GEOFAR - Emerging financing scheme for fostering investment in the geothermal energy sector

Emerging financing scheme
for fostering investment
in the geothermal energy sector

GEOTHERMAL FINANCE
AND AWARENESS
IN EUROPEAN REGIONS

GEOTHERMAL FINANCE
AND AWARENESS
IN EUROPEAN REGIONS

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It does not represent the opinion of the European Communities.
The European Commission is not responsible for any use that may be made of the information contained therein.

The sole responsibility for the content of this publication lies with the authors. It does
not necessarily reflect the opinion of the European Communities. The European Com-
mission is not responsible for any use that may be made of the information contained
therein.

GEOFAR Emerging financing scheme for fostering investment in the geothermal energy sector

Abstract

Investment in renewable energy re- initial stages of geothermal energy thermal projects in cases in which
quires financial support from pub- projects, that is the exploratory and geothermal fluids are not found, or
lic sources, not only to overcome the production-drilling stage. GEO- are found in inadequate quantity
technical barriers and to generate FAR expects that an overall finan- or quality. The programme should
economies of scale, but, also, to cial envelope of a maximum of 450 provide guarantees throughout the
motivate investors to bring forward million € to be committed over a EU and should run for a period of
the timing of their investment, to in- five- to seven-year period may be five to seven years.
vest now, rather than wait and see expected to double the current rate
if they can invest later, when ener- of capital investment in geothermal The governance of the programme
gy prices will be even higher. energy. should be along the lines of a mul-
tilateral financial institution with
Investment in geothermal energy Public authorities at the EU deci- technical assistance in the fields
faces a higher timing barrier be- sion-making level can accelerate of geology and drilling-engineering
cause it needs to commit irrevers- investment in geothermal energy to be drawn from a pool of experts
ibly the bulk of its expenditure by providing targeted financial sup- nominated by EU Member States.
earlier than other renewables and port to suitably qualified geother- A portion of the programme should
because it needs to compensate mal energy electricity-generation be assigned to co-finance pre-
investors for taking mining risk, a and heat-generation projects. The feasibility studies in EU regions in
form of technical risk that can only mechanism for delivering this sup- which there is geothermal poten-
be managed financially by pooling port should be a geothermal risk tial, but low public awareness of
together a number of projects. This mitigation programme. This pro- that potential. Such pre-feasibility
is an expensive and time-consum- gramme should support the early studies should be commissioned
ing process. exploratory and production-drilling exclusively by public authorities at
stages of geothermal projects. It will the local or regional level.
Public intervention to overcome provide guarantees to pay a part
the disadvantages particular to of the costs of the exploratory and
geothermal energy must target the production-drilling stages of geo-

ABSTRACT 03


Introduction

Renewable energy sources have seen rapid growth
in the last five years. Capital investment, installed
power and energy produced have increased, but
so has public awareness of their presence and
achievements.
Wind turbines and photovoltaic panels are no longer exotic lifetime of such a station, consumers would be called to
gadgets. No doubt this growth is due to the rapid rise of pay about 20 million € more for their electricity over the
market prices for non-renewable primary energy sources, cost of a modern natural-gas-fired, combined cycle plant.
such as oil and natural gas. Another factor in renewables Of course, consumers are already paying such renewable
growth is public policy. The public concerns about climate energy premiums for other forms of renewable energy and,
change and the limitations, including carbon taxation, have sometimes, those premiums are significantly higher. Total
led public authorities to offer substantial financial support to capital investment in such a station would need to rise to
start and sustain the growth of alternative energy. 30 million €.
Geothermal energy has lagged behind in this process. Geothermal resources can be used for generating heat
Earlier analyses in the GEOFAR project have found many and, if the thermal capacity (based on temperature and
non-technical barriers to investment in geothermal energy. flow rate) and quality of the resource happens to be
GEOFAR focuses on those barriers that can be removed, sufficient, for generating base load electricity. In some
wholly or partially, by action at the EU decision-making level. cases, joint production of electricity and marketable heat
In our understanding, if the action proposed by this project energy is possible. It is important to realise that the scale of
at the EU level is taken, one can expect perhaps a doubling geothermal electricity projects is, on average, significantly
in the rate of capital investment in geothermal energy in larger than the scale of heat projects. This means that
the five to seven years following the implementation of the capital costs for electricity projects are, on average, three
policies recommended. to four times larger than they are for heat projects. The risks
Investment in renewable energy must overcome, not only are, also, correspondingly higher, as the flow rate is decisive
technical barriers but, also, the cost disadvantage, before its factor, which depends strongly on the geological situation,
scale of production brings its cost down to levels competitive i.e. transmissivity of the reservoir. On the other hand, the
with conventional energy. This is the motivation for offering expected benefits, both environmental and financial, can be
support from public sources to such investment. correspondingly higher for electricity-generating projects.
The reluctance to invest in geothermal energy, relative to GEOFAR recommends a balanced approach in supporting
investing in other renewable energy sources, is stronger. both larger-scale (electricity generating) and smaller-scale
Not only is drilling for geothermal fluids irreversible (one (heat-supply) projects. This is the standard approach to
cannot close a dry well and recover any of the money capacity planning in energy. Moreover, the EU endowment
spent drilling it), but most of the cost must be committed in geothermal resources consists of few electricity-capable
before knowing the resource is even there. Uncertainty geothermal fields. Concentrating investment on them may
about the price at which the energy to be produced is to be appear to promise rapid, if finite, progress in developing
sold is complemented with uncertainty about potential cost geothermal energy. However, such concentration also
overruns in drilling the production wells. concentrates the risks. Therefore, GEOFAR favours
geothermal energy development by many small lower-risk
To illustrate the arguments calling for support of geothermal
steps. Heat-capable geothermal fields are more numerous,
energy, we present the investment options facing investors
their wells need to be drilled at shallower depths and cost
in a typical 5MWel electricity-generating geothermal plant1.
less to drill. Their risks are correspondingly lower. Those
Just paying investors, by means of a feed-in tariff, to
smaller-scale projects should add up to a significant
undertake the investment immediately, would call for a feed-
proportion of the geothermal investments portfolio.
in tariff of at least 170 €/MWhel, without taking into account
the risk of dry holes or of drilling-cost overruns. Over the To overcome the aforementioned handicaps of geothermal

1 This is a reference plant. The scale of actual plants is closely related to the size of the geothermal resource.

Introduction 04
05


energy relative to other forms of renewable energy, GEOFAR Instrument I proposes co-financing prefeasibility studies
recommends targeting significant financial support from to be commissioned exclusively by regional and local
public sources to the initial, exploratory and production-well authorities in areas with geothermal potential in which public
drilling stages of qualifying geothermal projects. To increase awareness of that potential is inadequate.
the flow of qualifying geothermal projects beyond the Instrument II proposes extending partial guarantees to the
medium term, especially in EU Member States in Eastern exploratory stage of qualified geothermal energy projects.
and Southern Europe, GEOFAR proposes financing partly
Instrument III proposes extending partial guarantees to
from public sources small-scale pre-feasibility and feasibility
the production-drilling stage of qualified geothermal energy
studies.
sources.
GEOFAR outlines three delivery mechanisms for such
The geothermal energy risk mitigation programme should run
support, all coming under the management of a Geothermal
in all EU Member States, cover both electricity-generation
Risk Mitigation (GeoRiMi) programme.
and heat-generation projects and run for between five and
seven years.

