Geothermal Project Development Management and Financing

1. Geothermal Project Development Management and Financing Presented by Dr. R. Gordon Bloomquist Washington State University Extension Energy Program

2. Course Goals • Introduce participants to principals of good project management • Strategies for identifying and overcoming risk • requirements for financing geothermal projects • The role of data management as a critical element of project management and project financing

3. The principles introduced through the course will be reinforced through the use of case studies that bring to life real project development histories.

4. Finally, we would like to emphasize the importance of course instructor and participant interaction. We encourage you to ask questions and to relate relevant personal experiences.

5. Project Development -Managing Risk • Geologists are taught how to accept risk • Engineers are taught how to minimize risk • Financiers are taught how to avoid risk

6. 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.”

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

8. 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.

9. Managing Risk:The Key to Financing

10. Banks and other financing institutions are extremely risk adverse.

11. 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.

12. 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.

13. 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.

14. 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.

15. Although the revenue stream is key to obtaining financing, other risk factors will also be evaluated. These factors include: • Fuel supply • Environmental, legal, and institutional regulations • Developer qualifications and track record • Type of conversion technology • Qualifications and experience of design engineer

16. Experience and track record of construction contractor • Qualifications and experience of O&M team • Need for and cost of power • Strength of power purchaser and terms of power purchase agreement

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

18. Fuel 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.

19. 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.

20. Although a preliminary analysis of this data may satisfy financiers, continual tracking and analysis of this information is critical to maintaining resource life and marking future decisions regarding operations, expansion, and the financing of such expansions.

21. Environmental, Legal, andInstitutional 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.

22. Three main types of regulatory risk that face geothermal developers include: • Resource access • Environmental regulation • Utility law

23. 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.

24. With the advent of legislation protecting the environment as well as cultural and historical resources, regulations that limit or strive to mitigate any impacts are now in place in most countries or imposed upon developers by international funding agencies.

25. 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.

26. Utility deregulation has introduced a new and as of now undefined regulatory risk. Unfortunately, this new area of institutional risk also carries with it a totally new level of revenue risk.

27. Developer 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.

28. 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.

29. Conversion 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.

30. 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.

31. Engineering Design Experienced, big-name consulting engineers are preferred by all financing entities. The only exception to the rule is with some small, highly-specialized, and highly-regarded firms with extensive experience in geothermal development and with proven track records.

32. Construction 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.

33. Operation and Maintenance 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.

34. Good O&M goes beyond meeting payment schedules and maximizing current profits. Smart developers understand that a good performance record will be critical to obtaining contracts for the long-term sale of electricity and financing for future plants.

35. Incentives and penalty clauses have found their way into O&M contracts. For example, when seasonal rates or even time of day rates are paid for plant output, it is imperative that plant operates well during those periods. A bonus for good operation, tied with a penalty for not meeting minimum performance requirements, helps ensure optimum performance and a positive case flow.

36. Need 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.

37. The Power Purchase Agreement 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.

38. Although the power purchase agreement is still the primary form of security for financing of independent power projects, with the advent of utility deregulation, developers can no longer look to a single entity as the purchaser of power output.

39. Independent power developers may well have to market output directly to retail customers of electricity or possibly to companies that will serve as aggregators and marketers.

40. Without a fixed, long-term power purchase contract, i.e., retail purchasers are able to switch from one provider to another at will. Where and when this happens, need for and cost of power will take on much greater significance as the only assurance developers will have they can successfully sell into market place is where they can provide superior product at competitive price over the scheduled life of the project or, at a minimum, the length of the financing package.

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

42. 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.

43. Risks that developers of international power projects must be able to overcome in order to be successful include: • Frequent changes in government and resulting changes in policies and priorities • Nationalization of assets • Retroactive application of laws or regulations • Loss of exemptions from new laws and environmental regulations • Licensing • Legal • Venue of dispute resolution

44. Import tariffs • Currency convertibility • Tax treatment and double taxation • Force majeure including, in addition to natural events such as earthquakes, floods, etc. • Acts of terrorism • Coup d’état • Embargoes

45. With utility deregulation actively sweeping the world, development of stable, positive environment for wide-spread independent power may be well in future. A number of things can be done including:

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

47. Writing more complex documents than would normally be required to cover items and issues not adequately covered by local law. • Spending time educating government officials and utility executives about benefits of independent power and require-ments of non-recourse financing for independent power projects.

48. Retaining experts in local legal and regulatory system as members of development team, or partner with such individuals or firms. • Requiring use of established international law applied by recognized arbitration tribunal in neutral forum. • Seeking price indexing or government support to counter fluctuations in currency rates.

49. Reducing devaluation risk by using local currency. • Seeking sovereign guarantees.

50. Construction Contracting - Risk Allocation Construction is characterized as a process governed by complicated contracts, complex rela-tionships, and more than ample opportunity for conflict if not managed properly. Three primary entities involved include: 1. developer with specific project goals and objectives and an ability to finance or obtain financing for the project;