-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-629		

TITLE:     Renewable Energy: Increased Geothermal Development 
Will Depend on Overcoming Many Challenges

DATE:   05/24/2006 
				                                                                         
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GAO-06-629

     

     * Report to the Ranking Minority Member, Committee on Energy and Natural
       Resources, U.S. Senate
          * May 2006
     * RENEWABLE ENERGY
          * Increased Geothermal Development Will Depend on Overcoming Many
            Challenges
     * Contents
          * Results in Brief
          * Background
          * Current Geothermal Development Is Limited, and Estimated
            Potential for Additional Development Varies
               * Electricity Generation from Geothermal Resources Is Small
                 and Relies on Federal Resources
               * Estimates of the Potential for Additional Electricity
                 Generation from Geothermal Resources Vary Widely
               * Direct Use Applications Are Numerous and Diverse, and Few
                 Are Located on Federal Land
               * The Potential for Developing Additional Direct Use Is
                 Uncertain
               * Geothermal Heat Pumps Show Increasing Use
          * Geothermal Development Faces Many Challenges
               * Geothermal Power Plants Face High Risk, Financial
                 Uncertainty, and Technological Impediments
               * Lack of Adequate Electrical Transmission Hinders Geothermal
                 Development
               * Geothermal Power Plants on Federal Lands Face Delays in
                 Processing Applications, Fragmented Lease Holdings, and a
                 Complex Royalty System
               * Direct Uses of Geothermal Resources Face Business
                 Challenges, Remote Locations, Water Rights, and Royalty
                 Issues
          * Efforts by Federal, State, and Local Governments to Address
            Challenges Show Promise
               * Financial Incentives Are Used to Address the High Risk and
                 Uncertainty of Geothermal Development
               * Federal and State Grants Are Addressing Technology
                 Challenges
               * Expanded FERC Authority and Planning Initiatives Are Aimed
                 at Transmission Challenges
               * Provisions within the Energy Policy Act and BLM Planning
                 Efforts May Address Leasing and Royalty Issues
          * Geothermal Royalty Disbursements Will Change Significantly, and
            Changes in Electricity Prices Could Alter Total Royalty
            Collections
               * The Energy Policy Act Redistributes a Greater Portion of
                 Federal Royalties
               * Provisions of the Energy Policy Act Are Likely to Have
                 Little Impact on Overall Royalty Revenues Only if
                 Electricity Prices Remain Relatively Constant
               * MMS Does Not Routinely Collect the Royalty Data Necessary to
                 Maintain the Same Level of Royalty Collections
          * Conclusions
          * Recommendation for Executive Action
          * Agency Comments and Our Evaluation
     * Objectives, Scope, and Methodology
     * Comments from the Department of the Interior
     * GAO Contact and Staff Acknowledgments
     * PDF6-Ordering Information.pdf
          * Order by Mail or Phone
     * appendix1.pdf
          * Objectives, Scope, and Methodology

Report to the Ranking Minority Member, Committee on Energy and Natural
Resources, U.S. Senate

May 2006

RENEWABLE ENERGY

Increased Geothermal Development Will Depend on Overcoming Many Challenges

Contents

Tables

Figures

May 24, 2006Letter

The Honorable Jeff Bingaman Ranking Minority Member Committee on Energy
and Natural Resources United States Senate

Dear Senator Bingaman:

American families and businesses rely heavily on electricity and natural
gas to heat and light homes and buildings, to power appliances, to
manufacture goods, and to supply services. Increasing demand and rising
prices for electricity and natural gas have increased interest in
alternative forms of energy, including geothermal energy. Geothermal
energy is a unique type of renewable resource in that it can provide power
that is independent of weather and climate, thereby enabling a consistent
and uninterrupted supply of heat and electricity. Geothermal energy also
creates fewer environmental impacts than the production of natural gas and
other conventional fossil fuels that are used to generate electricity.
Because many areas that have the potential to produce additional
geothermal energy are located on federal lands, the federal government is
a major participant in the future development of geothermal energy.

Geothermal energy is literally the heat of the earth. This heat is
abnormally high where hot and molten rocks exist at shallow depths below
the earth's surface. Water, brines, and steam circulating within these hot
rocks are collectively referred to as geothermal resources. Geothermal
resources often rise to the surface naturally along fractures to form hot
springs, geysers, and fumaroles. For centuries, people have used naturally
occurring hot springs as places to bathe, swim, and relax. More recently,
some individuals have constructed buildings over these springs,
transforming them into elaborate spas and resorts, thereby establishing
the first direct use of geothermal resources for business purposes.
Businesses have also established other direct uses of geothermal resources
by drilling wells into the earth to tap the hot water for heating
buildings, drying food, raising fish, and growing plants. Where the
earth's temperature is not high enough to supply businesses with
geothermal resources for direct use, people have made use of the ground's
heat by installing geothermal heat pumps. Geothermal heat pumps consist of
a heat exchanger and a loop of pipe extending into the ground to draw on
the relatively constant temperature there for heat in the winter and air
conditioning in the summer.

Geothermal resources can also generate electricity, and this is their most
economically valuable use today. Only the highest temperature geothermal
resources, generally above 200 degrees Fahrenheit, are suitable for
electricity generation. When companies are satisfied that sufficient
quantities of geothermal resources are present below the surface at a
specific location, they will drill wells to bring the geothermal fluids
and steam to the surface. Upon reaching the surface, steam separates from
the fluids as their pressure drops, and the steam is used to spin the
blades of a turbine that generates electricity. The electricity is then
sold to utilities in a manner similar to sales of electricity generated by
hydroelectric, coal-fired, and gas-fired power plants.

Geothermal resources are found throughout the world. In the United States,
geothermal resources are concentrated in Alaska, Hawaii, and the western
half of the country, primarily on public lands managed by the Bureau of
Land Management (BLM). The Congress set forth procedures in the Geothermal
Steam Act of 1970 for leasing these public lands, developing the
geothermal resources, and collecting federal royalties. Today, BLM leases
these lands and sets the royalty rate, and the Minerals Management Service
(MMS)-another agency within the Department of the Interior (DOI)-collects
the federal geothermal royalties and disburses to the state governments
its share of these royalties as required by law.1 In 2005, the most recent
year for which data are available, MMS collected $12.3 million in
geothermal royalties, almost all of which was derived from the production
of electricity.

Since 1970, determining the amount of royalty payments has become
increasingly complex due to restructuring in the geothermal industry and
changing economic conditions. Government and industry representatives
formed a task force in late 2004 to devise a simpler royalty system that
would address these changes. During deliberations on the Energy Policy Act
of 2005 (Act), we briefed you on the findings of this task force and on
challenges facing geothermal development. Shortly thereafter, the Congress
passed the Act, which contains provisions to simplify the federal
royalties on electricity generation and reduce royalties on direct use.
The Act also contains other provisions designed to encourage the
development of geothermal resources. This report formalizes the content of
our briefings and our work since then, including: (1) the current extent
of and potential for geothermal development; (2) challenges faced by
developers of geothermal resources; (3) federal, state, and local
government actions to address these challenges; and (4) how provisions of
the Act are likely to affect federal geothermal royalty disbursements and
collections.