05


Table of contents

Abstract 1
Introduction 4
Contents 6
List of Figures 8
List of Tables 9
1 Main advantages of geothermal energy – Stylised macro facts EU 10
1.1 Main advantages of geothermal energy – Stylised macro facts EU 10
1.1.1 Price stability and security of energy supply 11
1.1.2 Reduction of greenhouse gas emissions 13
1.2 Status of geothermal energy- Stylised macro facts in selected EU Member States 16
1.2.1 District heating in France 16
1.2.2 District heating in Germany 17
1.2.3 District heating in Hungary 17
1.2.4 Synthesis 18
1.3 Status of geothermal energy-Micro facts in selected geothermal projects 19
Sample projects of deep geothermal energy 19
1.3.1 Borehole heat exchanger at the RWTH Aachen 19
1.3.2 Hydro-thermal site at Simbach-Braunau (Germany/Austria) 20
1.3.3 Hydro-thermal installation at Unterschleißheim (Germany) 20
1.3.4 Cogeneration of heat and power at Altheim (Austria) 20
1.3.5 Cogeneration of heat and power at Unterhaching (Germany) 21
1.3.6 Hydro-thermal installation at the Paris-Basin (France) 21
1.3.7 Power generation in the Azores (Portugal) 21
1.3.8 Synthesis 21

2 Main barriers in geothermal energy projects - Analysis of needs for financial support 22
2.1 Legal security 23
2.2 Limited basic geological research data 23
2.3 Small-scale of plants 23
High risk of drilling for high-energy geothermal resource
2.4 24
High up-front costs of geothermal energy plants
2.4.1 Output-price risk 24
2.4.2 Risk of non-discovery 26
2.4.3 Resource-discovery risk – Drilling cost overruns 28
2.4.4 Investment timing risk – Irreversibility 29
2.4.5 Economic factors determining investment in geothermal energy 33
2.4.5.1 Projected revenues flows 33
2.4.5.2 The cost of investment 33


2.4.5.3 The discount rate 33
2.4.5.4 The growth prospects rate 33
2.4.5.5 The volatility rate 35
2.4.5.6 The subsidy or premium to ensure immediate investment 35
2.4.6 Extension to the heat-generation option 36
2.5 Varied legal and policy environment in EU Member States 37
2.6 Awareness issues 37
2.7 Generation costs of heat using geothermal energy 37
2.7.1 Factors determining heat generation costs 37
2.7.2 Calculation of heat generation costs of geothermal energy 39
2.7.3 Comparison of the heat generation costs
41
Fossil-fuels versus Geothermal
2.8 Conclusions 42

3 A Geothermal Risk Mitigation (GeoRiMi) programme 44
3.1 Principles of operation 44
3.2 Reasoning 44
3.3 Operation of the geothermal guarantees mechanism 45
3.3.1 Decision-making and management structure of the geothermal guarantees mechanism 46
3.3.2 Revenues and expenses of the Geothermal Risk Mitigation Programme 46
3.3.3 Aligning interests in the Geothermal Risk Mitigation Programme 47
3.4 Summary of financial flows 48
3.5 Insurability 50

4 Instrument I 51
4.1 Awareness - Needs for Financial Support 51
4.2 Description of Instrument I 51
4.2.1 Objectives of Instrument I 51
4.2.2 Target group 52
4.2.3 Eligible costs 52
5 Instrument II 53
6 Instrument III 55
Conclusions 56
7 Draft GeoRiMi constitutive document 57
8 Projected GeoRiMi Financial flows 59

Appendix: A high-enthalpy geothermal power plant 64


List of Figures

Figure 1-1 Primary energy consumption and production by fuel in the EU-27 p. 10
Figure 1-2 Import Prices of Hydrocarbons to Europe p. 11
Figure 1-3 Forecast of fossil fuel imports of the EU in the year 2030 p. 12
Figure 1-4 Contribution of renewable energy sources to final energy consumption in the EU p. 12
27
Figure 1-5 CO2 emissions for power generation p. 13
Figure 1-6 CO2 reduction factor for power generation in Germany p. 14
Figure 1-7 CO2 emissions of fossil fuels for heat generation p. 14
Figure 1-8 Additional value for the reduction of CO2 emissions p. 15
Figure 1-9 Geothermal resources potential in France p. 16
Figure 1-10 Geothermal resources potential in Germany p. 17
Figure 1-11 Geothermal resources potential in Hungary p. 17
Figure 1-12 Share of heat generation sources p. 18
Figure 1-13 Draft of the borehole heat exchanger Aachen p. 18
Figure 1-14 Overview of the drillings at Simbach/Braunau p. 20
Figure 2-1 Energy price more volatile than other prices p. 24
Figure 2-2 Relative price of primary energy p. 25
Figure 2-3 Volatility of the real price of primary energy p. 25
Figure 2-4 Relationship between Profitability, Flow rate of water and Probability of success p. 27
Figure 2-5 Investment Timing (Zero Premium) p. 30
Figure 2-6 Investment Timing (35% Premium) p. 30
Figure 2-7 Investment Timing (67% Premium) p. 30
Figure 2-8 Value of investment opportunity; No growth prospects; No risk p. 31
Figure 2-9 Value of investment opportunity; 2% per year growth prospects; No risk p. 31
Figure 2-10 Value of investment opportunity; 2% per year growth prospects; 12.5% risk p. 32
Figure 2-11 Euro yield curve p. 34
Figure 2-12 Factors determining heat generation costs p. 38
Figure 2-13 Annual load duration curve p. 39
Figure 2-14 Heat generation costs of sample projects p. 39
Figure 2-15 Structure of heat generation costs from geothermal energy as per plant capacity p. 40
Figure 2-16 Structure of heat generation costs from geothermal energy Sensitivity to interest p. 41
rate
Figure 2-17 Heat Generation Costs Comparison p. 42
Figure 3-1 Geothermal Risk Mitigation Programme Flows of investment funds – exploratory p. 49
and drilling
Figure 3-2 Geothermal Risk Mitigation Programme Outstanding balances of investment funds p. 50
– exploratory and drilling
Figure 5-1 Geothermal Risk Mitigation Programme Flows of investment funds – exploratory p. 53
only
– exploratory only
Figure 6-1 Geothermal Risk Mitigation Programme Flows of investment funds – drilling only p. 55
– drilling only
Figure A-1 The geothermal power plant at Pico Vermelho, Azores, Portugal p. 64


List of Tables

Table 1-1 Baseline Prices of Fossil Fuels p.11
Table 2-1 Probability that the cost overrun overcomes the expected present value of 5 million p.28
Euros in the hypothetical scenario examined
Table 2-2 Premium required over breakeven for a 30 million € investment in a geothermal p.32
electricity-generating plant under alternative scenarios of growth prospects and
volatility
Table 3-1 Time-profile of the operation of the Geothermal Risk Mitigation Programme p.48
Table 3-2 Effects of success rate on funding flows p.49


1. Main advantages of geothermal energy

1.1 Main Advantages of geothermal energy
- Stylised Macro facts EU

Renewable energy is energy deriving from natural resources such as sunlight, wind, rain, tides, and geothermal heat, which
are renewable. As Figure 1-1 shows, renewable energy sources (RES) still provide only a small share of the total primary
energy consumption in the European Union. Nevertheless, the share of RES increased from 1997 to 2007 from 5% to 8%.

Figure 1-1 Primary energy consumption and production by fuel in the EU-272

Geothermal energy is power extracted from heat stored within the earth. It is a renewable energy source with high
potential. It offers many advantages to its users:
 Price stability and security of supply relative to fossil fuels.
 Reduced greenhouse gas emissions for power generation as well as for heat generation.
 Diversification of energy supply. Reduced dependency on fossil-fuel or nuclear base-load sources, no
intermittence of supply unlike other renewables.
 Less impact on the environment owing to the small size of geothermal power plants relative to other renewable
energy installations.
 Suitable to connect to existing district heating networks at low conversion cost.

2 Eurostat (2009), “Energy, transport and environment indicators”, pp. 29 and 31.

10 MAIN ADVANTAGES of GEOTHERMAL ENERGY


1.1.1 Price stability and security of energy supply
This section deals with the price stability and security of energy supply stemming from the use of geothermal energy.
Geothermal energy has several advantages in comparison to other energy sources, in particular fossil fuels:
 Geothermal energy is available 24 hours a day and can be used as base-load energy supply.
 The generation costs are more stable than those of energy generated from fossil fuels.
The European Commission expects a rapid rise in fossil-fuel prices for the next twenty years in comparison with prices in
the year 2005. The forecast until 2030 is illustrated below in Table 1-1. The figures suggest that in particular the prices for oil
and gas will rise substantially in real terms in the next twenty years. In the case of oil, an increase of 15% in the real oil price
is expected. For gas prices, the European Commission projects an even higher rise in the real price of 38% in comparison
to the prices of 2005.

2005 $ /
2005 2010 2015 2020 2025 2030
boe
Oil 54,5 54,5 57,9 61,1 62,3 62,8
Gas 34,6 41,5 43,4 46,0 47,2 47,6
Coal 14,8 13,7 14,3 14,7 14,8 14,9

Table 1-1 Baseline Prices of Fossil Fuels3

Figure 1-2 below illustrates the expected prices of hydrocarbons and, additionally, shows the volatility of fossil fuels prices
of the last twenty years.

