects, they usually obtain a concession from the government in a developing country. Not uncommonly in the developing country, the politicians studied Marxism in their university days
  • Then the companies promote their geothermal site at conferences. They give their site a name like “Hell’s Hot Springs” to make it sound like the devil bathes there in the superheated steam. They show their slides, pound the podium and raise funds from private players. Eventually, they write a fire-and-brimstone prospectus and issue stock in the Canadian junior marketplace
  • Then comes a years-long cycle of burning the cash. In the U.S. or Canada, they start a long process of obtaining federal, state and local government permits to do everything. They need permits to drive trucks over wilderness roads, to remove water, to blow exhaust into the air, to drill wells, to erect towers. Every geothermal site in the U.S. or Canada involves at least 700 permits and constant renewals. No wonder they need the tax credits on the back end
  • Then they identify enough funds to drill a primary steam well, and a confirmation well or two. These wells are expensive — much more so than a comparable gas well, that’s for sure. In fact, there are only a handful of drilling rigs in the U.S. and Canada that routinely drill geothermal wells. Sometimes a rig breaks down or gets stuck at one site. That impacts the drilling schedule for other customers for many months onward. Often, the geothermal companies pay for drilling wells by issuing new stock and diluting the previous investors
  • Then they hire a consultant. It’s almost always GeothermEx Inc., of Richmond, Calif. GeothermEx is not just small, it’s TINY! There are eight upper-middle-aged guys who do all the work. GeothermEx does good work despite having virtually NO competition. But it goes to show how small and clubby the geothermal world is
  • Once in bed with its pals at GeothermEx (whoops, I mean “once it’s retained GeothermEx”), the geothermal company tests the wells for “the report.” Then the GeothermEx consultants write up “the GeothermEx report” on the heat and energy potential of the site. The key point of “the report” is how many megawatts (Mw) the project ought to yield over how many years
  • Then the geothermal company shops the GeothermEx report around to the local or regional power companies to get a power purchase agreement (PPA). The PPA is a promise that IF the geothermal company ever produces electricity, the power utility will buy it at some price. (The utility companies like PPAs because they can impress the state utility regulators and get them off their back. “See? We’re working that green energy RPS mandate.”)
  • Then the geothermal company uses the PPA to borrow money from a bank or other source of funds. If a utility company will pay for future power supplies, that’s bankable. “Energy bankers,” as they fancy themselves, have been trained to kowtow to PPAs based on GeothermEx reports. “GeothermEx reports are the gold standard in this business,” is the common expression
  • Then the geothermal guys use the borrowed money to pay debts and bills and to drill more wells for steam production and water injection. At the same time, the small team of geothermal players — which could hold their corporate luncheon in the back of a McDonald’s restaurant — designs and builds a generating plant. This requires large upfront costs for construction and equipment
  • Sometimes, the geothermal guys farm out the power plant as a turnkey project to a publicly traded company named Ormat. “Ormat is the go-to company in this business,” is the common expression
  • Meanwhile, Ormat is tightly run by a family of bright, but very quirky, upper-middle-aged people. The company growth plan gets a C- and its succession plan gets a D, in my view. (Another story.)
  • Then while the geothermal people are designing and building their generating plant, they have to worry about how to get the power from the plant to the main transmission wires. This often involves permitting and building out a new set of power lines from nowhere (out in Nevada or the like) to somewhere else (such as where the electric load is, in California or the like)
  • Then, about four or five years down the road from the original lease sale, the geothermal company tests its steam wells and generating plant. If the dynamos spin true, the geothermal company now has electrons moving down the wires. That is, the geothermal company is in the power-generating biz
  • Finally, with electrons in the wires, based on the PPA, the utility company starts sending a check every month to the geothermal company. It’s usually the first real cash flow that the geothermal company has seen in many years.

Let’s Think This Through

Most of the foregoing applies to most of the companies (public and private) in the geothermal space. This is how it works. This is the current geothermal business model, controlling things from prospect to power line. Of course, not everything applies to everybody. But you get the idea.

Let’s think this through. If you’re a small company with a handful of employees, how can you possibly accomplish and manage all of this… and make money for your investors? You’ve got a cadre of people who do it all. They prospect for acreage, lease it, obtain permits, raise funds, drill-drill-drill, test the wells and other systems, design and engineer a power plant, procure material and equipment, build out a generating system, erect power lines, spin electrons and deal with a regulated utility.

Does it sound like there’s a lot going on? There are lots of moving parts, with lots of things that can go wrong. And it’s all going on for a long time, on borrowed money or invested funds. So it takes a lot of time and cumulative risk to see any monetization. No wonder the geothermal stock prices are in the dumps.

There’s Got to Be a Better Way

Indeed, it seems like this business model was put together by Rube Goldberg. And remember that I’m only focusing on the “big picture” aspects of running this show.

When you look closer, there are more “little pictures” in this effort. How many? Well, more than hang in the National Gallery. That is, there are countless items that are much smaller, but which add up to time, money and managerial competency (or incompetency).

Sure, running a geothermal project takes talent. You’ve got to be a jack-of-all-trades. I guess that’s why the guys at the top get the big bucks, eh? But c’mon. There’s got to be a better way. Yet it seems like everybody does it this way — or they did in the late-departed era of easy credit. But we don’t live in that era any more. There’s no more easy, patient money.

In the past five years or so, the geothermal industry has raised and spent a couple billion dollars using this business model. Can it raise another few billion in the years ahead? On this business model?

News flash to the geothermal players: Aside from insiders and a few other people who’ve been able to trade in and out of the stocks (mostly lucky, not good), nobody has made any decent return from geothermal. It’s always “next year, next year, next year.” And the business model, based on shoestring budgeting and lack of monetary return for years at a time, helps to explain why.

Stay Tuned…

Don’t get me wrong.  I still like geothermal and I’ll continue to monitor our geothermal stock positions closely.  The geothermal business is small.  It’s not something that many investors know about.  If just one or two of the companies in the ESI portfolio can make it out of the woods, that’ll hand us enough profit to make up for any others that lag behind.

For now, I want to hold all of the geothermal companies in the portfolio.  I’ll keep a close eye on the business environment, and get more information for you. I’ll check in with several of the geothermal companies in the ESI portfolio. I’ll find out exactly where they are on their project timelines.

Along the way, I’m going to see another private geothermal project. I’ll talk with other people who are working in the geothermal space. There are other business ideas out there — how to monetize the projects at earlier stages — and we need to know what they are.

That’s all for now. Thanks for reading.

Until we meet again,
Byron King

July 24, 2009

The Daily Reckoning