In responding to these objectives, we reviewed key studies on the extent
and potential of geothermal development and interviewed BLM and industry
officials in California, Nevada, and Utah. To identify the challenges
facing geothermal developers and to assess actions taken by federal,
state, and local governments, we interviewed a variety of government and
industry officials, reviewed substantial supporting documentation and the
Act, and toured geothermal electricity plants in California and Nevada and
direct use facilities in Idaho, Nevada, and Oregon. To assess how
provisions within the Act will affect federal geothermal royalties, we
interviewed MMS and BLM employees; reviewed a report authored by the
Royalty Policy Committee;2 and analyzed geothermal royalty, production,
and sales data from January 2000 through December 2004. We performed our
work between May 2005 and May 2006 in accordance with generally accepted
government auditing standards. A more detailed description of our
objectives, scope, and methodology is provided in appendix I.

Results in Brief

Although locally important in Hawaii, California, and Nevada, geothermal
resources produce a very small portion of our nation's total electricity
and heating needs, and estimates of the potential for additional
development vary. In 2004, geothermal resources generated about 0.3
percent of the nation's total electricity and supplied heat and hot water
directly to about 2,300 businesses and organizations, including district
heating systems, fish farms, greenhouses, food drying plants, spas, and
resorts. In addition, the Geothermal Heat Pump Consortium estimates that 1
million geothermal heat pumps are installed in the 50 states, tapping the
shallow heat of the earth to both heat and cool individual homes and
businesses. Estimates of future electricity generation from geothermal
resources vary widely based on methodology, sites considered, development
costs, and future electricity prices. The most recent assessments suggest
that the current production of 2,500 megawatts of electricity-enough to
supply 2.5 million homes-could increase to between about 3,100 and 12,000
megawatts in 11 years. The future potential of using geothermal resources
in direct use applications is less known because of the wide variety of
applications and the widespread occurrence of suitable geothermal
resources. However, the Geo-Heat Center at the Oregon Institute of
Technology estimates that about 400 undeveloped geothermal wells and hot
springs have the potential to supply heat and hot water directly to a
variety of businesses and other organizations. The potential for
geothermal heat pumps, however, is almost unlimited in the United States.
Heat pumps are the fastest growing sector of the geothermal industry, with
about an 11 percent increase in units added each year. Finally, the
potential for geothermal development is, to some extent, dependent on the
federal government. Whereas nearly all direct use applications of
geothermal resources are on private lands, geothermal power plants depend
upon resources located on federal lands for about 50 percent of the
electricity they generate.

Businesses and individuals face significant financial, technical, and
logistical challenges when trying to develop geothermal resources.
Developers of electric power plants that use geothermal resources face a
capital intensive and risky business environment in which obtaining
financing and securing a contract with a utility are difficult and where
recouping the initial investment takes many years. Geothermal power plant
developers must also use exploration and drilling technologies that are
inadequate because of the unique attributes and high temperatures
associated with geothermal reservoirs. Furthermore, because portions of
the electrical grid lack adequate transmission capacity and because
geothermal resources are often in remote locations, new geothermal power
plants may face costly transmission expenses. Developers of electric power
plants on federal lands face additional challenges, including: (1) lengthy
administrative/regulatory reviews of lease and permit applications that
can become complicated by lawsuits involving environmental and/or Native
American issues, (2) scattered federal leases that make it difficult to
develop an economically viable project, and (3) a complicated royalty
payment system. Businesses and individuals trying to tap geothermal
resources for direct use face unique marketing, financing, and technical
challenges characteristic of their industry, as well as challenges that
are unique to the site that they hope to develop. In some cases, these
businesses and individuals must also contend with remote locations and
state water rights that may restrict the use of geothermal resources. In
addition, the developers of direct use facilities face higher federal
royalties because royalty payments are based on the price of natural gas,
which has recently risen to levels that substantially reduce profit
margins.

To address the many challenges of developing geothermal resources,
federal, state, and local governments have implemented a number of
incentives and initiatives, including tax credits, technology grants,
requirements to use renewable energy, and leasing and royalty
simplification. Many of these efforts show promise, but it is too early to
assess their overall effectiveness. To address the capital intensive and
risky business environment facing the developers of geothermal power
plants, the Act grants developers a federal tax credit that allows them to
recoup their investments more quickly. The Act also seeks to lower
exploration risk by directing that the Secretary of the Interior update
the U.S. Geological Survey's 1978 assessment of geothermal resources. Some
state governments are addressing the capital intensive and risky business
nature of geothermal development by granting various tax credits for the
production of electricity from renewable energy and for the construction
of renewable energy facilities and systems. Twenty-two states and the
District of Columbia have further encouraged the production of electricity
from renewable resources with laws or policies containing renewable
portfolio standards. Most of these standards mandate that public utilities
provide a minimum percentage of their electricity from renewable energy
such as geothermal resources. To address technological challenges, the
federal government and the state of California have awarded grants for
research and development efforts through the Department of Energy's
Geothermal Technologies Program and the California Energy Commission,
respectively. To address transmission challenges, the Act gives the
Federal Energy Regulatory Commission (FERC) new authorities to issue
permits for transmission facilities in the national interest, increase
their capacity, and develop incentives. Some states and local governments
have also developed several planning initiatives aimed at transmission
challenges. Finally, the Act contains provisions designed to improve the
efficiency of the federal geothermal program, including simplifying the
federal leasing process, improving coordination between leasing
responsibilities of BLM and the Forest Service, consolidating small
federal leases, and simplifying or reducing federal royalty rates on
electricity generation and direct use facilities.

How federal geothermal royalties are to be shared with local governments
will change significantly after passage of the Act, and the total amount
of royalties collected could change significantly if electricity prices
also change. Prior to passage of the Act, half of federal geothermal
royalties were disbursed to the states, and half were retained by the
federal government. Now, half of the federal government's share will be
disbursed to the counties in which the geothermal resources are located,
leaving the federal government with 25 percent of the total royalty
revenue, instead of the original 50 percent. While, for most leases, the
Act directs that the Secretary of the Interior seek to maintain the same
level of royalty revenues as before the Act, our analysis suggests that
this will be difficult because changing electricity prices could
significantly affect the percentage of royalty revenues collected in the
future. Furthermore, it will be difficult for MMS to show that it plans to
collect the same level of royalty revenues from electricity generation
because it does not routinely collect revenue data from electricity sales,
and these data are necessary to calculate and achieve the royalty
percentages prescribed in the Act. Finally, while a provision within the
Act lowers the royalties on direct use applications in order to encourage
additional development, the monetary impact on collections is likely to be
small because total royalty revenues from direct use applications on
federal lands are already minimal.

To demonstrate their attempt to collect the same level of royalty revenues
as prior to passage of the Act, we are recommending that the Secretary of
the Interior instruct the appropriate managers within MMS to routinely
collect future sales revenues for electricity when royalty payments are
due.

Background

The temperature of geothermal resources generally dictates their use. Low
temperatures from 40 to 70 degrees Fahrenheit (F) that occur in the ground
at shallow depths are best used for geothermal heat pumps. Geothermal heat
pumps, also known as ground-source heat pumps, are devices that take
advantage of the relatively constant temperature immediately beneath the
earth's surface to provide heat in the winter and air conditioning in the
summer. During the winter, a heat pump transfers the heat of the ground to
a fluid filled set of coils and then pumps this fluid to the building. A
heat exchanger then transfers the heat to another set of coils filled with
a refrigerant that boils. The resulting gas is then compressed and pumped
to a condenser, where it gives up its heat as a fan blows over the
condenser coils. During the summer, heat pumps work in reverse, extracting
heat from the building and transferring it to the ground. Although heat
pumps run on electricity, they produce three to four times the energy that
they consume. As a result, they can reduce energy consumption by 20 to 70
percent relative to conventional electrical heating and cooling systems.
They also can produce hot water for free during the summer and for about
half price during the winter.

