(Mid-November 2008)

The global economy might be falling into a black hole, but geothermal executive Gary Thompson is still confident that the deep holes he’s drilling will turn out to be a great investment. Even though investment sources are rapidly drying up and interest in alternative energy seems to be ebbing with the price of oil, executives such as Thompson say that they remain committed to their sector and what they view as its massive long-term potential.

Thompson, a Canadian engineer, has some perspective. Formerly in oil and gas and mining exploration, Thompson has been in the geothermal field for eight years. After trying to raise money and obtain government approvals in Canada, he extended his Vancouver-based company, Sierra Geothermal Power Corp. , into Nevada, where he is currently trying to get a geothermal plant up and running. “We’ve been hit extremely hard in this financial market meltdown,” says Thompson, who is also vice chairman of the board at the Canadian Geothermal Energy Association. “We’ve lost most of our valuation in the past year.”

Still, his company — and six others like it in North America — are continuing their operations. The technology requires expensive drilling (up to five kilometres) to find water that is super-heated by the furnace at the earth’s core. But the start-up costs are massive and the outcomes unpredictable: as a result, geothermal has struggled to secure its place on the alternative energy spectrum, while more popular options, such as wind and solar power, take centre stage.

Thompson, however, remains optimistic. “What’s interesting about this whole meltdown is, it really hasn’t anything to do with what we’re doing,” he says. “The fundamentals of the space have remained very strong.” The term “geothermal” can cause some confusion as it is often used as a catch-all to describe a variety of applications, but two main distinctions are important. “Geoexchange” refers to a type of heating and air conditioning system that uses a basic heat pump to transfer the constant temperature of the earth into a home or other building to heat or cool it. It extends the principle that makes a basement cooler in summer but warmer in winter. According to the Canadian GeoExchange Coalition, more than 41,500 of these systems were installed in Canada by 2006 and the heat-pump market has expanded by almost 40% annually since 2004.

Then, there’s the big gun: geothermal. It refers to much deeper drilling, which allows access to underground temperatures powerful enough to allow for large-scale power generation. Once tapped, such operations are capable of generating a virtually endless supply of clean energy at relatively little cost.

The key phrase here is “once tapped.” The upfront cost of punching a deep hole in the earth’s surface and then collecting the heat, is enormous. And because it makes sense to choose locations where the Earth’s heat is closer to the surface (often near the edge of tectonic plates, such as the west coast of North America) operations can be located in far-flung locations.

Nevertheless, the promise of the field has been enough to fuel several start-ups. Thompson’s Sierra Geothermal Power is one of seven publicly traded companies in North America looking to establish themselves as frontrunners in the area. The four others trading on Canadian stock exchanges are: Vancouver-based Western GeoPower Corp., Nevada Geothermal Power Inc. and U.S. Geothermal Inc., all of which have projects in the U.S. Toronto-based Polaris Geothermal Inc. is developing a site in Nicaragua that is currently up and producing 8.5 megawatts (with a projected output of 72 MW by 2010) and is producing an EBITDA of $2 million (projected to reach $45 million by 2010). Western is the only firm with a project in Canada, in the South Meager area of Northern British Columbia, which is expected to begin producing power in 2011.

Proponents of the technology point to the relatively small environmental footprint it leaves behind. Another key plus that differentiates geothermal from its more popular rivals, wind or solar, is that the power produced from these sources is constant. Facilities can run at more than 90% capacity — as opposed to relying on fluctuations of sun or wind — which means they can provide a steady, or “base load” source of power.

@page_break@Currently, about 9,000 megawatts of power is produced in 20 countries worldwide using geothermal technology. Countries ranging from Nicaragua to Iceland to Australia have geothermal capacity, but the U.S. leads the charge, producing approximately one-third of the total power, mainly in California and Nevada. And here in Canada? None.

But as the realities of climate change enter mainstream consciousness, interest in clean renewable sources of electricity is ramping up. And, of course, when oil topped $140 a barrel, alternatives became more attractive. But geothermal still sat under the radar for many investors. Why?

Ian Tharp, senior analyst of cleantech and renewable energy with Toronto-based Dundee Capital Markets and one of the authors of a recent report on geothermal by Dundee, said he wrote the “primer” because he received so many calls and requests for more information from people who just couldn’t find it elsewhere. According to Tharp’s research: “A significant opportunity is currently available to investors who participate in the advancement of the geothermal industry.”

But, of course, there are risks. “The unfortunate thing in today’s environment is that the equity returns do rely on a certain portion of leverage on these projects,” says Tharp. “People will leverage between 60% and 80% and the concern right now is, if the credit markets dry up considerably, then they will not even consider these projects, let alone attach a higher cost of capital to them.”

Thompson says drilling costs are 30%-40% of the overall price of a project and that, because exploratory drilling is often done without a power contract and without a proven resource, it’s risky. “You ask, ‘Well if geothermal is so great, why aren’t there more of these things?’ It’s because the early drilling costs are very expensive and it’s high risk money at work,” he says. “The No. 1 challenge for geothermal power development is drilling.”

Then, there are the regulatory hurdles. Canada has next to no rules specific to geothermal drilling, which makes securing land for drilling very difficult. “There needs to be policy,” says Thompson. “There is no governing policy that will allow someone to get a lease.”

B.C. is the only province that has a geothermal legislation, but it falls under the umbrella of the Ministry of Energy, Mines and Petroleum Resources, which, according to Thompson, doesn’t fit the geothermal scheme. Sierra, for example, did manage to acquire a lease in Canada in 2002, but getting permits for work proved difficult and raising money was tough without a wide understanding about the technology. “After a few years of beating our heads against the wall, we [Sierra] went stateside and started looking at projects there.”

But Tharp believes there are some useful public incentives. Geothermal falls under the federal ecoENERGY for Renewable Power program, which provides production credits for renewable energy projects in Canada. In addition, the Canadian Renewable and Conservation Expense measure of the Income Tax Act allows for flow- through share agreements on eligible expenses for investors.

“They’re pretty powerful incentives, in my view,” says Tharp. But “in the case of geothermal, most of the capital costs are not eligible under CRCE.”

As oil prices remain uncertain and concerns over energy security grow, the call for renewable sources will likely build. “The real value in these projects comes in year 10, 15, 20, 30, 40, 50 and beyond,” says Thompson. “It’s a matter of changing people’s investment profile.” IE