Figure 1-2 Import Prices of Hydrocarbons to Europe4

Another fact to be taken into consideration is the dependency on energy imports, which is shown in Figure 1-3. As oil, gas
and coal reserves are unevenly distributed around the globe, Europe is heavily dependent on non-EU countries for its future
supply of those fossil fuels5. In 2000 EU overall energy dependency was about 50% and will rise to approximately 70% in
2030, if no action is taken. However, a shift towards renewable energies, geothermal energy in particular, can reduce this
dependency.

3 See Eurostat Report “European Energy and Transport – Trends to 2030”, p. 28.
4 See Eurostat Report “European Energy and Transport – Trends to 2030”, p. 29.
5 See EurActiv: http://www.euractiv.com/en/energy/geopolitics-eu-energy-supply/article-142665.

MAIN ADVANTAGES of GEOTHERMAL ENERGY 11


Oil and gas, the two main energy
sources for the generation of heat, will
have to be imported mostly from non-
European countries. Today 45% of EU
oil imports originate from the Middle
East and as forecasted by the EC, by
2030, 90% of EU oil consumption will
have to be covered by imports. Gas
imports originate mainly from Russia
(40%), Algeria (30%) and Norway
(25%) and by 2030, it is estimated that
over 60% of EU gas imports will come
from Russia and in total more than 80%
of gas imports will come from outside
the EU. By 2030, it is also expected
that 66% of the demand for coal will
Figure 1-3 Forecast of fossil fuel imports of the EU in the year 2030 have to be covered by imports.
Because of the soaring costs of hydrocarbons, the volatility of prices and the forecasted import dependency, it is obvious
that fossil fuels should be substituted by other energy sources. As geothermal energy presents a reliable and clean energy
source that can be used for the generation of base load energy for heat and electricity it seems to be a good substitute
for hydrocarbons. Therefore, it should play a more important role in the future energy mix of the European Union Member
States.
In fact, it has already a significant role in the renewable energies mix. Figure 1-4 shows that a considerable part of the
renewable energy produced in the EU is used in the form of heat. The bulk of the heat generated from renewable energy
sources comes from geothermal energy. The role of other renewables in heat generation is minimal. Geothermal energy is
the most straightforward way to meet heat energy needs from renewable energy sources. This can be achieved by providing
limited, suitably targeted support from publicly-funded financing sources to investment in geothermal energy.

Biofuels consumption
Renewable electricity consumption (normalised)
Renewable heat consumption

Note: Hydropower was calculated according to
the new methodology proposed in the CARE
package (15-year average). it is important to
note that the final methodology may be subject to
further changes.

Source:Eurostat

Figure 1-4 Contribution of renewable energy sources
to final energy consumption in the EU-276

6 European Environment Agency (http://www.eea.europa.eu/data-and-maps/figures/contribution-of-renewable-energy-sources-to-
primary-energy-consumption-in-the-eu-27)



1.1.2 Reduction of greenhouse gas emissions

About 60% of the total CO2 emissions in the EU are emitted from burning fossil fuels to generate heat for heating buildings7.
Therefore, the installation of geothermal plants will reduce Greenhouse Gases (GHG) emissions in the EU by substituting
fossil fuels and thus providing a clean and reliable source of energy. Geothermal energy can not only generate heat but also
electricity. Thus, from a purely environmental point of view, geothermal energy is the perfect energy source to reduce GHG
emissions. The figures below shall underline the GHG emissions reduction potential of geothermal energy.8
By comparing several studies concerning CO2 emissions by using different sources of energy, Klobasa and Ragwitz
concluded that power generation by geothermal is the most effective way to reduce CO2 emissions as it can be used as
base load electricity and thus can replace coal power plants. Figure 1-5 illustrates the CO2 emissions per kilowatt hour of
electricity of several energy sources. The figure shows that geothermal energy has the lowest CO2 emissions.

Figure 1-5 CO2 emissions for power generation

The reduction factor of a renewable energy source can not be completely calculated by the figures above. The reduction
factor shows how much CO2 can be mitigated per kWh by using renewable energies in comparison to other energy sources.
Not every renewable energy source can be used as base load energy and therefore the type of the power plant which is
replaced by a renewable energy power plant, is different. From this point of view, geothermal energy seems to be the perfect
energy source, as it provides both heat and electricity reliably and therefore can replace big coal power plants which have
the biggest share of the CO2 emissions due to power and heat generation. Only hydro energy, of which nearly all resources
in Europe are already in use, has a similar reduction factor.
The CO2 emitted per average kWhel differs from country to country. In France, for example, the CO2 emission factor is
relatively low due to the high proportion of nuclear power, whereas in Germany, CO2 emissions per kWhel are relatively high
due to the high proportion of coal-fired power plants.
The reduction factor of geothermal energy in Germany is: 1030 g/kWhel. The CO2 reduction factors are illustrated in Figure
1-6. In France, those reduction factors for power generation are significantly lower and could even be 0 g/kWhel.

7 See http://www.superc.rwth-aachen.de/cms/front_content.php?idcat=4
8 The following figures are mainly taken from the report of Klobasa/Ragwitz of the Fraunhofer Institute for Research on Innovation
(2005), “CO2-Minderung im Stromsektor durch den Einsatz erneuerbarer Energien”.



Figure 1-6 CO2 reduction factor for power generation in Germany

The heat provided by geothermal energy can be used as base load energy for district heating networks. Thus, these
installations can be used to replace fossil fuel fired installations and reduce CO2 emissions substantially. Figure 1-7 illustrates
the CO2 emissions of fossil fuels generating heat and thus shows the reduction potential of geothermal energy.

Figure 1-7 CO2 emissions of fossil fuels for heat generation9

Assessing the CO2 emissions for geothermal energy is rather difficult, as many different factors have to be considered. One
of the most important factors is the electricity needed for the water circulation and the size of the geothermal installation.
Therefore, the CO2 emissions of geothermal energy providing heat are estimated to 10 g/kWhth10. The German Federal
Environmental Agency assesses the reduction factor of geothermal energy when replacing fossil fuels for heat generation
to 229 g/kWhth.11
The reduction factor of geothermal energy generating power is much higher than the reduction factor of heat generation.
However, the heat generation option merits special consideration for the following reasons:
1. The heat market has a higher share of primary energy consumption than electricity.
2. The resources for high-enthalpy geothermal energy in Europe that are suitable for electricity generation are
relatively few in comparison with resources outside the EU.
3. There are many district heating networks already in use, in which geothermal energy can directly substitute
fossil fuels.
4. Other renewables cannot provide heat energy as readily and as cheaply as geothermal energy.



Following the argumentation of the “Stern review on the Economics of Climate Change” for each ton of CO2 emitted,
a certain price should be included in calculating the full social costs of different sources of energy. Thus, apart from the
environmental gain from the reduction of CO2 emissions when using geothermal energy or other emissions-free energy,12
for each ton of CO2 not emitted, in comparing production cost with energy from fossil fuels a certain amount has to be
considered. Either it must be added to the cost of fossil-fuel energy, or it must be subtracted from the cost of emissions-free
energy. The Stern Review assesses this amount to be 85 €/t CO2. Other reports, e.g. the one elaborated by Krewitt and
Schlomann in the year 2006, assess the costs to be rather 70 €/t CO213. This figure has to be included in the calculation of
heat generation costs. Figure 1-8 illustrates the additional value for the reduction of CO2 emissions per MWh for both, heat
and power generation. The amount is multiplied by the CO2 reduction factor mentioned above.

Figure 1-8 Additional value for the reduction of CO2 emissions

Environmental costs do not enter into the calculations of private investors and of their financial backers. However, it is the
duty of public authorities to take them into account in shaping their support mechanisms. In a sense, support mechanisms
must externalise the environmental benefits of renewable energy sources, so as to attract private capital and thus remedy
a market failure and lead to truly efficient use of scarce resources. In terms of reduced CO2 emissions, geothermal power
can, based on the findings illustrated in Figure 1-8, claim support of between 70 and 90 €/MWhel (for electricity generation)
and between 17 and 30 €/MWhth (for heating).
This analysis of the environmental costs and benefits of geothermal energy leaves out the important factor of risk. This
approach oversimplifies the analysis. The experience with capacity planning in the energy sector shows that there are very
long time periods, especially following energy crises and financial crises, when the optimal path for building energy capacity
is to forego large high-risk projects and focus on incremental capacity additions. Therefore, the choice of large-scale
(electricity-generation) or smaller-scale (heat generation) projects is not a priori clear and must be dynamically adjusted in
response to conditions in the energy market and the financial markets.