Direct use applications begin with geothermal resources that have
temperatures as low as 70 degrees F and can include geothermal resources
as hot as 300 degrees F. Geothermal waters can be mixed with groundwater
or surface water to achieve the most desirable temperature for the
specific application. Geothermal waters with temperatures between about 70
and 125 degrees F are best used in spas and resorts for recreational
swimming and bathing, in aquaculture operations for raising fish and other
aquatic animals (fig. 1), and within sidewalks and roads for melting snow.
Geothermal resources between about 125 and 300 degrees F can be used for
various applications, each of which has optimal temperature ranges.
Specific applications include food processing; fruit and vegetable drying;
space and district heating; raising flowers, plants, and trees in
greenhouses; processing pulp and paper; drying lumber, cement, and
aggregate; curing concrete blocks; pasteurizing milk; dyeing fabric;
making ice; and providing refrigeration.

Figure 1: Tropical Fish Raised in Oregon with Geothermal Water

Electricity generation requires geothermal resources of at least 200
degrees F, with higher generation capacity coming from temperatures above
350 degrees F. Geothermal power plants extract geothermal fluids-hot
water, brines, and steam-from the earth by drilling wells to depths of up
to 10,000 feet (fig. 2). The geothermal resources are then used, in lieu
of running water or the burning of fossil fuels, to produce a vapor that
turns the blades of a turbine that spins a generator to produce
electricity. Geothermal resources with temperatures from about 200 to 350
degrees F are best suited for binary power plants. In a binary plant, the
geothermal fluids are passed through a heat exchanger to heat a secondary
fluid, like isopentane, that vaporizes at a lower temperature than water
and spins the power-producing turbines. The fluid is then condensed back
into a gas and recycled, and the geothermal resources are injected back
into the reservoir. When geothermal resources have temperatures over about
350 degrees F, flash plants are most appropriate. In flash power plants,
highly pressurized hot water is brought to the surface, where the pressure
decreases and part of the water explosively boils, or "flashes," into
steam. The steam is then separated from the remaining hot water and used
to turn the turbines. Residual water is injected back into the reservoir.
In some rare geothermal systems with temperatures above 455 degrees F, as
at an area known as The Geysers Geothermal Field (The Geysers) in northern
California, the geothermal resources may consist entirely of steam within
the reservoir. Dry steam power plants use the steam directly to spin the
turbines. Although some of the steam condenses back to water that can be
injected back into the reservoir, much water is lost to evaporation in
this process. Flash and binary power plants can also be combined in
sequence for the most efficient generation of electricity. In these hybrid
power plants, hot water is first flashed within a flash plant and then the
steam is condensed, combined with the lower temperature water, and routed
to a binary plant for further generation of electricity.

Figure 2: Geothermal Power Plant near Reno, Nevada

The leasing of federal lands for geothermal resources is governed by the
Geothermal Steam Act of 1970, as amended.3 To explore and develop
geothermal resources on federal lands, developers must first obtain a
federal lease from BLM. The lease is a contract between the federal
government and the lessee that specifies certain terms for development and
payment of rents and royalties. Regardless of the federal agency managing
the lands where the geothermal resources are located, BLM has
responsibility for issuing these leases after obtaining concurrence from
the federal land managing agency. Before passage of the Act, BLM
designated certain areas that it believed to have a reasonable potential
for the commercial development of geothermal resources as "known
geothermal resource areas (KGRA)." Within a KGRA, BLM was required to
lease lands to the highest qualified bidder under a formal competitive
bidding process, as long as the highest bid equaled or exceeded fair
market value.4 For land outside of a KGRA, BLM was required to issue a
lease noncompetitively to the first qualified buyer applying for the
lease. Under provisions of the Act, BLM no longer establishes KRGAs, but
instead accepts nominations from parties interested in leasing available
lands and holds a competitive auction at least once every 2 years. If bids
are not received for lands offered in the sale, the Secretary is to make
them available for 2 years for noncompetitive leasing. BLM issues
geothermal leases for 10 years and requires lessees to pay an annual
rental of at least $1 per acre until commercial production is established.
Thereafter, lessees pay a royalty from 10 to 15 percent of the value of
production.

BLM will not issue federal geothermal leases until the federal land
management agency completes an extensive environmental review process. The
leasing and development of these lands must be consistent with the
management objectives for the lands as documented in the appropriate
resource or forest management plan. Should these plans not adequately
address exploration and development of geothermal resources, the
appropriate agency personnel may need to amend or rewrite the plans. Prior
to leasing, agency officials must also comply with provisions of the
National Environmental Policy Act of 1969, as amended (NEPA). NEPA
requires federal agencies to prepare an environmental impact statement
(EIS) for major federal actions that may have a significant affect on the
quality of the human environment. When an agency is not sure whether an
activity will have significant impact on the environment, the agency
prepares a less detailed environmental assessment (EA). If an EA
determines that the activity will significantly affect the environment,
the agency then prepares an EIS. During these analyses, agency personnel
analyze potential impacts of geothermal leasing to various resources such
as air and water quality, vegetation, wildlife, threatened and endangered
species, and visual and cultural resources. In California, state laws also
require a similar environmental review. Agency personnel may also need to
comply with provisions of other federal legislation, such as the
Endangered Species Act of 1973, as amended, and the National Historic
Preservation Act, as amended.

Under the Geothermal Steam Act of 1970, as amended, calculating geothermal
royalties was relatively simple because the developers of the geothermal
fields sold steam and hot water to power plants, establishing a sales
price upon which royalties could be based. The statutory royalty rate
specified in the lease, which was from 10 to 15 percent, was multiplied by
the sales value of the geothermal resource each month to yield royalties
due. In the 1980s, the developers sold the fields to the power plants, and
this basis for valuing the geothermal resource was lost. In 1991, MMS
issued new regulations that were in effect until passage of the Act. These
regulations established the value of the geothermal resource based on the
value of the electricity sold. The regulations called for subtracting, or
"netting back" from the electricity's sales revenues, the costs of
generation and transmission. Formulas for netting back these costs were
complex due to different methods of accounting for depreciation,
uncertainty over which costs qualified for deduction, and commingling of
federal and nonfederal resources. The Act contains provisions aimed at
simplifying this process by allowing lessees the option on existing leases
to pay royalties based on a percentage of gross sales revenue and by
prescribing a set schedule of royalty rates for future leases. In
addition, royalties due on direct use facilities prior to passage of the
Act were based on the price of natural gas, which has risen substantially
in recent years, making the direct use of federal geothermal resources
unattractive. The Act provides for replacing this system of direct use
royalties with a schedule of fees that encourages the development of
geothermal resources.

Current Geothermal Development Is Limited, and Estimated Potential for
Additional Development Varies

Electricity generated from geothermal resources is small, about 0.3
percent of the total electricity produced in the United States, with about
half of this amount coming from federal resources. Recent estimates of the
potential for additional electricity generated from geothermal resources
vary from an increase of about 25 percent by 2015 to 367 percent by 2017.
There were over 2,300 businesses and heating districts that used
geothermal resources for heat and hot water in the United States in 2005,
with only two businesses using federal geothermal resources. The total
potential for direct use applications is largely unknown because of the
widespread occurrence of lower temperature geothermal resources and the
many diverse applications.

