Economics of Deep Geothermal Power Plants and District Heating

  NPV and option values for the example of CHP plant No. 2 (Source: Heuser and Madlener, 2011)

In this research project we evaluate a geothermal heat and power plant from an economic perspective. To this end, we have to identify the most important factors influencing the profitability of such a plant. The valuation itself is done with a real options approach. While the basic real options model developed treats the electricity price as a stochastic variable, an extended version then allows to also incorporating the uncertainty in the heat price. The robustness of the results is checked by means of a sensitivity analysis for various parameters.

The renewable energies used today are mainly solar, wind, hydro, biomass and geothermal. Wind and solar energy in particular are very volatile, so that power production suffers from daily and seasonal fluctuations. In contrast, geothermal power is available constantly, irrespective of the daytime or season. Due to the typically relatively low installed capacity of geothermal plants, as compared to fossil or nuclear power plants, these are mainly suited for the decentralized supply of smaller communities or city quarters. In combination with district heating the operation of such a plant can be profitable even in case of low levels of subsidies (if necessary at all). Also, due to the expected cost increases both for fossil fuels and CO2 permits, in the long run geothermal heat and power plants will become more cost-competitive against conventional heat and power plants (FCN Working Paper No. 21/2011). In Switzerland, for example, after the decision to phase out nuclear power, energy providers envisage to replace four of the existing nuclear power plants until 2050 by geothermal power plants.

In light of new policy instruments for promoting renewables that reduce the investor’s risk markedly, these receive more and more attention, lately also from the side of financial institutions that have come up with positive assessments. A recent study of Deutsche Bank judges geothermal energy to be advantageous both from a business economic and macroeconomic perspective, and estimates that the investment volume over the next twenty years could be up to € 25 billion.

Aside from the advantages of geothermal energy supply mentioned, it also suffers from disadvantages compared to fossil and other renewable energy sources to provide electricity. Whereas for instance photovoltaic systems can be installed turnkey ready, and conventional power plants be planned up to smallest details before construction starts, geothermal plants require large upfront investments that are subject to high financial risk due to resource uncertainties. By means of suitable promotion policy instruments or market-based services, such as insurance coverage, the ‚finding risk’ and thus the related investor’s aversion to invest can be mitigated markedly. Other promotion instruments, such as guaranteed feed-in tariffs or capital grants, are suited to raise the profitability of geothermal heat and power plants significantly.

References

Heuser B., Madlener R. (2011). Geothermal Heat and Power Generation with Binary Plants: A Two-Factor Real Options Analysis, FCN Working Paper No. 21/2011, Institute for Future Energy Consumer Needs and Behavior, RWTH Aachen University, December.