Opportunities geothermal energy in Germany

This article was originally published in Infra News.

About ten years ago, geothermal energy was the new hope for climate change. The possibilities offered by this energy source seemed perfect: it was inexhaustible, not dependent on wind or weather, operational by day and night and capable of contributing to the production of base load power requirements. Geothermal energy was designated the hidden champion among the energy sources of the future.

Yet, the first setbacks had a sobering effect and exploration risk in particular made investors hesitant. Exploration risk is the risk of carrying out costly drilling at the location but not finding sufficient quantities of thermal water or the required subsoil temperatures for the economic implementation of a project. Along with the technical challenges, exploration risk is one of the main reasons why relatively few geothermal energy projects have been implemented in Germany to date.

Germany is, however, experiencing a renaissance of geothermal projects due to a stable regulatory framework, a more advanced level of technical expertise, as well as the increasing ability to insure the associated risks.

We take a look at the German market for geothermal projects and consider the risks and rewards available.

Currently, 34 geothermal energy plants are in operation in Germany, of which 25 produce heat, four produce electricity and five are combined geothermal power plants providing both heat and electricity. In total, the plants produce 301.96 MW heat output and 41.99 MW electricity output. According to the German Geothermal Association (Bundesverband Geothermie), the leading industry association for geothermal technology in Germany, approximately 30 further plants are currently being planned or constructed.

Most geothermal energy projects are located in southern Bavaria, as the Molasse basin (a foreland basin north of the Alps) offers very favourable geotechnical conditions for the economic exploitation of geothermal energy. The largest projects to date were developed in Unterhaching and Oberhaching/Grünwald. Other potential geothermal locations in Germany suitable for electricity production are located in the Rhine valley and in the North German basin.

From an economic point of view, geothermal energy projects are especially attractive where the plants produce both heat and electricity. Securing long-term contracts for the supply of heat to consumers is the most important factor for a project to be economically viable. Generally, either a local partner of the heating network or a bulk purchaser, such as public or municipal utilities or large industrial consumers, is required to ensure the project is financially viable and in each case, appropriate forms of cooperation with these off-takers must be agreed. Besides its technical capabilities, such local player can also grant support in dealing with potential opposition from the public.

Alternatively, it may be possible to implement a compulsory connection and use obligation (Anschluss- und Benutzungszwang) with regard to the consumer target group.; If permitted by the law of the relevant state, such concept allows the municipalities to require that all consumers in a specific area connect to and use the heating grid.

The German Renewable Energy Sources Act (EEG) offers a stable and transparent support scheme for electricity generation using geothermal resources. Under the EEG, the feed-in tariff for electricity generated by geothermal energy amounts to 25.20 cents per kilowatt hour. The tariff is paid for twenty years in addition to the year in which operation of the plant began. For projects commissioned from 2021 onwards, this amount will be reduced annually by 5 per cent, however, once the plant is operational, the applicable feed-in tariff is stable during the payment period of 20 years . Unlike wind energy and photovoltaic plants, the tariff will not be determined by auctions introduced by the new EEG 2017 but funding will continue to be effected through a fixed tariff and sales of geothermal electricity in conjunction with the market premium. In combination with the cost roll-over mechanism for the EEG surcharge, the support scheme for geothermal energy results in a cash follow risk structure very similar to a risk profile of a directly state-backed payment mechanism.

Importantly, the German regulation offers investment reliability. While there are no signs that the feed-in tariff for geothermal energy could be reduced in the near future, the past changes to the EEG for other renewable energy sources have to date always comprised grandfathering provisions as well as sufficient transition periods.

Potential investors must also consider regulations concerning mining, water and water management, construction planning and building, as well as regional development and natural conservation regulations. Relevant approvals and permissions must be applied for and regulatory inspection procedures must be passed. Due to the existence of different approval procedures with various regional authorities, investors and their advisers not only need to show comprehensive legal expertise in the entire regulatory environment (including European and antitrust matters) but also ensure the right timing and approach to the diverse regulatory decision-making processes.

The approval procedure comprises two main levels: the exploitation approval, which entitles the holder of the approval to investigate the site resources, and the mining approval, granting the right to extract the natural resource. The total time required from identifying the location to erecting the plant and grid connection is approximately five years.

Approval is usually granted for 50 years. During the operation of the plant, operational plans agreed with the relevant authority must be followed. In this respect, a rather technology-friendly licensing practice has evolved especially in southern Bavaria.

Attractive investment opportunities and successful funding

Source: Bundesverband Geothermie, dated: November 2016

According to different estimates, the geothermal technical potential for electricity generation is approximately 15 to 132 terawatt hours per year (TWh/a), not including the production of heat in combination. Currently, electricity generation only amounts to 0.1 TWh/a and combined electricity and heat generation to less than 1 TWh/a.

To date, geothermal energy remains a niche market, although a highly promising one. Due to the increase in project experience over the last few years, geothermal energy can be considered as a ‘proven technology’ from a bank and investor perspective. Experts from the German Geothermal Association predict that with the further development of geothermal energy, increased cost savings can be expected due to savings on drilling and construction costs.

In light of the declining returns seen for other renewable energy assets, the expected project returns for geothermal heat supply seem rather attractive by comparison.

Electricity generation projects which are eligible for EEG funding and at the same time benefit from a secure buyer’s market for the generated heat are especially attractive. Through long-term supply contracts or local compulsory connection and use obligations, it is possible commit bind consumers in the long-term, which again might have positive consequences for the projects’ risk assessment.

Overview: Selected geothermal projects for thermal and electricity output

One of the major advantages of geothermal energy is that it does not depend on weather conditions, seasons or time of day and therefore constitutes an innovative energy source for securing base load supply in the long term. It is also a proven technology. Technological development and a growing level of experience minimize the economic risk for investors. Initial setbacks have eventually led to a better understanding of the geothermal resource in Germany today so that professional investors and project partners can assess and manage potential risks much better.

Another benefit is that Germany offers a stable regulatory regime and transparent market. Public funding of geothermal energy in Germany guarantees a fixed feed-in tariff over 20 years for electricity production and offers an attractive risk/return profile. Returns offered by other renewable energies are slimmer due to the large number of investors and ambitious sellers’ expectations. The implementation of a compulsory connection and use obligation or the conclusion of long-term supply contracts may assist in the mitigation of project risks whilst project returns can be substantially higher than in other renewable energy investments.

Initial investments (exploration, drilling and site development) are not eligible for project financing and thus have to be funded with equity or mezzanine capital. An increasing number of insurers are offering solutions for securing early development risks, which in turn makes the major economic risks more manageable. In some cases, drilling companies are also willing to bear part of the risk. In addition to the criteria already detailed above, institutional investors and banks request the involvement of experienced partners both for the construction and operation of the geothermal plants.