Electricity Generation from Geothermal Resources Is Small and Relies on
Federal Resources

Geothermal resources currently produce about 0.3 percent of the annual
electricity in the United States, or 2,534 megawatts-enough electricity to
supply 2.5 million homes. Even though the percentage of electricity
generated from geothermal resources is small nationwide, it is locally
important. For example, geothermal resources provide about 25 percent of
the Island of Hawaii's electricity, 5 percent of California's electricity,
and 9 percent of northern Nevada's electricity. As of January 2006,
companies were constructing geothermal power plants in California, Nevada,
and Idaho that collectively will produce another 390 megawatts of
electricity. Table 1 shows the number, location, and capacity of
geothermal power plants that currently produce electricity or are under
construction.

Table 1: States with Power Plants and Their Capacity

                                        

     State             Number of existing    Total Number of power Additional 
                  geothermal power plants capacity    plants under   capacity 
                                                      construction 
California                          41    2,239               2        285 
Hawaii                               1       30               0          0 
Idaho                                0        0               1         10 
Nevada                              10      239               3         95 
Utah                                 2       26               0          0 
Total                               54    2,534               6        390 

Source: The Geo-Heat Center, the Department of Energy (DOE), and BLM.

Note: Each unit of capacity is a megawatt.

Over half of the nation's electricity generated from geothermal resources,
about 1,275 megawatts, comes from geothermal resources located on federal
lands. Of the 54 geothermal power plants, 26 are located on federal lands
managed by BLM, and 28 are located on private or state lands. As of
January 2006, there were 50 federal geothermal leases from which
electricity was produced-48 on BLM lands, and 2 on Forest Service lands.
Twelve of these leases are located in The Geysers in northern California,
and they account for over one-third of the electricity produced from
federal geothermal resources. The other 44 producing federal geothermal
leases are located in and near the Sierra Nevada Mountains of eastern
California, near the Salton Sea in the southern California desert, in
southwestern Utah, and scattered throughout Nevada.

Estimates of the Potential for Additional Electricity Generation from
Geothermal Resources Vary Widely

Industry and government estimates of the potential for electricity
generation from geothermal resources vary widely, due to differences in
the date by which forecasters believe the electricity will be generated,
the methodology used to make the forecast, assumptions about electricity
prices, and the emphasis placed on different factors that can affect
electricity generation. Five estimates published since 1999 indicate that
the potential for electrical generation from known geothermal resources
over the next 9 to 11 years is from about 3,100 to almost 12,000
megawatts. By 2025, two of these sources estimate that electrical
generation from these known resources will increase to between 6,800 and
13,000 megawatts. The difference in estimates could also be due to the
different methodologies used to make the forecasts, such as surveys of
experts in the geothermal industry and/or detailed economic modeling.
Placing different emphasis on geothermal development costs, electricity
prices, natural gas prices, and/or reservoir characteristics also probably
led to differences in the estimates. Table 2 summarizes the estimates of
potential electricity generation from geothermal resources.

Table 2: Estimates of Potential Electricity Generation from Geothermal
Resources

                                        

    Source and date of estimate        Estimate of electricity generation     
U.S. DOE, Energy Information    6,800 megawatts by 2025 for known          
Administration's Annual Energy  geothermal areas based on stable natural   
Outlook, 2004                   gas prices. This estimate does not take    
                                   into account Enhanced Geothermal Systems,  
                                   which is a DOE program to create man-made  
                                   geothermal reservoirs.                     
California Energy Commission,   11,822 megawatts by 2017 in California,    
2005                            Nevada, Arizona, Idaho, Utah, Oregon, and  
                                   New Mexico from known geothermal resource  
                                   areas based on amount of heat in place,    
                                   reservoir characteristics, economic        
                                   factors, and a Monte Carlo simulation.     
Oregon Institute of             3,160 megawatts based on all planned       
Technology, Geo-Heat Center,    capacity at known geothermal areas coming  
2005                            on line by 2015.                           
Western Governor's              5,600 megawatts by 2015 and up to 13,000   
Association, 2005               megawatts by 2025, based on consensus of   
                                   professional opinions for known geothermal 
                                   resource areas and economic modeling of    
                                   costs and electricity prices.              
Geothermal Energy Association,  Between 6,340 megawatts and 11,700         
1999                            megawatts using 1999 technology and        
                                   between 15,080 megawatts and 25,390        
                                   megawatts using enhanced technology, based 
                                   on a survey of expert opinions and known   
                                   geothermal areas.                          
U.S. Geological Survey, 1978    23,000 megawatts from known geothermal     
                                   areas and an additional 72,000 to 127,000  
                                   megawatts from undiscovered resources      
                                   based on amount of heat in place,          
                                   reservoir characteristics, 1978            
                                   technology, and a Monte Carlo simulation.  

Source: GAO.

A detailed comprehensive study of electricity generation from all
geothermal resources in the United States has not been undertaken since
1978, when the U.S. Geological Survey (USGS) published Circular 790,
"Assessment of Geothermal Resources of the United States-1978." This
assessment, based on the amount of thermal energy in place, estimated that
known geothermal resources could generate 23,000 megawatts if all of them
were developed, significantly more than that estimated by the five other
studies. The other five estimates in table 2 differ from the USGS estimate
in that they attempt to estimate how much electricity could be
economically produced from known resources, given competing commercial
sources of electricity, and they are based on more extensive reservoir,
production, and economic data. In addition, none of the five estimates
include undiscovered resources; the USGS estimated that undiscovered
resources could generate an additional 72,000 to 127,000 megawatts.

Direct Use Applications Are Numerous and Diverse, and Few Are Located on
Federal Land

Over 2,300 businesses and heating districts in 21 states used geothermal
resources directly for heat and hot water in 2005. About 85 percent of
these users are employing geothermal resources to heat homes, businesses,
and government buildings (table 3). While most users heat one or several
buildings, some users have formally organized heating districts that pipe
hot water from geothermal wells to a central facility that then
distributes it to heat many buildings more economically than other
available sources of energy. The largest concentration of geothermal
heating districts occurs in Boise, Idaho, where four heating districts
distribute geothermal waters to over 50 buildings, including the Capitol
and City Hall (fig. 3). Geothermal heating districts supply heat to about
20 commercial and government buildings in Klamath Falls, Oregon, and to
400 homes in Reno, Nevada. The next most plentiful direct use applications
are resorts and spas, accounting for over 10 percent of sites. About 244
geothermal resorts and spas offer relaxation and therapeutic treatments to
customers in 19 states. Spas and resorts can be as primitive as an
unsheltered hot spring in the backcountry to an elaborate resort with
multiple soaking pools, an Olympic-sized swimming pool, a 100-room hotel,
and gourmet restaurants. Two percent of geothermal direct use applications
consist of heated greenhouses in which flowers, bedding plants, and trees
are grown. Idaho leads the nation with the most geothermally heated
greenhouses-13, and New Mexico leads the nation with the largest
geothermally heated greenhouse-covering 32 acres. Another 2 percent of
geothermal direct use applications are for aquaculture operations that
heat water for raising aquarium fishes for pet shops; catfish, tilapia,
freshwater shrimp and crayfish for human consumption; and alligators for
leather products and food (fig. 4). Other direct use geothermal
applications include dehydrating vegetables, like onions and garlic, and
melting snow on city streets and sidewalks. Geothermal direct use
applications are summarized in table 3.

