1

Geothermal Project Development Geothermal Project Development Management and FinancingManagement and Financing

Presented byPresented by

R. Gordon Bloomquist, Ph.D.R. Gordon Bloomquist, Ph.D. Washington State University Extension Energy ProgramWashington State University Extension Energy Program(Retired)(Retired)

GeoFundGeoFundIGA-Geothermal WorkshopIGA-Geothermal WorkshopIstanbul TurkeyIstanbul Turkey15-20 February 200915-20 February 2009

2

Project Development -Project Development -Managing RiskManaging Risk

Geologists are taught how to Geologists are taught how to accept riskaccept risk

Engineers are taught how to Engineers are taught how to minimize riskminimize risk

Financiers are taught how to Financiers are taught how to avoid riskavoid risk

3

Geothermal development can possibly best be described as a process of managing all the various risks inherent in any development project, but made more complex because of the nature of the “fuel.”

4

Geothermal fuels cannot be purchased on the open market or transported over long distances.

5

Geothermal fuel risk can only be reduced through exploration, reservoir confirmation, and field development to a point where financial institutions can be satisfied as to reservoir deliverability over time. Deliverability being defined as not what is in the reservoir, but the quality and quantity of resource that can be delivered to the project over an extended period of time.

6

Managing Risk:Managing Risk:The Key to FinancingThe Key to Financing

7

Banks and other financing institutions are extremely risk adverse.

8

Financing of exploration and confirmation drilling must generally come from company equity or risk capital provided by investor. Risk capital comes at a high cost, and most investors will require a 20+% return on investment, depending on the project and perceived risk.

9

A geothermal project is in many ways analogous to a revenue bond because the lender or investor can only look to the revenue stream generated by the project, e.g., sale of electricity to a utility, directly to retail customers, or to an aggregator and marketer of, e.g., green power.

10

Non-power producing geothermal projects will be dependent upon other revenue sources such as, for example, a geothermal district energy project where revenue is dependent on sales of thermal energy to residential, commercial, and possibly industrial customers.

11

For those projects where the sale of items produced is the source of the revenue, it is even more difficult to calculate and justify investments in geothermal exploration and development. These include, for example, aquaculture projects and greenhouses.

12

Although the revenue stream is key to Although the revenue stream is key to obtaining financing, other risk factors will obtaining financing, other risk factors will also be evaluated. These factors include:also be evaluated. These factors include:

Fuel supplyFuel supply Environmental, legal, and institutional Environmental, legal, and institutional

regulationsregulations Developer qualifications and track Developer qualifications and track

recordrecord Type of conversion technologyType of conversion technology Qualifications and experience of design Qualifications and experience of design

engineerengineer

13

Experience and track record of Experience and track record of construction contractorconstruction contractor

Qualifications and experience of Qualifications and experience of O&M teamO&M team

Need for and cost of powerNeed for and cost of power Strength of power purchaser and Strength of power purchaser and

terms of power purchase agreementterms of power purchase agreement

14

International projects may introduce additional risk due to cultural differences and political uncertainties.

15

Fuel SupplyFuel Supply

Geothermal resources cannot be purchased on the open market, transported over long distances, or stored for long periods of time. The geothermal “fuel” must be used on-site, and the amount of fuel available at any particular site must be adequate to meet long-term requirements of project – 30-50 years.

16

The only way to fully assure financial institutions that a resource will be able to adequately meet the fuel requirements of a project over time is to demonstrate reservoir capability with multiple wells and extended flow tests.

17

Environmental, Legal, andEnvironmental, Legal, andInstitutional RegulationInstitutional Regulation

Although fuel risk may be rated as the number one risk factor facing geothermal development, environmental, legal, and institutional factors may rank number one in terms of their impact upon the successful development of geothermal projects.

18

All power projects will have some impact on air, land, water, flora, and fauna near a project site. In addition, development will often have an impact on cultural, historical, and archaeological resources.

19

Financiers prefer “clean” resources that require minimum mitigation and resources where there is minimal risk for conflict or project disruption. Assuring minimum regulatory risk has become a prerequisite for obtaining financing. Developers must be able to confirm that all regulatory hurdles have been cleared or they can be cleared.

20

Developer QualificationsDeveloper Qualifications

Developer qualification and track record are carefully evaluated by financial institutions. Being a major, well known developer is not required because financiers know opportunities come to many parties, having considerable experience in developing energy projects, providing equity in them, or both are important developer attributes.

21

Developers can demonstrate their competency by selecting experienced and well respected consultants, selecting and specifying equipment with a proven track record, and by negotiating contracts that are seen as advantages to project success.

22

Conversion TechnologyConversion Technology

The conversion technology chosen should fit the characteristics of the resource and, wherever possible, serves to best meet applicable environmental regulations. It should also be optimally designed to meet contractual obligations, e.g., baseload operation, load following, etc.

