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San Giorgio Group Report: The Role of Public Finance in Deploying Geothermal – Background Paper

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Published: October, 2014

Executive Summary

Geothermal energy is broadly cost competitive with fossil fuel alternatives even without a carbon price. The levelized cost of geothermal electricity is around 9-13 USDc/kWh, making it one of the cheapest renewable energy options available. Its ability to provide low-cost, low-carbon power reliably and flexibly means it is well-placed to meet developing countries growing energy needs while displacing polluting fossil fuel power plants.

However, its rate of deployment has been slower than other renewables over the last thirty years and will need to speed up rapidly if this technology is to deliver on its promise. In addition, geothermal technologies that can harness lower temperature geothermal resources need to achieve more deployment to bring costs down.

This report is part of a project carried out by Climate Policy Initiative (CPI) for the Climate Investment Funds (CIFs) which will focus on the effective use of public finance to scale up geothermal deployment in developing countries.

The public sector plays a significant role in financing geothermal with 76-90% of project investments utilizing some aspect of public debt or equity support. Much of the current support targets the operational phase of the project but these public resources might be better used to address the risk in the exploration and field development phases.

The private sector has demonstrated willingness to invest in geothermal technologies but little appetite for investment in the early exploration and drilling phases of the project. This is a significant barrier to further geothermal expansion in many markets. Furthermore, public-private partnerships still play a limited role despite their potential for attracting additional private capital.

Private Sector Reluctant to Accept Resource Risk

The resource identification and exploratory drilling phase is the riskiest part of geothermal project development and the biggest barrier to obtaining financing as it increases investors’ equity returns requirements. Costs related to exploration drilling can reach up to 15% of the overall capital cost of the project. Resource availability is highly uncertain. Global success ratios of wells drilled during the exploration phase are estimated at 50-59% (IFC, 2013b). Longer lead times due to the resource identification and exploratory drilling phase, together with a large initial equity commitment usually required prior to debt financing, means investors demand a higher return for their equity investment (IFC, 2013a).

There is little appetite from the private sector to fund projects where the nature and extent of the resource are unknown. The private sector only financed all stages of the project in 7.5% of the utility-scale projects in our database. 58.5% of projects had the costs entirely borne by the public sector, while 34% projects had the private sector bear costs at later stages in the development chain once the resource had been proved. This is due to significant development costs when there remains a large degree of uncertainty on the viability of the project (ESMAP, 2012).

Resource exploration risk still affects the financing of the project during the production drilling phase. The effect of learning during the exploratory drilling phase means rates of success rise to 74% (IFC, 2013b) in the production drilling phase. However, the remaining resource uncertainty combined with the high capital expenditure necessary during this later phase means resource risk is still relevant. As a consequence most private financiers are not willing to provide financing until all or at least 70% of the MW capacity has been drilled (Audinet and Mateos, 2014).

Policy support mechanisms for geothermal are increasingly focusing on resource availability, but much of the current support focuses on the operational phase of the project. International and national efforts in particular are increasingly focusing on the reduction of geothermal drilling risk on an international scale, on resource identification and exploration, and measures to increase the viability and attractiveness of geothermal projects to energy investors (Armstrong et al. 2014). However, much of the current support available remains for the operational phase of the project (Speer et al, 2014), such as through feed-in tariffs or quote obligations such as renewable portfolio standards (ESMAP, 2012). New approaches are needed to reduce all geothermal project risks.

Key questions for future analysis

This background paper has led us to identify the follow- ing questions as key to determining more effective ways for public finance to drive geothermal deployment in developing countries:

How effective or cost-effective are different policy and public investment tools?

How can international public finance best support national policy efforts in developing countries?

How can public support be reduced over time, shifting to a higher contribution from private finance?

How can risks be addressed across the project development chain, and in particular the exploration phase?

What are the characteristics, pros and cons of available financial structures and project development models? How effective are they in ensuring bankable projects?

Do financing instruments and development approaches need to be tailored to technology types?

These questions will inform the analysis of three projects in three different regions using the San Giorgio Group case study approach: Sarulla (Indonesia), Olkaria III (Kenya) and Gumuskoy (Turkey). The findings of this analysis will shed light on how public money can be used most effectively to further advance this renewable energy technology.