Table 3: U.S. Geothermal Direct Use Applications as of 2005

                                        

                 Application                                  Number of sites 
Space heating                                                        1,976 
District heating                                                        20 
Resorts and spas                                                       244 
Aquaculture                                                             48 
Greenhouses                                                             44 
Snow melting                                                             6 
Agricultural drying                                                      3 
Other industrial                                                         3 
Total                                                                2,344 

Source: The Geo-Heat Center at the Oregon Institute of Technology.

Figure 3: District Heating in Boise, Idaho

Nearly all direct use businesses and heating districts are currently
located on private lands. Only two direct use businesses that use federal
geothermal resources are currently in operation. One of these businesses,
located at Honey Lake in northern California, uses geothermal resources to
preheat a boiler in which biomass is burned to create electricity. Four
additional businesses-a nursery, a food processing plant, and two
mines-have also used federal resources at one time in direct use
applications. A nursery in New Mexico used federal geothermal resources
for heating greenhouses, but the owner reported that he stopped using the
federal geothermal resources because he considered the federal royalties
to be excessive. Two gold and silver mines also used geothermal waters
from BLM lands in Nevada to enhance their cyanide heap leeching operations
but suspended these operations, due in part, to high federal royalties.
The owner of the food processing plant, which dried garlic, reported being
forced out of business by lower priced imports from China.

Figure 4: Raising Tropical Fish with Geothermal Resources in Idaho

The Potential for Developing Additional Direct Use Is Uncertain

The potential for additional direct use of geothermal resources in the
United States is uncertain due to the geographically widespread nature of
low-temperature geothermal resources and the many different types of
applications. The USGS performed the first national study of low-

temperature geothermal sites in 19825 and estimated the amount of heat
in-place that could be available for direct use applications across the
United States. However, this study was neither specific enough to identify
individual sites for development, nor did it estimate the amount of heat
that could be recovered and converted into energy savings for homes or
businesses. In 2005, the Geo-Heat Center at the Oregon Institute of
Technology identified 2,211 geothermal wells and springs with temperatures
appropriate for direct use. The Geo-Heat Center estimated that 404 of
these wells and springs might be commercially developed because they are
within 5 miles of communities. The study estimated the minimum amount of
heat that could be produced at each site but did not assess the economics
or business climate of the various direct use applications.

Geothermal Heat Pumps Show Increasing Use

Geothermal heat pumps have become a major growth segment of the geothermal
industry by making use of the earth's warmer temperature in the winter to
heat buildings and using the earth's cooler temperature in the summer for
air conditioning. The Geothermal Heat Pump Consortium estimated that 1
million units were in operation in all 50 states as of January 2006. The
number of geothermal heat pumps has steadily increased over the past 10
years. Because geothermal heat pumps are effective where ground
temperatures are between 40 and 70 degrees F, they can be installed in
almost any location in the United States and, therefore, are the most
widespread geothermal application and have the greatest potential.

Until 1999, few geothermal heat pumps were installed in federal
facilities. The annual federal investment in geothermal heat pumps has
increased substantially since then, from $6 million in 1999 to $74 million
in 2001-the latest year for which data are available. As of November 2005,
federal facilities had installed over 25,000 individual heat pumps-over
24,000 of them in military bases. The other 1,000 heat pumps were
installed by the Department of Housing and Urban Development, DOI, the
U.S. Postal Service, and the Environmental Protection Agency.

Geothermal Development Faces Many Challenges

The development of geothermal resources for electricity production faces
major challenges, including high risk and financial uncertainty,
inadequate technology, and insufficient transmission capacity. Developers
of geothermal power plants face additional challenges when operating on
federal lands. These challenges include: (1) a lengthy review process for
the approval of leases and permits,(2) insufficient resources at BLM to
conduct the necessary reviews, (3) different priorities between the BLM
and the Forest Service when lands under their jurisdiction occur within a
project area, (4) fragmented lease holdings that make it difficult to
develop an economically viable project, and (5) a complex federal royalty
system. Developers of geothermal resources for direct uses also face a
variety of other business challenges, remote locations, water rights
issues, and higher federal royalties over the past few years. The recently
passed Act addresses some of these challenges and is discussed in the next
section of this report.

Geothermal Power Plants Face High Risk, Financial Uncertainty, and
Technological Impediments

Geothermal development for the production of electricity is a risky,
expensive, and lengthy process. Geothermal groups reported that most
attempts to develop geothermal resources are unsuccessful, that costs to
develop geothermal power plants can surpass $100 million, and it can take
3 to 5 years for plants to first produce and sell electricity. The
development of geothermal resources for electricity generation follows a
series of phases, starting with finding the geothermal resources through
exploration, then confirming the magnitude and extent of the resource, and
ending with full field development and power plant installation. Although
some resources are easy to find because they produce telltale signs such
as hot springs or fumaroles, most resources are buried deep within the
earth-at depths sometimes exceeding 10,000 feet-and finding them often
requires an in-depth knowledge of the area's geology, geophysical surveys,
remote sensing techniques, and at least one test well. The Geothermal
Energy Association estimates that average wells cost from $2 million to $5
million and that only about 25 percent of the initial test wells are
successful in finding commercial geothermal fields. Companies must then
drill additional wells to assess the extent, temperature, pressure, and
productivity of the reservoir, thereby allowing companies to confirm the
magnitude and extent of the resource and decide whether it is economically
viable. Estimates of failure rates for wells drilled during this phase run
as high as 60 percent. According to the Geothermal Energy Association,
developers typically spend about 10 percent of the total cost for this
phase. It costs $75 million to develop a typical 25 megawatt power plant.
Such a plant can produce enough electricity for 19,000 homes. The drilling
of additional wells to produce and manage the reservoir, installing the
power plant, and connecting the wells to the plant with pipes generally
account for another 23 percent, 54 percent, and 7 percent of the total
costs of the plant, respectively. In addition, operating and maintenance
costs for a plant of this size could be about another $5 million per year.

The risks and high initial costs associated with geothermal development
limit financing and make financing more difficult. Energy consultants told
us that few companies, including venture capitalists, are willing to
provide funding for geothermal projects, particularly for the initial
phases of exploration and confirmation. Industry officials who do provide
funding for geothermal development told us that they would only fund
projects that are either fully confirmed or are in areas of well-known
geothermal potential. Even when fully confirmed, moreover, few lenders
will finance a geothermal project until a contract has been signed by a
utility or energy marketer to purchase the expected electricity.
Geothermal industry officials describe the process of securing a contract
as complicated and costly, especially for small geothermal developers who
are generally unfamiliar with the various bidding mechanisms that
utilities use to establish electricity prices. Officials with a large
utility expressed their reluctance to purchase more costly electricity
from geothermal plants and cited an inability to pass on the additional
cost to ratepayers. Electricity from geothermal resources may also be
unavailable during time frames specified by the contract because of delays
due to environmental litigation or lack of available transmission. In
addition, an energy consultant told us that most utilities are unfamiliar
with geothermal resources, and they are unlikely to invest the necessary
time to assess geothermal projects because geothermal electricity would
make up a small percentage of their total energy portfolio.

