geothermal power
Explore different approaches to developing geothermal to accelerate the development cycle, mitigate early risk, and lower tariffs.

The role of geothermal energy in the power mix for East Africa is a topic of on-going discussion among government officials, donors, and developers. As a base load, renewable resource, geothermal is quite attractive for countries with high renewable targets, or that are looking to hedge against volatility in oil and gas markets, or replace unreliable or expensive base load power.

On the other hand, the high upfront costs, limited ability to de-risk the resource without significant capital deployment, and the long development cycle pose significant challenges to the viability of geothermal as a significant source of energy in East Africa where downward pressure on tariffs is in conflict with required returns from developers. As such, the geothermal community in East Africa continues to explore different approaches to developing geothermal to accelerate the development cycle, mitigate early risk, and lower tariffs.

What is geothermal?

Geothermal power development involves drilling into the ground to find either steam or hot water at sufficient temperatures and flow rates to power a turbine when it is brought to the surface. The process of determining the location and character of these reservoirs involves surface and subsurface surveys and exploration, and ultimately drilling. Until wells are drilled into the reservoir, a developer does not know if the resource is ‘commercial’ (i.e. can produce sufficient megawatts to be profitable at a given tariff rate). This means significant capital must be spent while significant risk remains in the project.

Pros and cons of geothermal

Despite the risk, geothermal has many potential benefits, including:

  • It is base load, renewable energy with 95%+ capacity factor
  • No volatility in price of fuel source It has low operating and maintenance costs
  • It has a smaller footprint than most other forms of energy
  • Its levelised cost of energy is comparable to wind and lower than solar PV, nuclear, and biomass
  • Low emissions
  • Established technology

Unique risks for geothermal

Geothermal is unique among energy sources in that the fuel source (steam or hot water) must be extracted from the ground, and – unlike oil, gas, or coal – is not portable, so plants must be located at the site of the resource.

This adds to the complexity and therefore risk project. Because of the high levels of risk in the early stages of the development process, there is little or no capital available in the exploration phase. This presents a challenge for cash-strapped private developers, or for governments with competing budget priorities.

What is the best approach to develop geothermal?

The focus of much of the discussion around geothermal in East Africa has been on the right approach or ‘business model’ for developing geothermal. To-date, the majority of the development in East Africa has been carried out by the public sector (KenGen developing nearly 600MW at Olkaria), with the private sector (Ormat) accounting for the other operating plant (also at Olkaria).

Kenya, Ethiopia, and other countries in East Africa have been looking toward public-private partnership models with the public sector leading the early stage development to de-risk the resource and avoid the high tariffs required by the private sector to meet their return requirements. The most advanced of these is at Menengai, where the Kenyan Geothermal Development Company has developed the steamfield at Menengai and awarded the EPC tender to three independent power producers (IPPs).

The project has faced headwinds, however, for a number of technical, contractual, and financing issues.

Throughout the world, the most common models for developing geothermal are either fully public (government-led), or fully private development. As Graph 1 on “Geothermal generation by business model” shows [Source: author database of global geothermal resources], the private sector leads the way in terms of number of plants developed (nearly 70), while the public sector leads in terms of MW brought online (~5,000). Public private partnerships (in this case, any project involving a mix of public and private development) accounts for only around 15% of development in terms of both MW and plants.

Why is this scenario the case?

There are any number of reasons why geothermal tends to be developed entirely by either the public or the private sector. In the case of the former, the public sector may have the capital (either through its own funds or through donor funding) and human resources, the policy and regulatory mandate, and the lack of return requirement necessary to carry out high risk development while maintaining low tariffs. Furthermore, in cases where the public sector leads geothermal development, there is often a very strong mandate from the government to protect the indigenous resources of the country for economic, spiritual, or sovereignty reasons. New Zealand, Mexico, and Japan are clear examples where this has been the case.

For private sector-led development, a number of factors need to be in place:

  • IPPs must have access to capital (either through their own balance sheets or investors) in the early stages of the project, followed by debt financing as the resource is proven and the power plant is ready to construct.
  • The tariff regime (PPA prices) must be sufficiently high for the project to achieve a reasonable return.
  • The policy and regulatory environment must be clear so as to avoid project delays and costs.
  • The off-taker must be creditworthy (or backed by sovereign or donor guarantees).

For a model involving both the public and private sector, some or all of the requirements listed for each model above must be in place. In addition, there must be a robust licensing and contracting process to delineate responsibilities, ring fence risk, and other safeguards to make the project bankable.

So what is the path forward?

While geothermal development has largely been an either/or for public or private sector-led development, it is possible that other models may be viable in Africa. From a public sector perspective, the priority is on accelerating geothermal development at the lowest cost possible. For the private sector, the priority is on managing the risk and cost such that a project can be developed and financed profitably in the prevailing tariff regime.

The presence of donor financing, grants, tax or depreciation benefits, drilling insurance, or other incentives can be used to accelerate the development of geothermal.

The KfW and DFID-sponsored Geothermal Risk Mitigation Fund is a step in the right direction, as is the drilling risk insurance product offered by MunichRe. Power Africa is looking to develop a risk mitigation facility to address the financing gap remaining between exploration drilling and project finance. These financial tools will offset financial risk for the private sector, which will hopefully bring more developers into the region, while alleviating upward pressure on geothermal tariffs.

Governments and donors are also taking the approach of ‘de-risking’ resources through taking on some of the exploration risk themselves. Kenya and Ethiopia in particular are carrying out donor-financed exploration drilling at a number of resources with the intent to tender them after the resources are proven.

In spite of these financial and technical tools, geothermal development in East Africa (outside of Kenya) has been very slow to progress due to suboptimal policy, regulatory, and tariff environments that cause delays and confusion among developers, donors, and the governments themselves.

The news is not all bad, however. There are several intrepid developers active in the region, and donors and governments are forging ahead and developing projects. Their ability to successfully develop geothermal will shape the future of the base load resource in East Africa. Continued development of risk mitigation mechanisms and improvements to enabling environments will be critical to their success