9 See University of Göttingen: www.uni-goettingen.de/de/79037.html
10 Other sources assume CO2 emissions of 27 g/kWhth. See Forschungstelle für Eneuerbare Energien (website http://www.ffe.de/
taetigkeitsfelder/ganzheitliche-energie-emissions-und-kostenanalysen/211-geothermie-freiham)
11 German Federal Environmental Agency (Bundesumweltbundesamt) (2005), Erneuerbare Energien – Einstieg in die Zukunft, p. 8.
12 The Stern Review can be found at http://www.hm-treasury.gov.uk/stern_review_report.htm.
13 Ingenieurbüro für Erneuerbare Energien, “Nutzen durch erneuerbare Energien im Jahr 2008”, p7. See http://erneuerbare-ener-
gien.de/files/pdfs/allgemein/application/pdf/nutzen_ee_2008_bf.pdf



1.2 Status of geothermal energy
– Stylised macro facts in selected EU Member States
Many European countries14 already have extensive networks of district heating (DH) and, thus, by being economically
viable, geothermal energy can substitute fossil fuels in those networks. This will be illustrated by examples of some European
countries. They are typical, in many respects, of conditions in the whole of Europe.15

1.2.1 District heating in France
France, especially the northern regions, has a rather high demand for heat. Consequently, France supported the development
of geothermal energy particularly in the Paris Basin during the oil crises in the 1970s and 1980s. Nowadays, 27% of the
total heat delivered to DH networks is generated by renewable energy sources and 11% of this is generated by geothermal
energy. In 2009, 29 geothermal district heating networks with a total installed capacity of 240 MWth were running in the Paris
Basin.
In total, there are about 425 district heating networks with a total installed capacity of 17,442 MWth and about 2 million
French households are connected to DH networks. The industry makes an annual turnover of about 1.25 billion € delivering
a total district heat of 80,078 TJ (that is an average price of 56.2 €/MWhth). As nearly 70% of district heat is still provided by
fossil fuels, such as coal, natural gas and oil, there is still a great potential for substituting these environmentally unfriendly
technologies by geothermal energy. The objectives set are to increase the production of direct uses from geothermal energy
(DH) by 370 Ktoe to 2020 (2006: 130 Ktoe, 2020: 500 Ktoe).16
As shown in the map below, much of the potential of geothermal energy is close to the major population centres, but as
much is found in relatively remote areas, such as the Massif Central, where the heat generated would, perhaps, have
difficulty finding buyers immediately.

Figure 1-9 Geothermal resources potential in France

14 For a short overview of the geological characteristics of France, Germany, Greece, Portugal, Spain, Hungary, Bulgaria and Slovakia
(the GEOFAR project target countries) see the GEOFAR Report “Non-technical barriers and the respective situation of the geother-
mal energy sector in selected countries”.
15 The data is taken from the statistics published by the Euroheat & Power Association of the year 2007 (for further information see:
http://www.euroheat.org/District-heating-cooling-4.aspx) and the GEOFAR Report “Non-technical barriers and the respective situa-
tion of the geothermal energy sector in selected countries”
16 See: www.legrenelle-environnement.fr/IMG/pdf/rapport_final_comop_10.pdf



1.2.2 District heating in Germany
The German heat market is one of the largest DH markets with a total installed capacity of 57.000 MWth. As the exploitation
of geothermal energy started already in the 1970s there are some DH networks fed by geothermal energy although
geothermal energy resources can not be found in all regions of Germany.
About 4.9 million households are connected to DH networks and receive a total amount of about 267.171 TJ per year, which
leads to a turnover of around 16 billion € (that is an average price of 215,6 €/MWhth). Although there is such a high heat
demand, the share of renewable energies generating heat for DH networks, including geothermal energy, is still only 10%.
The current capacity of geothermal energy installations regarding heat generation is about 100 MWth.

Figure 1-10 Geothermal resources potential in Germany

1.2.3 District heating in Hungary
Hungary, like many Eastern European countries, disposes of a large number of DH networks17. In total, there are 92 DH
networks operating with an installed capacity of 9.722 MWth. These networks deliver about 44.835 TJ of heat to more than
650.000 households. Although Hungary disposes of some of the largest reserves of geothermal energy in Europe, only a
share of 8% of the overall heat consumption is provided by renewable energies while more than 80% of the district heat is
generated by natural gas. Industry turnover is around 0,74 billion € (that is an average price of 59,5 €/MWhth).

Wells in sandstone
Wells in carbonate

Figure 1-11 Geothermal resources potential in Hungary

17 http://www.iea-gia.org/documents/SzanyiKovacsHungaryExperience-draftAxelsson4Apr09.pdf



1.2.4 Synthesis
Figure 1-12 illustrates that the share of renewable energies used for district heating, especially geothermal energy, is very
small. If geothermal energy received support commensurate with its environmental benefits, it would become economically
competitive and there would be huge potential for geothermal energy to substitute fossil fuels not only in Eastern European
countries, but also in Western European countries like France and Germany. The valuation of the environmental benefits of
geothermal energy is, therefore, an important matter as has been already shown in section 1.1.2 above.

Figure 1-12 Share of heat generation sources

One could point to many reasons why the utilisation of renewable energy and geothermal energy for district heating varies
so much among Member States. The findings of the GEOFAR project (see Report “Non-technical barriers and the
respective situation of the geothermal energy sector in selected countries”) pointed out the lack of awareness for
geothermal energy among decision makers. As an attempt to remedy this discrepancy between received opinion and reality,
a number of sample deep geothermal energy projects are presented below, focusing on the record of high reliability and
maturity of a few real-world geothermal energy projects.



1.3 Status of geothermal energy
– Micro facts in selected geothermal projects
Sample projects of deep geothermal energy
While many heat markets in the European Union still rely on heat produced by fossil fuels such as oil, gas and coal, there
are already many geothermal energy projects in various European countries which are providing heat, and sometimes
also electricity, to thousands of households. These projects prove the feasibility and reliability of geothermal energy and
its contribution to the reduction of GHG emissions in the European Union. Some of those sample projects are listed below.
In order to get an idea of the economics of geothermal plants below, one should bear in mind the following guidelines. They
are a rough outline of the investment appraisal process of the European Investment Bank (EIB). They are only a rough
guide, because geothermal projects are so diverse. Moreover, the economics of geothermal investment are analysed in
depth in section 2 below.
The basis for evaluating mature renewable energy projects is the least cost fossil-fuel alternative. This is a Combined Cycle
Gas Turbine at 55% efficiency. The capital costs of such a plant augmented with the fuel cost, a hefty CO2 premium and a
security-of-supply surcharge led to an alternative cost of 72€/MWhel. In mid-2007, this was already a large increase over
a cost of 50€/MWhel in mid-2005. Moreover, the prospect of further increases in the CO2 premium and forward pricing for
what the EIB expects to be the marginal mature renewables technology in 2020 led the EIB to adopt a figure of 80€/MWh
as its target price for electricity to be generated from mature renewables. The upheaval in the energy markets in 2007 and
2008 has led the EIB to revise the figure further upwards to 96€/MWhel. In sum, to qualify for EIB financing, a geothermal
energy electricity-generation project must return 5% or more over 15 years at an assumed price of 96€/MWhel or lower for
the generated electricity.
The reference figures for electricity imply reference figures for heat energy between 24 and 32 €/MWhth.

1.3.1 Borehole heat exchanger at the RWTH Aachen

A good example of the practicability of a borehole heat exchanger is the
installation at the University of Aachen in Germany. In this region the
conditions for geothermal energy are not favourable for installing hydro-
thermal applications. Still, a borehole heat exchanger can be an economically
viable investment when assuming a high increase in fossil fuel prices in the
future. In the year 2004 the University of Aachen started to drill a 2.500 m
deep borehole in order to install a borehole heat exchanger providing heat
to the student service centre18. The total investment sum was 5,1 million €,
installing a capacity of 450 kWth at an operating temperature of 70°C. The
total heat generation is about 620 MWhth per year. Reported capital costs,
assuming a rate of return of 5%, are 411 €/ΜWhth per year or 567.000 €/
ΜWth per year. One should, however, note that the implied rate of utilisation
of this facility is only 1377 hours per year. The facility was built with a focus
on developing technology and not on commercial operation.
In order to maximize the effectiveness of the installation, the borehole heat
exchanger is used to cool the buildings during the hot summer periods. This
type of installation can be installed in any region in the EU and thus shows
the applicability of geothermal energy in any heating and cooling system
within the EU.