Inadequate technology adds to the high costs and risky nature of
geothermal development. Since geothermal systems are geologically more
complex than oil and gas systems, exploration tools commonly used in the
oil and gas industry, such as geophysical surveys, are less effective. In
general, geothermal reservoirs are located in very hard and fractured
rocks that make drilling difficult. Operators often experience difficulty
in drilling because drill bits wear quickly and because the medium used to
lubricate the borehole and remove rock fragments, called drilling fluid,
is commonly lost into the many fractures in the rock. Compared with oil
and gas wells, the temperatures encountered when drilling are considerably
higher and the geothermal resources are more corrosive, resulting in
corrosion of drilling equipment and production casing and the failure of
electronic components. Geothermal wells are also larger in diameter than
oil and gas wells drilled to the same depth, which drives up drilling
costs. The recent boom in oil and gas drilling has added to the scarcity
and higher costs for drilling rigs and equipment.

Lack of Adequate Electrical Transmission Hinders Geothermal Development

Lack of available transmission creates a significant impediment to the
development of geothermal resources for electricity production. To send
electricity produced at geothermal power plants to utilities, geothermal
companies often need to construct new transmission lines from their plant
to existing lines. In the West, however, many geothermal resources are
located far from existing transmission lines, making the construction of
additional lines economically prohibitive, according to federal, state,
and industry officials. For example, there are no significant transmission
lines between the geothermal resources in northern Nevada and the
populated area of Las Vegas in southern Nevada. In California, there is a
need for new or upgraded transmission to access renewable resources in
Nevada and in the Imperial Valley of southern California, which has
significant geothermal potential. Even when geothermal resources are near
major transmission lines or developers can fund the construction of an
additional transmission line, adequate transmission capacity may still be
unavailable. Many existing transmission lines are operating at or near
capacity and may not be able to transmit electricity without significant
upgrades.

Paramount among transmission concerns is who will pay for the needed
transmission capacity. Transmission costs can be very large. In Nevada, a
BLM official told us that transmission lines there cost over $500,000 per
mile. The California Energy Commission said in a June 2005 report that new
transmission lines with interconnections cost between $375,000 and $3.3
million per mile for single circuit lines, depending on their voltage. In
the summer of 2005, FERC denied a request from a utility to pass the costs
for transmission lines on to ratepayers. According to utility officials,
this reaffirms that developers must pay for the costs since utilities will
not voluntarily absorb the costs directly. Under current rules, when a
developer requests new transmission capacity, the bulk of the costs are
assigned to the project that first pushes the transmission system beyond
its existing capacity. In addition, federal, state, and industry officials
note that small geothermal plants are discouraged from connecting to these
large transmission lines because utilities do not want to bother with the
small amounts of electricity unless there are many of them in the same
area.

Cumbersome planning and permitting processes have hindered the addition of
necessary transmission capacity. In a July 2005 report, a consultant for
the Edison Electric Institute noted that nationally the task of getting a
transmission project planned, approved, permitted, and financed remained
daunting. The authors stated that the investment climate for transmission
remained fragmented by different procedures, incentives, and constraints
from one region of the country to another. The California Energy
Commission noted in a November 2005 report that the state's inefficient
transmission planning and permitting processes were contributing to
worsening the state's transmission problems. Addressing the same issue, an
official of a large California utility told us that obtaining agreement on
where to construct transmission lines, addressing environmental issues,
obtaining approvals, and a "not in my backyard" philosophy, contributed to
the uncertainty and long lead times in building additional transmission
capacity. In addition, a geothermal developer complained about extensive
hearings and an inability to determine jurisdictions between the state and
the federal government and between agencies within California.

Geothermal Power Plants on Federal Lands Face Delays in Processing
Applications, Fragmented Lease Holdings, and a Complex Royalty System

Geothermal developers state that the process for approving leases and
issuing permits to drill wells and construct power plants has become
excessively bureaucratic. BLM and Forest Service officials often have to
amend or rewrite resource or forest management plans, which can add up to
3 years to the approval process, depending upon the complexity of the
proposal and when the last plan was written. Delays in finalizing resource
and forest management plans and in conducting environmental reviews have
resulted in a backlog of 31 lease applications in California, with an
average age of 7.4 years, and 136 lease applications in Nevada, with an
average age of about 2 years. Despite the high backlog in Nevada, BLM
officials noted that they processed 177 lease applications from January
2001 through June 2005. In contrast, during the same period, BLM did not
process any lease applications in California. Nevada BLM officials
reported that they can generally make decisions on whether to allow
leasing and development faster because the public raises fewer issues and
BLM documents its decision within a shorter document known as an EA. In
California, however, the public raises more environmental issues and
concerns involving Native American spirituality so BLM often prepares a
more detailed document called an EIS, which typically takes 2 years to
complete. While geothermal developers told us that they support
environmental analyses, they complained about the duplication of federal
and state documentation in California and of the appeals and lawsuits
filed by groups opposing the federal and state decisions, citing that it
often takes years for their resolution. The California Energy Commission
reported in a June 2005 report that the entire process from exploration to
the first production of electricity can take more than a decade and that
it was not unusual to redo environmental documents because they became
outdated.

Geothermal applications, permits, and environmental reviews are also
delayed because of a lack of staff and budgetary resources at the BLM
state and field offices that conduct the necessary work. Nevada and
California BLM officials noted that lack of funding and dedicated staff to
work on lease applications was a constant problem. Lack of funding in
California has slowed completion of BLM resource management plans and EISs
necessary for lease approvals and drilling permits. BLM officials noted in
California that they received only $90,000 to conduct two extensive EISs
for which staff had requested $1.2 million while Nevada BLM received a
one-time allocation of $700,000 for processing a backlog of lease
applications and writing several less extensive EAs, which generally cost
$80,000 to $90,000 each.

Approvals for leases and permits may also be delayed when BLM must
coordinate with the Forest Service, which manages land in some project
areas. The Forest Service manages significant lands on geothermal projects
in Oregon, Washington, California, and Nevada. Although BLM is the lead
federal agency for geothermal development, the Forest Service must concur
with leasing and development, and it has its own permitting process. BLM
and industry officials report that there can be a lack of coordination
between the Forest Service and BLM because of differing objectives and
directives. While both agencies manage their lands according to the
multiple use doctrine, they may have different priorities for land use and
the public often submits more negative comments concerning geothermal
development on Forest Service lands. A Forest Service official noted that
it is important to balance the competing issue of geothermal development
with other land uses such as preservation and recreation. He cited a
limited budget for updating forest management plans, which can lead to
delays, and noted that since geothermal development generates far less
revenue than logging and coal mining on Forest Service Lands, geothermal
development receives less priority.

Companies may also encounter difficulties in developing geothermal
resources for electricity production due to a patchwork of lease
ownership. Geothermal resources within a project area may be owned by the
federal government, state government, or private entities. Even when all
resources within a project are under federal lease, several lessees with
competing interests and objectives may own these leases. Some BLM
officials noted that some developers have reported difficulty in
consolidating the various geothermal leases into an economically viable
project that can recover the costs of the power plant and transmission
line. These developers, according to these BLM officials, say that
speculators often lease geothermal resources not for development purposes
but rather to resell the leases at a significant profit, running up the
cost of the project.

Geothermal developers, BLM officials, and MMS officials concur that the
complex federal royalty system in effect before passage of the Act was a
challenge to the development of geothermal electricity plants. While
developers did not consider this royalty system to be a major obstacle in
constructing a geothermal power plant, some described calculating royalty
payments as burdensome and reported expending considerable time and
expense on royalty audits. Several industry officials cited the complex
royalty system as a reason for advocating revisions to the Geothermal
Steam Act of 1970, as amended.

