Transparency and Government Support Will Spur Geothermal Market Growth

In the renewable energy space, geothermal energy could one day be one of the most profitable areas. It is, however, the forgotten renewable and compared with fossil fuels, it has a long road to travel before it becomes a household word in the markets.

One of the reasons geothermal power is having a hard time finding its way into the energy mainstream is that a lack of consistency in reporting standards makes it hard for investors to really know what they are investing in - which is exactly what a serious investor wants to be able to do -- compare apples with apples to decide between investing in, say, a Europe-focused natural gas explorer or a Nevada-oriented geothermal junior.

The Canadian Geothermal Energy Association (CanGEA) recently convened to examine the series of challenges the geothermal energy industry faces before it can be taken as a serious and viable alternative to the energy king, fossil fuels. Here's a summary of strengths and weaknesses that came up at the forum, and our expert summation:

Investors Need To See Government Support

One of the geothermal industry's biggest hurdles is obtaining further subsidies in an environment where all the generating technologies are competing for the same dollars. Many don't know that fossil fuels as well as renewables are subsidized by governments in the form of grants and loans, fiscal incentives such as tax credits, and other support in addition to infrastructure.

As you'll see below, the per-unit basis for fossil-fuel subsidies is low:

However, when taking into account the fact that there was so much more fossil-fuel generation, the picture is dramatically changed. In total governments worldwide conveyed an estimated US$700 billion in subsidies toward fossil-fuel consumption in 2008, according to the U.S. Energy Information Administration (EIA). Meanwhile, the same governments allocated only about US$100 billion toward the energy sources they get the most press for supporting, renewables.

The White House has proposed reducing tax breaks for the oil, gas, and coal industries by approximately US$40 billion in the 2011 budget, which would be a nearly 50% decrease from levels in 2002-2008. If that figure passes -- not a given, especially with Republicans in control of the House -- the remaining US$40 billion in subsidies is still twice that of renewables.

Government policy and subsidies are essential for private investment in the geothermal sector. Greater recognition would be a huge catalyst for this industry.

Another Must for Investment: Reporting Standards

One of CanGEA's main achievements is creating a Canadian geothermal code for reporting public information. Similar to the mining and oil/gas sectors, this self-regulation standardizes mechanisms and presentation of data. The idea is not only to make it easier for investors to evaluate projects and companies but to foster confidence to invest in the sector at all.

The standards provide a minimum set of requirements for the public reporting of exploration results, geothermal resources and geothermal reserves. The result of a committee set up two years ago, compliance with the code is voluntary until 2011. At that point it'll become a requirement for CanGEA membership.

The code pertains to both public and private geothermal assets. Key principles are:

1. Transparency: to provide sufficient information that is clear and unambiguous.

2. Materiality: to present all relevant information that investors would reasonably require and expect to be made available to make a reasonable investment decision.

3. Competence: to ensure the reporting is done by a qualified person based on experience and knowledge. "Qualified" means at least five years' relevant experience, professional registration with an association with a governing code of ethics, and CanGEA membership.

It will also establish value for companies whose assets are underdeveloped -- what a company has "in the ground" -- similar to the NI 43-101 (mining) and NI 51-101 (oil and gas) classification rules.

So far, it works something like this: -- graphic courtesy of CanGEA.

Inferred resources occur when a temperature gradient well program has been completed, the earliest hands-on stage to determine a site's thermal characteristics. Next come slim-hole wells, which help determine the economic viability of a project and define indicated resources. A company's measured resources require that actual production wells have been started or completed as well as a demonstration that the company can deliver on them.

Then there's the reserves side, which takes into account factors such as accessibility and economic feasibility of the resources. Accordingly, probable reserves occur when deliverability has been demonstrated, and proved reserves occur when production wells have started or been completed and deliverability has been demonstrated.

All geothermal companies would follow this structure when publishing a variety of documents: quarterly and annual reports, reports required by the Canadian securities exchanges and/or by the law, company website information, press releases, environmental statements, technical papers, and so on.

CanGEA is proud of the code, and rightfully so. Geothermal exploration is a high-risk activity, and raising confidence and reducing unknowns will improve the industry's prospects for attracting capital. The only other country to have a geothermal code is Australia, which has a considerably smaller total market capitalization of geothermal companies than Canada.

The code has been submitted to the International Energy Agency (IEA) and the International Geothermal Association for review and endorsement.

The Take-Home Message

The geothermal sector faces a significant number of varied challenges. In the balance, however, the positives far outweigh the negatives.

Some say that the geothermal sector is where the oil sector was in the 1950s and is poised for a large bull run. We wouldn't wax that enthusiastic ourselves, but two drivers are indeed true. First, the potential for energy production from the ground is significant, and second, increasing innovation is leading to better exploration techniques and drilling capabilities.

Subsequently, although there are high capital costs right now, we expect solid returns on equity in the long term. Exploration and drilling accounts for approximately 36% of the total capital costs, and as technology improves, this risk will decline.

In short, don't look to the geothermal sector for get-rich-quick schemes but do consider getting in on the ground floor of some promising growth.

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