In previous publications we have described the dynamics holding back investment into the enhanced geothermal sector—namely, that the sector’s lack of project finance slows deployment and that lack of deployment, in turn, slows the maturation of the industry required to make it attractive to project finance lenders. Project debt investors search for steady, bond-like cash flows over a long period of time. One of the signals that lenders look for when issuing project finance loans to long-term projects like these is whether the developer has guaranteed a creditworthy source of offtake for their electricity at a price that keeps them solvent. But the inadequacy and small size of the available pool of of offtakers is therefore a “capital bottleneck” for the sector. It is generally accepted that offtake commitment mitigates this portion of an infrastruture project’s risk by guaranteeing that, if a project is completed on time and budget, it will have the necessary cash flow to pay off its debts.
In the energy generation sector, such offtake commitments are secured through power purchase agreements (PPAs)—contracts between a developer and a an offtaker to whom the project guarantees the delivery of a certain amount of power at a pre-agreed price. For the offtaker, signing a PPA with a well established and reliable generation source (especially larger commercial or industrial sites, or even utilities) allows them to avoid the much higher rates they would pay on the spot market for electricity. For the developer, a PPA that is signed before their projects enter operations allows them to secure project financing at a low rate and incentivizes them to offer significant discounts.
However, EGS has very specific features that not only make securing offtake a challenge but, even when offtake is secured, currently serve to constrain the ability of EGS developers to use their PPAs to raise project finance. EGS development requires, first, developers to drill exploratory pilot wells to scope out subterranean heat sources and, second, flow testing in those wells in order to, third, set up “commercial generation pilots to scale up their drilling project in to a power generation project. Heat resource confirmation is uncertain and expensive, preventing developers from finding reliable investors and customers, particularly when customers might prefer energy resources that seem cheaper, quicker to develop, and more scalable. Why would they agree to pre-purchase power from a source that is still exploring its resource availability? This same uncertainty is also why secured PPAs signed by strong, creditworthy offtakers do not necessarily provide developers with cheaper financing from lenders as they might for other, known technologies: lenders simply do not have enough data on comparative project costs to fully understand how to assess the range of risks that might drive such costs up and make the signed PPA prices no longer economically viable.
The uncertainty of first-of-a-kind development means that traditional offtake markets do not help connect new EGS projects to likely commercial and industrial customers, even the ones who might pay a premium to obtain clean firm energy from a comparatively higher-risk source. Turning to utilities is not easy, either. Should a pilot or exploratory-stage project secure partial offtake from several customers that are willing to pay higher prices relative to other technologies for guaranteed access to clean firm power, regulators are hesitant to allocate any remaining portion of high capital costs onto utility ratepayers for the same reason that standalone customers may be hesitant: they don’t want to expose their balance sheets to various project risks, to say nothing of higher costs—to which public utilities commissions are particularly sensitive.
Breaking the project finance bottleneck requires breaking this offtake bottleneck. Policy must spur demand for the electricity output of pilot projects. Creating such demand requires both building a market for EGS power before EGS projects are completed—first, by incentivizing customers with firm power needs to prioritize the procurement of geothermal power, and, second, by furnishing upfront power purchase agreements to eager project developers. State governments, utilities, and grid operators are well-poised to collaborate on both tasks.