Direct Uses of Geothermal Resources Face Business Challenges, Remote
Locations, Water Rights, and Royalty Issues

The small business owners, operators of heating districts, and individuals
who commonly develop geothermal resources for direct use face a variety of
business challenges. Foremost among these challenges are obtaining
capital, overcoming specific challenges unique to their industry,
containing costs, and securing a competitive advantage. While the amount
of capital to start a business that relies on geothermal resource is small
compared with the amount of capital necessary to build a geothermal power
plant, this capital can be large relative to the financial assets of the
small business owner or individual. Unforeseen problems in well
construction, piping, and water disposal can also increase original
funding estimates. Obtaining funding is difficult as commercial banks are
often reluctant to loan money for unproven projects and ideas that appear
risky. Even district heating systems that are operated by municipalities
have encountered financing difficulties as city or state legislatures may
be reluctant to provide funding or customers may be reluctant to pay for
modifications that are necessary to use geothermal resources in their
current heating systems. We observed a number of business challenges
unique to various industries that the successful owners of direct use
businesses were able to overcome. They used their extensive knowledge of
their respective industries to combat diseases in fish farms; to combat
corrosive waters used in space heating; and to control temperature,
humidity, and light according to the specifications of the various plant
species they grew in nurseries. Escalating costs also pose a challenge to
direct use operations. Rising labor costs and cheaper imports closed a
food processing plant in Nevada. Greenhouses in Idaho and Oregon remained
profitable by shifting from high-cost natural gas to cheaper geothermal
resources for heating. Successful operators of direct use businesses have
secured competitive advantages by entering specialty niches (see figs. 5
and 6). For example, the operators of two aquaculture facilities in Idaho
and Oregon sell alligator meat, tilapia, and freshwater shrimp to
restaurants. Also, a resort operator in Alaska that relies on geothermal
resources constructed and markets an "ice museum" where guests can spend
the night with interior furnishings sculptured from ice. We noticed that
some greenhouse operators gained a marketing advantage by selling from
their retail outlet rather than selling at a lower price to wholesalers.

Figure 5: Alligator Farm Using Geothermal Resources in Idaho

The remote location of many geothermal resources hampers their development
for direct use. Geothermal direct use is constrained because the
geothermal waters cannot be economically transported over long distances
without a significant loss of heat. An official with the Geo-Heat Center
noted that for space heating, spas, and resorts, the geothermal resources
should be located within 5 miles of the location where they will be used.
While some greenhouses, aquaculture operations, and food processors that
rely on geothermal resources have successfully produced their products far
from consumers, they still need access to adequate transportation and a
cheap labor market, both of which are generally dependent on proximity to
population centers. The distant location from major population centers of
geothermal resources on federal lands contributes to their
unattractiveness for direct use applications.

Figure 6: Nursery Heated with Geothermal Resources in Idaho

Obtaining water rights can be a significant challenge to direct use
development. Western states are not uniform in classifying geothermal
resources, considering them legally to be mineral, water, or having
characteristics of both minerals and water. Depending sometimes on the
depth and/or the temperature at which they occur, geothermal resources can
be subject to state water laws in the western states and are then managed
by the state agency responsible for protecting groundwater. Even when not
legally classified as water, the production of geothermal resources for
direct use applications may still fall under regulations enforced by a
state agency responsible for groundwater protection. In areas of high
groundwater use, the western states generally regulate geothermal water
according to some form of the doctrine of prior appropriations, under
which specific amounts of water are appropriated to users in the order
when they first made beneficial use of the water. Additional amounts, if
available, are appropriated in the future to applicants on a first-come
basis. Those that have more senior rights have priority in using the water
when use exceeds supply, such as during a drought. Western states that
generally follow the prior appropriations doctrine when managing the
production of geothermal water for direct use include Utah, Idaho, Oregon,
New Mexico, and Nevada.6 Developers of geothermal resources for direct use
would face problems obtaining appropriations in the Snake River Basin of
Idaho, which consists of much of the state below the panhandle, because
groundwater is fully appropriated there and used predominantly for
irrigation. Over half of the state of Utah also includes areas in which
geothermal resources for direct use would be excluded or restricted due to
prior appropriations, and the state water engineers in Nevada and New
Mexico may also restrict appropriations in some areas of their states. In
addition, applications for development of geothermal resources for direct
use on federal lands may also be subject to state water laws. Unless the
federal government has reserved water rights on land in which a geothermal
developer is interested and the geothermal development fulfills the
specific purpose of the federal reservation, the development may still be
subject to restrictions under state water laws.

Developers interested in using federal geothermal resources for direct use
were concerned about high federal royalties prior to passage of the Energy
Policy Act of 2005. Royalties were computed according to a formula that
relies on the amount of heat extracted from the resource and the cost of a
reasonably available alternative form of energy. Since most inquiries into
the use of federal resources have been by operators of greenhouses, this
alternative form of energy-natural gas-has been the source generally used
to heat greenhouses. Average wellhead natural gas prices in recent years
have increased about two and a half times from $3.68 per million British
thermal units in 2000 to $9.50 in September 2005. Operators of greenhouses
have told us that heating greenhouses with natural gas is no longer
economically feasible as the costs of raising plants would exceed the
price they obtain for these plants. During meetings between BLM, MMS,
state, and industry officials, general consensus was reached that natural
gas was too expensive an energy source upon which to base royalties, and a
working group was formed to propose an alternative energy source. In the
report they drafted,7 the group proposed Powder River Basin coal, which
averages about 30 cents per million British thermal units-a fraction of
the price of natural gas. The report states that lower royalties on direct
use may encourage development and result in higher royalty revenues in the
long run. However, based on other challenges facing the development of
direct use applications, the lowering of federal royalties alone is
unlikely to stimulate the direct use of federal geothermal resources.

Efforts by Federal, State, and Local Governments to Address Challenges
Show Promise

The Act includes a variety of provisions designed to help the geothermal
industry address numerous challenges, including the high risk and
financial uncertainty of developing renewable energy projects, lack of
sufficient transmission capacity, delays in federal leasing, and complex
federal royalties. Although these efforts show promise, it is too early to
assess their effectiveness. Through the Department of Energy (DOE) and the
California Energy Commission, the federal government and the state of
California are attempting to overcome technical challenges by awarding
cost-share grants for research and development. State and local
governments have also made efforts to address challenges to geothermal
development. Chief among these efforts are financial incentives, such as
tax credits for production from renewable energy sources, sales and
property tax exemptions, and mandates that certain percentages of the
electricity generated within the state come from renewable energy sources,
such as geothermal resources.

Financial Incentives Are Used to Address the High Risk and Uncertainty of
Geothermal Development

Provisions within the Act address the high risk and financial uncertainty
of producing renewable energy by providing tax credits and other
incentives for renewable energy producers, including the producers of
geothermal electricity. Starting on January 1, 2005, section 1301 of the
Act extends for 10 years a tax credit on the production of electricity
from geothermal resources for already existing plants and for any new
plants producing by December 31, 2007. The credit is now 1.9 cents per
kilowatt-hour and has future adjustments for inflation. Although
government and industry officials praised this provision, they told us
that for the credit to be more effective, the date by which plants must
produce electricity needs to be extended. They explained that since it can
take 3 years or longer for the construction of geothermal electricity
plants, plants probably will not qualify unless they are ready to break
ground immediately. The Act also provides a financial incentive for
tax-exempt entities that cannot take advantage of the production tax
credit. Section 1303 of the Act permits the issuance of clean renewable
energy bonds by tax-exempt entities, such as municipalities and rural
electric cooperatives, for the construction of certain renewable energy
projects, including geothermal electricity plants. Investors can purchase
the bonds, which pay back the original principal and also provide a
federal tax credit instead of an interest payment. The Department of the
Treasury will manage the issuance of these bonds and the setting of credit
rates. The total issuance of bonds cannot exceed $800 million, and the
bonds are to be issued between December 31, 2005, and December 31, 2007.