Figure 1-13 Draft of the
borehole
heat exchanger Aachen19




1.3.2 Hydro-thermal site at Simbach-Braunau (Germany/Austria)

The geothermal energy project of Simbach-Branau is a perfect example
of European partnership as the project is providing energy to two cities
in different countries and due to its success new investments in the DH
network were initiated.
The drillings for the geothermal energy project of Simbach-Braunau
were started in 1999 and were finished in 2001. The plant provides heat
for the district heating network of the two cities of Simbach (Germany)
and Braunau (Austria). With an installed capacity of 5,4 MWth the
installation provides heat for the district heating network with a capacity
of up to 40 MWhth 20. Buildings like the local hospital and fire department
are connected to the 22 km DH network. The depth of the two drillings
is 1.848 m respectively 1.947 m carrying water with a temperature of up
to 80°C21.

Figure 1-14 Overview of the drillings
at Simbach/Braunau22

1.3.3 Hydro-thermal installation at Unterschleißheim (Germany)
Another sample project is the geothermal energy plant of “Unterschleißheim”. It took only 4 years from the first ideas to
23
realize such a project until the two drillings were completed .
In 2002, the first drilling of the geothermal energy project resulted in finding thermal water in a depth of 1.961 m with a
reservoir temperature of 81°C. The drilling costs of nearly 8 million € and the identification of the reservoir led to a total
investment of 21 million €. By installing this geothermal energy plant with a capacity of 27 MWth, a significant reduction of
GHG emissions could be achieved. Capital costs, assuming a rate of return of 5%, are 38.900 €/ΜWth per year. It annually
saves 8.600 tons of CO2 emissions as well as 4,5 tons of SO2 and 7,9 tons of NOX. The capital costs per ton of CO2
emissions saved is 122 €/ton. This is high, considering figures lower than 20 €/ton calculated in section 1.1.2 above.

1.3.4 Cogeneration of heat and power at Altheim (Austria)
The geothermal energy project of Altheim is a very special one as the heat generation has been operating since 1990. In
2000, an Organic Rankine Cycle (ORC) installation was added and Altheim became the first geothermal energy power plant
in Central Europe24.
The first steps to install the geothermal energy plant for heating were already taken in 1986 and in 1989 the contracts were
concluded. Due to the high risk of such a project and the little experience at that time, the local municipality had difficulties
in finding an insurance company, but finally two companies from Austria and Hungary took the risk. The total investment for
the 2,5 MWth installed capacity was 1,9 million €, a reinjection well was not built. Today the installation has a capacity of 11
MWth. The depth of the drilling is about 2.300 m, where a water temperature of about 106°C is registered.
In the year 2000 the installation was extended, adding a reinjection well as well as an ORC-turbine to generate electricity
and thus enhancing the profitability of the whole project. By adding new investment costs of 5 million €, a turbine with an
electric capacity of 1.000 kWel was installed, providing up to 2.000 MWhel per year. The implied utilisation rate is 2000 hours
per year.
The combination of heat and power generation is a perfect example of how geothermal power projects can take place: in the
first stage, wells for the supply of the district heating network are drilled verifying the assumed potential. If the temperature
and the flow rate are sufficient, a turbine can be added to the installation. The option to increase capacity and scope of a
project incrementally, where this is possible, is a desirable feature of investment projects.



1.3.5 Cogeneration of heat and power at Unterhaching (Germany)
25
The geothermal energy project of Unterhaching is a true success story . The special purpose vehicle to undertake this
project was founded in 2002 and it took only seven years to finalize the whole geothermal energy project. Rödl & Partner
was assigned to manage the whole project and achieved to obtain a drilling risk assurance in the year 2003. This insurance
solution lowered the risk for the project significantly and thus drillings could be started.
The drillings in the year 2004 and 2005 concluded in finding hydrothermal reserves of up to 133,7 °C and a flow rate of up
to 150 l/s, which was a huge success. The depth of the first drilling is 3.350 m and for the second drilling is 3.590 m. The
installed capacity of the plant will be a total of 70 MWth which will be delivered by a newly built district heating network.
Moreover, in order to generate electricity a so-called Kalina cycle was added to the installation to produce about 21.500
MWhel per year. The installed capacity is 3,36 MWel. It is planned to generate up to 126 GWhth of heat per year and distribute
it through the district heating network. The capital invested so far sums up to 80 million €.
Many other German municipalities followed the example of Unterhaching and try to develop their own geothermal projects
in order to become more independent from energy imports.

1.3.6 Hydro-thermal installation at the Paris-Basin (France)
The geothermal energy installations of Chevilly-Larue and L’haÿ-les-Roses have been providing energy to the two cities
since 1985 and the district heating network is one of the biggest geothermal district heating networks in Europe.
With an installed capacity of about 27 MWth the installation provides heat for the district heating network of up to 85 GWhth
26
(2004) . Two geothermal doublets are exploiting a thermal water of 74°C and the users are connected in cascade to a 22
km DH network feeding more than 22.000 households units. The depth of both drillings is 2.000 m carrying water with a
temperature of up to 80°C.

1.3.7 Power generation in the Azores (Portugal)
Portugal disposes of high-energy resources located at Portugal’s islands, especially the Azores. They are suitable for
geothermal power generation. Since 1980, geothermal electricity is produced in Sao Miguel Island, Azores. In December
2006, the Pico Vermelho plant started and replaced the 3 MW pilot unit which was operating since 1980.
The Pico Vermelho power plant is served by five geothermal production wells and two injection wells. Maximum temperatures
recorded at this sector of the field are between 235ºC and 240ºC. The most productive horizons of geothermal fluid are
between 500 and 800 meters deep. The geothermal production wells have an average flow rate of 120 tons/hour. The
installed power is 10 MWel, however the power output of the plant has been consistently more than 11 MWel. The annual
production is approximately 97 GWhel. The total investment costs for the power plant and drilling of geothermal wells were
27
34 million €. Capital costs, assuming a rate of return of 5%, are 17,6 €/ΜWhel per year or 154.500 €/ΜWel per year .
The case of the Pico Vermelho plant shows the capacity of geothermal power to provide highly reliable base load electricity.
This is especially valuable in a peripheral location such as the Azores and could be viable, even if the cost were not as low
as in the Azores with its favourable geology.

1.3.8 Synthesis
All the projects outlined above show the practicability of geothermal energy projects. One should note how varied the
circumstances of those projects are, suggesting that geothermal energy can be versatile in meeting diverse energy needs.
In Europe, given presently available technology, one should expect most geothermal development to be directed at the
generation of heat, as there are only few high-enthalpy resources which are suitable for electricity generation. Nevertheless,
due to the high amount of low-enthalpy resources and the large number of already existing district heating networks, there
is significant potential for geothermal energy to provide heat to many thousands of households.

20 See http://www.simbach.de/p/d1.asp?artikel_id=1029
21 See http://www.braunau.at/gemeindeamt/html/4ax.htm
22 See http://www.simbach.de/p/d1.asp?artikel_id=1029
23 See http://www.unterschleissheim.de/index.html?xml=/gtuAG/projekt.xml
24 http://www.altheim.ooe.gv.at/system/web/zeitung.aspx?menuonr=218375019&detailonr=218149727
25 For further information see: http://www.geothermie-unterhaching.de/ and http://www.geothermieprojekte.de/projektbeispiel-unter-
haching-1/projektanfang
26 Seehttp://www.semhach.fr/semhach02.htm
27 For a more detailed description of the Pico Vermelho plant, please see the Appendix



2. Main barriers in geothermal energy projects
- Analysis of needs for financial support
Notwithstanding its many advantages, investment in geothermal energy lags behind in comparison to other types of
renewable energy. GEOFAR has identified non-technical barriers that stand in the way of geothermal energy investment.
They can be overcome by limited, targeted public intervention that will encourage increased investment in geothermal
energy. It is up to the public authorities, at the EU and lower decision-making levels, to assess whether the specific public
benefits of investment in a geothermal energy project or class of projects are worth the costs of public intervention.
The GEOFAR project focuses on medium-depth and deep geothermal energy. In the experience of the project partners,
confirmed by the information provided by geothermal experts in one-on-one meetings, and by the technical and financial
information gathered for the GEOFAR project, the large and diffuse energy potential of shallow low-energy geothermal
sources is and can be sufficiently tapped by means of existing market and non-market mechanisms.
The identified barriers to further development of geothermal energy in the GEOFAR target countries are grouped in three
major groups: technical, financial and other. The terms of reference for the present project do not include an analysis of
technical barriers. One should keep in mind, however, the findings of GEOFAR that technical barriers, as perceived by
investors, public officials and the public, are a significant factor in explaining the present stage of slow development in the
field of geothermal energy. Moreover, GEOFAR findings show that technical barriers generally arise in combination with
non-technical barriers. Since the end-purpose of the GEOFAR project is to lead to concrete and practical proposals to
quicken the pace of investment in geothermal energy, the distinction between technical and non-technical barriers, made
for purposes of analysis, will not be so stark in this document.