23

Equipment specified should have a proven track record in similar applications and performance warrantees for critical components of power train should be negotiated. In order to ensure both high capacity and availability, specifications should require redundancy of critical components.

24

Construction ContractorsConstruction Contractors

Recognized, big-name construction companies are also preferred. Financiers would prefer that construction contracts be fixed price. Completion guarantees with formulae for rectifying any problems are seen as optimal.

It is also in the best interest of the developer to ensure that the construction company can and will make good on its guarantee.

25

Because operation and maintenance (O&M) is the key to long-term financial health of a project, operating costs and on-line performance – highly dependent upon proper maintenance – O&M receives close review by backers.

Operation and Maintenance

26

Need and Cost for PowerNeed and Cost for Power

The need for and cost for power will also be evaluated because of the impact on long-term project economics. From the risk perspective, it is preferable that economics and demand for power drive projects rather than contract provisions.

27

The Power Purchase The Power Purchase AgreementAgreement

Historically, the power purchase agreement has provided for the sale of capacity and energy by project developers to the purchasing utility at an agreed upon price, price structure, and specified time period. Terms of such an agreement reflect a willingness and ability on the part of both parties to follow through on the agreement. Contracts negotiated with either side being at a disadvantage cause concern.

28

International FactorsInternational Factors

International projects bring an entire other layer of issues and risk to project development.

29

The problem is often the local legal structure or the lack of a well-established legal structure capable of dealing with the intricacies of independent power. For example, some countries do not recognize private property, and many other have histories of not enforcing contracts.

30

Risks that developers of international Risks that developers of international power projects must be able to overcome power projects must be able to overcome in order to be successful include:in order to be successful include:

Frequent changes in government and resulting Frequent changes in government and resulting changes in policies and prioritieschanges in policies and priorities

Nationalization of assetsNationalization of assets Retroactive application of laws or regulationsRetroactive application of laws or regulations Loss of exemptions from new laws and Loss of exemptions from new laws and

environmental regulationsenvironmental regulations LicensingLicensing LegalLegal Venue of dispute resolutionVenue of dispute resolution

31

Import tariffsImport tariffs Tax treatment and double taxationTax treatment and double taxation Force majeure including, in addition to Force majeure including, in addition to

natural events such as earthquakes, natural events such as earthquakes, floods, etc.floods, etc.• Acts of terrorismActs of terrorism• Coup d’étatCoup d’état• EmbargoesEmbargoes

32

Learning the cultural differences and Learning the cultural differences and acting accordingly.acting accordingly.

Selecting local partners in order to Selecting local partners in order to reduce cultural and political risk. reduce cultural and political risk. Reputation, track record, financial Reputation, track record, financial strength and stability, and how well strength and stability, and how well firm(s) and their principals are firm(s) and their principals are politically connected are important politically connected are important considerations.considerations.

Things that can be done to Things that can be done to minimize risks of minimize risks of international projectsinternational projects

33

Writing more complex documents than Writing more complex documents than would normally be required to cover would normally be required to cover items and issues not adequately covered items and issues not adequately covered by local law.by local law.

Spending time educating government Spending time educating government officials and utility executives about officials and utility executives about benefits of independent power and benefits of independent power and require-ments of non-recourse financing require-ments of non-recourse financing for independent power projects.for independent power projects.

34

Retaining experts in local legal and Retaining experts in local legal and regulatory system as members of regulatory system as members of development team, or partner with such development team, or partner with such individuals or firms.individuals or firms.

Requiring use of established international Requiring use of established international law applied by recognized arbitration law applied by recognized arbitration tribunal in neutral forum.tribunal in neutral forum.

Seeking price indexing or government Seeking price indexing or government support to counter fluctuations in support to counter fluctuations in currency rates.currency rates.

35

Reducing devaluation risk by using Reducing devaluation risk by using local currency.local currency.

Seeking sovereign guarantees.Seeking sovereign guarantees.

36

SummarySummary

The goal is delivering a project within schedule and at or below budget. It is a process governed by complex contracts and involving tiers of complicated relationships.

Financiers must be comfortable with developer, developer’s consultants, with contractors, and contracts that bind various parties together.

37

Risks must be identified and assigned to those best able to accept them and to successfully manage them.

A balance must be reached between incentives and penalties.

38

It is often said that project management is as much an art as it is a science, and that the art of dealing with people is more important than contractual language, and all the safeguards that the lawyers can build into it.

39

In truth, however, it requires both good leadership and a team approach, and the correct contract(s) that clearly lay out the objectives and responsibilities of the various parties. Finding that balance is the key to the development of successful projects and the role of the project manager.

40

The End