This post is republished from the April 2024 installment of our Capacity Factor newsletter. Subscribe here.
The Department of Energy (DOE) released another commercial liftoff report, this time focused on enhanced geothermal energy. While all of their reports are excellent, this one features a wonderful discussion of how the changing grid shapes the price of geothermal energy—with many broader implications for energy finance writ large.
Increased variable renewable energy (VRE) penetration means that utilities are placing a premium on the ability of resources to “peak” in high demand periods. Specific industrial clients are looking for “clean firm” resources to avoid even minor fluctuations in electrical supply, which VRE cannot promise absent a massive expansion of long-term storage, which is in itself imperfect. Thus, the DOE’s report points out that the price of advanced geothermal, which is one of the most dispatchable, firm carbon-free energy resources, is going to be higher even as VREs otherwise bring the marginal price of electricity down because customers will want its “firm” attributes. The economics of advanced geothermal are better in a VRE dominated grid than they would be otherwise.

The DOE’s report draws on another exceptional study by the University of Texas. The study’s authors dove into the comparative economics of the oil and gas sector and the geothermal industry. Both industries face a lot of the same costs and require similar technologies, and workforce. Geothermal should be less risky because its products do not suffer from the same high price volatility as oil and gas. Most electricity is delivered on long term contracts, which means that consumers/offtakers completely absorb price risks. Therefore, before taking into account policy incentives, a private sector investment committee has a hurdle rate of around 15-20% return on equity for an oil and gas project, compared to a 12-15% return for a geothermal project with the same costs and risks.
So why isn’t every oil and gas investor piling into geothermal if it promises both higher returns and lower hurdle rates? The new generation of geothermal energy resources might not be as risky as oil and gas but it is more uncertain by virtue of its novelty. As Keynes pointed out in the General Theory, investors can assign probabilities, and prices, to risk, but not to uncertainty. Measures and perceptions of risk inform how investors distribute capital across their portfolios of investments, but uncertainty determines if investing in a certain asset is even an option. Enhanced geothermal has made leaps but still suffers from high uncertainty related to the deployment of a new technology at scale, environmental risks and regulations, and plant design replicability. This explains why investment into advanced geothermal comes from venture capital, which speculates on degrees of uncertainty, rather than the larger, cheaper pools of debt financing that energy projects usually benefit from.
The IRA has extended tax credits to the geothermal sector, and the LPO is planning to invest as well. This government action might be constituted as “de-risking” the sector for private capital. However, a better way to think about these programs is that they are aimed at familiarizing private investors with a new technology, like advanced geothermal, by rapidly scaling its deployment and identifying the importance of non-financial barriers that create uncertainties for firms. Increased familiarity provides the basis by which risks can be understood and further policies considered. So, in this instance, IRA isn’t just de-risking, but converting uncertainty into risk.