The primary obstacles to the development of geothermal energy projects identified by GEOFAR are the following:
- Legal uncertainty over the ownership and the rights of ownership of a geothermal resource
- Mainly in Eastern and Southern Europe, limited availability of basic geological research data and high cost of
obtaining new data.
- Diffuse nature of low-energy geothermal resource, requiring many small-scale plants. Some plants happen to
lie close to where energy is needed. Others don’t.
- High risk (relative to other renewables) of drilling for high-energy geothermal resource - High up-front costs
of geothermal energy plants. At EU level, the scale and risk problems are compounded by a legal and policy
environment that varies greatly from one Member State to another.
- Low awareness of geothermal energy benefits among investors, public officials and the public.

As it will become clear below the barriers to the development of geothermal energy are strikingly similar to the problems
faced by the fossil fuels extracting industries, such as coal-mining and oil-drilling in the very early days of their development.
The similarities have been repeatedly pointed out by the experts interviewed in one-on-one meetings conducted in the
framework of GEOFAR. The crucial difference is that those industries had a much longer time in which to mature, during
which the demand for their output grew steadily together with supply. In the case of geothermal energy, demand is already
at a high level. Because of the present-day climate problems, however, a long (century-scale) time frame for development of
the supply is not feasible. Climate science does not give the world that much time. Issues about the availability and security
of fossil-fuel supply, also, point towards investing now in diversified portfolio of alternative energy sources. It follows that
speeding up geothermal development requires a conscious decision by policy makers to devote significant resources to the
task. Geothermal energy is not merely CO2-neutral but almost CO2-free. This advantage should be appropriately valued by
policy makers.
Just finding information on an industry at an early stage of its development is not an easy task. In the GEOFAR study, the
information was gathered by significant and costly effort by the project partners. All of it has been checked and confirmed.
This process was followed by all the GEOFAR project partners because they all understood that the information was
gathered to support decisions and not merely to reach research conclusions.
Let us examine now each of the primary obstacles to development of geothermal energy listed above.
Before proceeding, one should note that the goal of accelerating geothermal investment in the short to medium term cannot
be reconciled with removing barriers to geothermal development that need addressing over the longer term. Moreover, it
is not clear what action at the EU level can remove obstacles at the local level, for example local opposition that mining
activities often arouse. Local authorities and operators have found out that, once fear in a community has been aroused,
the time and resources needed to quell it render the project infeasible for at least a generation.

22 MAIN BARRIERS in GEOTHERMAL ENERGY PROJECTS


2.1 Legal security

The question of ownership of renewable natural resources has not been resolved satisfactorily neither in the academic
field of law, nor in the academic field of economics. Some natural resources can be owned by economic agents and some
can’t. Even those that are owned, find their use regulated by public policy, at times strictly. The case of water, a resource
with universal use, illustrates this point. Water ownership and use arouses controversy virtually everywhere in the world.
What does not work in theory, often works in practice. Researchers have been able to observe very elaborate systems of
intertwined legal and economic practices that allow communities to share scarce renewable natural resources, for example
irrigation water, with astounding gains in economic efficiency. Unfortunately, such systems are developed over several
decades and defy general applicability.
In general, in most developed countries the mining codes concerning geothermal fluids have been updated to reflect recent
technological developments. Still, the issues of dual use, for example medical/touristic versus heating/electricity generation,
still arise. In part, this is due to the nature of the geothermal resource. Unless one drills, it is not known what precise use
the geothermal fluid, if found, can be put to. Thus, besides the risk of a dry hole, the operator runs the risk of overstepping
the terms of the drilling license. The license-granting authority, on the other hand, has the impossible task of weighing the
costs to a community of drilling against the benefit that can range from negative to tens of millions of euro. Thus, the terms
of a license that seemed sufficient to an operator, may turn out too restrictive in the light of drilling results.
It is impossible to devise a legal system to address this problem, even if it were possible, much less to have it adopted
throughout the EU. A partial remedy would be to facilitate financially public research organisations that would, then, direct
their effort to unearthing the minimum research information needed for an efficient licensing process. Even so, the legal
impediments will only be lowered, not eliminated, and this would cost dearly in money and time.

2.2 Limited basic geological research data

In the absence of a well-funded full-scale geological research programme, basic geological research data in Southern and
Eastern European countries have been obtained as a by-product of test-drilling for oil or gas or of test-drilling for water.
Private investment in basic research data is unlikely to be on a sufficient scale, since the benefits of it are not flowing
exclusively to the investor. For example, who would be prepared to buy data on a dry hole and at what price? Why should
the entity generating this data bother about retaining it, putting it into useable form and making it available to potential
competitors? Even if the overall interest of society were to be served, the agents have no interest in furthering it. Therefore,
public intervention in the shape of financing research-drilling is needed to remedy this deficiency. Public research funds are
not free, however. Test-drilling for geothermal energy must compete with numerous other worthwhile research proposals
in the field of energy from renewable sources, in the broader field of energy and in many other basic research fields. Thus,
overcoming the data availability barrier means primarily moving geothermal area further upwards in the policy agenda, both
at the EU and the Member-States. But public provision can be complemented in three ways:
First, a drastic expansion of shallow drilling, properly monitored, will provide data and greatly expand the number of
engineering professionals with experience in drilling and geothermal energy.
Second, the packaging of licenses to develop geothermal resources in sizes large enough, in both the geographical and the
geological and economic sense, to ensure that the licensee can be reasonably hopeful of finding “some” significant source
of energy, can attract private funding for basic geological research.
Third, public-private partnerships, as dictated by the prevalent financial and policy environment, properly structured, may
provide the means to resolve the twin problems of setting proper priorities and financing basic geological research.

2.3 Small-scale of plants

The present state of technology clearly does not allow geothermal energy to provide large-scale power stations, such as
is possible with fossil fuels and, even, large hydroelectric plants. There is promise in the Enhanced Geothermal Systems
(EGS) technology, but there are very significant technology barriers to be overcome, before it is commercially mature. The
value of pursuing EGS technology is, at present, the option value of a future and uncertain gain.
The scale limitation is a limitation affecting all renewable energy sources being developed at present. Geothermal energy,
however, differs. Solar panels and wind turbines can be manufactured in a central location in large quantities, thus capturing
very significant economies of scale. They can, then, be deployed in the field. Sometimes, they can be deployed exactly
where there is demand. On the other hand, geothermal resources, especially high- and medium-energy ones, are site-

MAIN BARRIERS in GEOTHERMAL ENERGY PROJECTS 23


specific. One could argue that each geothermal field requires knowledge specific to it alone to be developed.
The scale problem is well-known in the mining industry. Not all quantities of minerals are economical to mine. Some are
present in small quantities in a given geographical location, while others have small concentrations and yet others lie too far
from where they could be usefully processed. Moreover, the processes of extraction and refining very often differ radically
from one site to another.
To overcome this barrier, policy makers should aim for a two-pronged approach, one for low-energy geothermal resources
and one for medium- and high-energy ones.
Low-energy geothermal resources can be developed using technology that can be mass-produced. This production can
be simulated by encouraging (even mandating through the building code) geothermal heating and cooling in buildings in
high density areas in order to mitigate primarily both local warming and, by saving on energy consumption, global warming.
Medium- and high-energy geothermal resources are handicapped by their small scale. However, small scale is not always
and everywhere a handicap. From the point of view of regional development, development of energy resources particular to
each region is highly desirable. Moreover, geothermal energy has a much smaller environmental footprint than solar or wind
energy. Therefore, the absence of significant economies of scale may not be the most important consideration for public
policy makers when choosing to support a geothermal energy project.
All the primary obstacles listed under points 1 to 6 in the beginning of this chapter need addressing, if geothermal energy
is to be developed at a level closer to its potential. However, not all those difficulties can be analysed quantitatively. We do
believe though, that the issues of drilling risk and front-loading of costs (point 4) can be analysed quantitatively. For this
reason, the analysis of those two issues takes much more space and time than the analysis of the other issues. This is
needed in order to bring the readers/users of this report to a common starting point so as to follow the line of argument from
beginning to end.

2.4 High risk of drilling for high-energy geothermal resource
High up-front costs of geothermal energy plants

2.4.1 Output-price risk
The matter of risk is the most important in the energy sector overall. But there are many kinds of risks and one needs to
make distinctions between one kind of risk and another. Let us look into this issue by first developing some analytical tools
that will help us analyse each of the different types of risk.
The most visible type of risk in the energy industry is the output-price risk. This is shown in the graph below (Figure 2-1):

Figure 2-1
Energy price more volatile
than other prices



We are looking at the price of primary energy, that is, mainly, the price of oil, gas and coal. It is remarkable that the price
of energy relative to all goods and services stands today at about the level it was in 1982. However, the level of the price
of energy has stayed lower than the price level of all goods and services over most of the last 36 years. On the other
hand, for almost six years (2003-2009) energy prices outpaced the overall price level.

It is worth looking deeper at the relative price of energy that is at its price compared to all goods and services. It is shown
in the graph that follows (Figure 2-2):

Figure 2-2
Relative price of primary energy

If one chooses to discern a trend into the data graphed above, one would arrive at a growth rate of about 2% per year.
Since this rate has been adjusted by a measure of the general (producer) price level, this figure is a measure of the real
appreciation in the price of primary energy over the last 36 years.

The graph, also, illustrates the problem of investing for the long run in primary energy. An investment made in 1986 on
the expectation of price growth along the 2% trend would have had to withstand 16 years of below-trend prices. It is worth
noting that even investment in energy conservation, such as in better insulation of buildings, has suffered from the high
volatility in the price of energy.
There is yet more complexity in the energy output-price risk puzzle. One notices that in recent years the real price of en-
ergy is not only higher than in years past, but that it is also more volatile: It has more violent ups and downs. How much
more violent? One can consider the following graph (Figure 2-3):

Figure 2-3
Volatility of the real price
of primary energy



Observed volatility has been increasing over time in the period 1979-2009. Thus, the problem of an energy investor,
whether in the private or in the public sector is not one-dimensional. Forecasting the likely long-run trend of the price of
energy is not enough. An investor must also plan for increasing price volatility. As the graph above shows, volatility does
not go to infinity. But its ultimate upper bound is probably unknowable.

We have produced a set of simulations for the path of the price of energy over a period equal to the period examined. The
simulations were designed to exhibit the same statistical properties as the actual prices, allowing, of course for a sizable
random component, just as we observe in actual energy prices.

The practical conclusion of this exercise is that a house owner who saved 3000 Euros by not insulating the roof of his
house in the aftermath of the oil crises of 1974 and 1979 is better off today than an identical house owner which did
invest in insulating his roof. Worse, he or she would be better off in two thirds of the cases, even if energy prices had
developed otherwise.

The analysis so far illustrates clearly why some stability of the price at which energy is sold is so crucial to undertaking
any investment in the energy sector, be it in fossil-fuelled energy, in renewable energy or in energy conservation. Setting
and guaranteeing a feed-tariff is therefore a very important instrument for promoting investment in energy. Ensuring out-
put price stability is equally important in business policy in the private sector and in public policy in the public sector. This
is why so much energy is traded under medium- and long-term contracts.

What is perhaps not so clear in public debate is the size of the implicit subsidy in a guaranteed feed-tariff. To reduce the
chances of non-recovery of an investment undertaken in the terms we have examined in the roof-insulation example
above to, say, 25% from 64% would take a subsidy of almost half the cost of the investment in insulation. In other words,
granting a subsidy covering 50% of the investment cost would remove more than half of the risk.

The real question though is: Will this reduction in risk be enough or more than enough to make the investment attractive?
We need additional analytical tools to answer that question and these are developed later in this section.

On the other hand, we must note that a guaranteed price set to be paid for the entire life of an investment in energy
means that the rate of return for the investor need not be large. If that price is guaranteed by the state, the rate of return
for the investors need only be as high as the rate of return on state bonds of a similar maturity profile.

What about diversification? Would output-price risk be reduced for an investor that invested a small part of his or her
total investment funds in each project? The answer is no, if investment is diversified in portfolios of many energy projects,
whether renewable or non-renewable or conservation-only. Out of an infinite number of scenarios that one can generate
for the next 25 years, only one will come to pass. If prices are low for most of the next 25 years, then they will be low for
all the energy investments in one’s investment portfolio and the return on that portfolio will be low.

What about diversification into other sectors of the economy? High primary energy prices have often been blamed for
triggering declines in world economic activity, so they would appear to be strongly countercyclical. This popular view,
is, however, strongly refuted looking closer. Energy prices are strong signals of changes in the direction of the path of
economic activity, but once this change of direction has occurred, energy prices follow. So energy investments in prac-
tice carry little systematic risk, the risk of moving up and down with the whole economy. Thus, they can, in theory, fit into
well-diversified investment portfolios that will diversify away their high idiosyncratic risk. Geothermal energy investments,
however, are not yet mature enough in the perception of investors, nor are they so numerous as to allow this risk-mitiga-
tion technique to apply.

2.4.2 Risk of non-discovery

The commercial use of deep hydro geothermal energy for heat and/or electricity generation depends on finding suitable
“geothermal hotspots” beneath the earth.
Several examples across Europe showed that finding such a suitable “geothermal hotspot” is not guaranteed. The risk
connected to a successful exploration is also considered as a discovery risk.
28
The discovery risk is defined in particular as the risk of not achieving a thermal output capacity from a geothermal reservoir
29
by one (or more) well(s) in sufficient quantity or quality . In other words, not to achieve the required thermal capacity from

28 In fact it is a risk during the exploration of the resource and therefore often related to as “exploration risk”. In GEOFAR we wanted
to clarify the expression and therefore talk about the “discovery risk” as defined.
29 Dr. Rüdiger Schulz, Basic Requirements for an assessment of probability of success for hydrogeothermal wells



one or more production wells. This discovery risk can either be the risk of non-discovery (i.e. complete failure) or a partial
discovery (partial success).
The discovery risk in deep geothermal energy projects concerns mainly hydro geothermal wells. As most deep geothermal
energy projects currently running in Europe are based on hydro geothermal resources the discovery risk together with the
high upfront costs are the main barriers for the development of geothermal energy projects across Europe.
In each hydro geothermal project the assessment of the discovery risk is the central question for investors and decision
makers. In fact a “probability of success” is defined for particular cases, including usually a base case, a partial success
case and failure. For each case and for each particular project this assessment will have to be conducted to enable the
appraisal of the risk-reward-ratio for the investor. This risk-reward-ratio also can be expressed in the profitability of the
project. The profitability of the project therefore relates directly with the found amount of water (as a carrier of the energy) in
relation to the probability of success (see also the diagram in Figure 2-4). If a minimum profitability (depending on investor)
cannot be achieved, in general the project is considered to be not economic viable.

Figure 2-4 Relationship between Profitability, Flow rate of water and Probability of success

Consequently a failed drilling will lead to a complete loss of investment (for drilling, exploration activities and planning).
Partial success could mean, that with capital coming from insurance (as insured event) that a further utilization of the drilling
will be able (reaching a minimum profitability). Success leads to a further project development as planned.
A good quantitative assessment of the discovery risks by geoscientists – the common tool is a seismic analysis - can limit
the discovery risk. But, the seismic analysis cannot fully eliminate the risk of no or not sufficient discovery of resources. More
important are also drillings at nearby locations, which usually help to define the temperature and the general transmissivity
of the reservoir, but for a new drilling it is always essential to assess the particular location to identify e.g. karstified
structures (with cracks, etc.) which are zones for higher transmissivity.
If an unsuccessful well has to be abandoned, investments for the drilling works (including project development and planning)
are in most cases to be considered to be lost. Nevertheless, investments of often more than EUR 10 million per project are
subject to this particular risk. The investor must acquire capital to move the geothermal project from the first steps into later
stages of development, and the investor(s) must be willing to finance at significant risk.
The first injected equity has to be considered to be venture capital. Foreign capital at this stage is almost impossible to
acquire, as financing institutes surely will not deal with any discovery risk (this shows also the practical approach of the
European Investment Bank (EIB), which rejects application of financing for drilling phases of geothermal projects, but is
willed to finance later phases which could be e.g. the construction of district heating network or power plants.)
Consequently the projects lack of financing of these early project stages. Europe wide there is a gap in available financing
instruments – if not public supported mechanism are available – that correlates to the highest risk period of project



development phases (early stage of the project when the resource is not proven and the risk of non-discovery is very high),
each investor has to face a disproportionate share of project risk compared to other renewable energy investments.
One can state that the upfront costs associated with geothermal exploration and drilling require a major financial commitment
by investors in the face of a risk that a confirmation drilling may fail to identify an economically viable prospect, even when
the extensive seismic analysis indicate the potential for encountering a viable geothermal resource.
Mitigating the risk by a public instrument paves the way for geothermal project with all their advantages. Currently, only a
few European countries provide a risk-mitigation system on insurance-basis for geothermal projects in order to overcome
this barrier. These are France, the oldest one, Switzerland and Germany. At international level, the GeoFund (handled
by the World Bank) provides also a partial insurance system for GeoFund member countries whereof Eastern European
countries like i.e. Bulgaria can benefit from. But the access is limited to just a small share of geothermal energy projects
across Europe and up to now there was only one projected “insured” by the Geofund-mechanism.
To boost the European geothermal sector within a particular time frame as a whole a Europe-wide risk mitigation system
could be one solution.

2.4.3 Resource-discovery risk – Drilling cost overruns

Geothermal energy projects do not face only output-price risk. The cost of finding and accessing the geothermal resource
cannot be known in advance. This fact introduces another risk factor in the decision to invest.
In the course of the GEOFAR project information on several specific proposed projects has been gathered. Some of that
information has been presented above. Other information was gathered in meetings but in the understanding that it would
not be published in its original form or that it would be published in depersonalised form, or that it would be published
without attribution. However, it was found that the technology of geothermal electricity-generating plants is now so well
defined that no appreciable differences were found in the several projects examined. Therefore, the analysis will proceed
on a hypothetical example plant. The scale can vary in the case of larger or smaller plants, but the economic characteristics
will stay the same.
Let us, therefore, start with a hypothetical project with an investment budget of 30 million €, a time horizon of 25 years and
guaranteed net revenue of 2 million € per year over the life of the project. Assuming no uncertainty over the investment
budget, those baseline assumptions yield a modest net present value of 5 million €. But we cannot be sure that no cost
overruns will be encountered.
We are modelling the percentage of cost overruns by means of a beta distribution. It is a very versatile probability
distribution that allows us to examine different scenarios. We assume that a geothermal energy project will have cost
overruns starting at 0% and going up to a maximum value. Experts interviewed for the GEOFAR project, seem to suggest
that the maximum cost overruns is about 40%, after which, presumably, the project is abandoned, but we can use any
reasonable upper bound number. We can assume that the probability of incurring a cost overrun of size x (0<x<maximum)
is uniform over the interval [0, maximum]. We can assume that the probability of a cost overrun of size x declines with the
size of the cost overrun at a constant rate. We can, also, assume that the probability of a cost overrun of size x declines
faster than the rate at which the size of the cost overrun grows. All those cases and more can be modelled as instances of
the beta distribution.
How often will the cost overrun overcome the expected present value of 5 million € in our hypothetical scenario? This
probability is shown in the Table 2-1 below:

Maximum beta parameter
cost Table 2-1 Probability that the cost overrun overcomes the
1 2 4 10
overrun expected present value of 5 million € in the hypothetical
10.00% 0.0% 0.0% 0.0% 0.0% scenario examined
20.00% 16.8% 2.6% 0.0% 0.0%
30.00% 47.3% 19.0% 4.2% 0.0%
40.00% 59.3% 35.3% 11.2% 0.6%



It is clear that the risk associated with cost overruns in building a geothermal energy project can be significant. This risk
is not affecting investments in other renewable energy projects nor, even, investments in energy projects in general. It is
important to note that this is technical risk of the kind that can be mitigated by pooling together as many projects as possible.
This observation explains the ever increasing size of companies in the mining sector, where resource-discovery risk is high

2.4.4 Investment timing risk – Irreversibility

Let us now turn on the matter of investment timing.
Investment projects, including projects in geothermal energy, may be viewed as options that can be exercised now or at any
time in the future. Assuming the goal of public policy is to accelerate development of geothermal energy projects, what are
the conditions that will encourage project developers to invest now, rather than in the future?
Let us consider the example of a 5MWel geothermal plant generating electricity30. The total investment cost of building such
a plant, including the cost of drilling, is about 30 million €. Current technology allows such plants to operate for 8000 hours
per year for a minimum of 15 years. The capital costs of such a plant, assuming a discount rate of 5% per year are 73€/
MWhel. With operating costs of 23€/MWhel, one arrives at a break-even cost of 96€/MWhel. It is clear that, under such
circumstances, investment in geothermal energy cannot be very attractive to investors. There does not appear to be a
significant margin left over, after all the costs have been paid. However, this conclusion needs qualification.
1. The price for the electricity produced is high, if one compares it to fossil-fuel-fired electricity-generating plants. It
does, however, exactly meet the criterion adopted by the European Investment Bank (EIB): 96€/MWhel for plants
generating electricity from renewable energy sources. This figure has been provided by officials from the Lending
and Projects Departments of the EIB during the exploratory meeting the GEOFAR WP3Leader had with them at the
Bank’s Headquarters, in February 2009, for the purpose of presenting the GEOFAR project.
2. Electricity prices for certain other sources of renewable energy are, in some countries, considerably higher. Photovoltaic
panel plants receive over 450€/MWhel in Greece, and other solar plants over 250€/MWhel. However, such high prices
are largely justified by the economies of scale that manufacturers of solar plants of all kinds have promised and, in
significant part, already delivered.
3. There is potential for revenue enhancement, where demand for the excess heat released by the plant exists near the
plant.
4. Regional conditions favour the building of geothermal plants in remote locations, such as in islands, where shipping
energy from afar is uneconomical. Regional policy may, in such instances, provide additional incentives.
5. Assuming a long-term contract for the sale of electricity can be negotiated, a geothermal plant can be financed by debt,
thus allowing a higher return for equity investors. In such a case, however, the return for the equity investors is not paid
for by the operation of the plant, but by the erosion of the return of debt investors.
But our example plant cannot be reasonably expected to operate in a static world. After all, climate change is expected
to drive upwards the real price of energy. Might not the plant be more profitable, if one factors in the prospect of higher
energy prices in the future? Assuming a growth in the real price of energy produced by the plant grows by 2% per year,
the breakeven cost of the plant falls by 9.4% to 87€/MWhel. So, should investors who believe that the price of energy will
continue rising in the long run invest now? The surprising answer is “no”! 31
Investors seeking a higher return may find it more advantageous to invest in the plant not immediately, but later.
The graph in Figure 2-5 below summarises the choices available to a potential investor in our plant. Clearly, the maximum
profit is not to be earned by investing immediately, but by waiting for about 25 years! The maximum profit is to be earned
by investing after about 25 years.

30 This is a reference plant. The scale of actual plants is closely related to the size of the geothermal resource. For approximately
similar figures from an actual plant, please see the Appendix.
31 Dixit, A.K. & R.S. Pindyck (1994): Investment under Uncertainty Princeton University Press, Princeton, N.J., 1994
Most of the analysis of investment timing under uncertainly in this section draws on the findings of this study. The seminal paper in
this field of economics is: The Value of Waiting to Invest, Robert McDonald; Daniel Siegel, The Quarterly Journal of Economics, Vol.
101, No. 4. (Nov., 1986), pp. 707-728.

28
MAIN BARRIERS in GEOTHERMAL ENERGY PROJECTS NATIONAL INSTRUMENTS 29


Figure 2-5 Investment Timing (Zero Premium)

The prospect of higher energy prices in the future makes investment in energy both more profitable, but, also, more remote!
In an extreme case, if the growth rate rose to a level close to the discount rate, one could hardly expect any investment! The
prospect of growth increases the value of an investment project, but, at the same time, makes it less likely that this same
project will be undertaken immediately.
Suppose, however, that this investor were to be offered a premium for investing now. How would that affect the decision to
invest and how high would that premium have to be?
As one can see in the following graph (Figure 2-6), a premium of 35% of the cost of the plant would bring the optimal time
for investing forward. Maximum profits are to be earned after about “only” 12 years.

Figure 2-6 Investment Timing (35% Premium) Figure 2-7 Investment Timing (67% Premium)
Present Value of funds flows (discount rate = 5%) Present Value of funds flows (discount rate = 5%)


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