The Act also extends the federal government's Renewable Energy Production
Incentive, which expired on September 30, 2003. This incentive entitled
eligible electric production facilities, including not-for-profit
cooperatives, public utilities, and various government entities who sell
renewable electricity, including that generated from geothermal resources,
annual financial incentive payments from the federal government.
Additionally, section 1333 of the Act makes a $300 tax credit available to
purchasers of geothermal heat pumps who place them in service in 2006 and
2007.

Another provision in the Act may decrease the uncertainty inherent in
geothermal exploration. The Act directs the Secretary of the Interior,
acting through the USGS, to update the 1978 Assessment of Geothermal
Resources made by the USGS. This assessment, published as Circular 790, is
widely considered to be out of date and in need of revision. USGS
officials reported that, since 1978, there have been significant
advancements in technology that are not reflected in Circular 790. Now,
electricity can be generated from lower temperature resources and from
resources located deeper within the earth. Today, according to USGS
officials, scientists and engineers can make more accurate resource
estimates because they are more knowledgeable of reservoir characteristics
and have benefited from the knowledge gained during the 27 years of
exploration and development that has occurred since the original study.

State governments are also offering financial incentives to the geothermal
industry by creating additional markets for their electricity through
Renewable Portfolio Standards (RPS). An RPS is a state policy directed at
electricity retailers, including utilities, that either mandates or
encourages them to provide a specific amount of electricity from renewable
energy sources, which may include geothermal resources. To date, 22 states
plus the District of Columbia have RPSs, and three other states have set
RPS targets. Requirements for the program vary by state as each RPS is
unique, and not all states have significant geothermal resources.
California and Nevada, which have large geothermal production and
potential, have each established an ambitious RPS. California law mandates
that retailers must supply 20 percent of their electrical energy from
renewable energy by 2017, and the state is currently seeking to move this
date up to 2010. Nevada requires certain percentages of its electricity to
be generated from renewable energy each year, with 20 percent by 2015.
Since California and Nevada requirements were implemented, one 20
megawatt-geothermal plant in Nevada, which has gone on line, and
geothermal developers have signed contracts for three plants in California
for as much as 260 megawatts of future geothermal power, which can be
attributed to RPSs. Nevada utilities currently are not meeting their
annual RPS requirements. Officials from two large California utilities
told us that they are interested in purchasing electricity generated from
geothermal resources specifically because of RPS and noted that the RPS
may be instrumental in constructing a new transmission line from the
Imperial Valley to utilities in southern California.

Additional state programs also provide tax credits and other financial
incentives for renewable energy development, including electricity
generation from geothermal resources. These incentives include property
tax incentives, sales tax incentives, and business tax credits. For
example in California, eligible geothermal developers can be awarded
supplemental energy payments from the state if they have a contract for
electricity at above market costs with one of California's three
investor-owner utilities. In Nevada, state law exempts from local sales
and use taxes the sale, storage, and consumption of products or systems
designed to generate electricity from renewable resources. In Utah, the
purchases of equipment to generate electricity from renewable resources
are excluded from state sales tax. Both Nevada and Oregon do not count the
value added by renewable energy systems when assessing property taxes.
Oregon also offers a business energy tax credit of up to 35 percent of the
cost of certain renewable energy projects, including geothermal systems.

Federal and State Grants Are Addressing Technology Challenges

DOE and the state of California provide financial assistance and grants to
the geothermal industry in trying to overcome technical challenges. At
DOE, the Geothermal Technologies Program's mission is to work in
partnership with U.S. industry to establish geothermal energy as an
economically competitive contributor to the U.S. energy supply. Several
goals of the program include reducing the cost of geothermal development
to 5 cents per kilowatt-hour by 2010 and increasing electrical capacity
from geothermal resources to 40,000 megawatts by 2040. The program seeks
to accomplish these goals by competitively awarding cost-shared grants to
industry for research and development. The program's budget was $25.3
million in fiscal year 2005. In the past, program funds have been used to
pioneer new drill bits, demonstrate the large scale use of binary
technology, produce new seismic interpretation methods, commercialize
geothermal heat pumps, develop slimhole (reduced diameter) drilling for
exploration, and produce a strategy for reinjection at The Geysers. Within
the program, an initiative called GeoPowering the West provides technical
and institutional knowledge on opportunities to use geothermal resources
and on how to overcome challenges. Goals of this initiative are to
increase the number of homes using geothermal energy to 7 million by 2010
and to double the number of states producing geothermal electricity to
eight by 2006.

California provides financial and technical support for geothermal
development through grants under two programs administered by the
California Energy Commission. Under the Geothermal Resources Development
Account, grants are competitively awarded to promote research,
development, demonstration, and commercialization of geothermal resources
in California. Funding is provided from a portion of the federal
geothermal royalties disbursed to the state. The program's costs are
shared with awardees. One noteworthy project funded by the program was the
piping of treated wastewater from Santa Rosa, California, to The Geysers,
where it was injected into the geothermal reservoir, increasing reservoir
pressure and boosting electricity production by an estimated 10 percent.
For California's fiscal year 2006, $3.9 million in funding is available
for 12 to 15 projects. The state's Public Interest Energy Research Program
also funds awards for renewable resource projects, including geothermal
projects. Money comes from a surcharge on California residents'
electricity bills. Of the $62 million collected by the state in 2005, $2
million was available for geothermal projects.

Expanded FERC Authority and Planning Initiatives Are Aimed at Transmission
Challenges

The Act may also address transmission challenges by providing FERC with
new authorities in permitting transmission facilities and in developing
incentive-based rates for electricity transmission in interstate commerce.
FERC can now approve new transmission lines in certain instances in a
"national interest electric corridor" when a state fails to issue a permit
within 1 year of a company's filing of an application. The Act also
authorizes companies that obtain FERC permits for transmission facilities
to acquire rights of way through eminent domain proceedings. In addition,
the Act directed FERC to develop incentive-based rates for transmission of
electricity in interstate commerce to promote increased investments in
transmission. Within 1 year of passage of the Act, FERC is to issue a rule
establishing incentive based rates. In November 2005, FERC initiated the
rulemaking process for establishing these rates.

Several planning initiatives are aimed at addressing challenges to
transmission. In the West, a number of regional entities composed of state
public utility commissions, local governments, utilities, and others are
working on transmission planning. These entities include Southwest
Transmission Expansion Planning, the Northwest Transmission Assessment
Committee, and the Rocky Mountain Area Transmission Study. Certain
utilities are also being proactive. The Los Angeles Water and Power
District is proposing that the City of Los Angeles spend $240 million to
help construct or upgrade a transmission line from the Salton Sea, an area
rich in geothermal resources near the Mexican border, to the Los Angeles
area. Similarly, San Diego Gas and Electric is proposing a new
transmission line from the Imperial Valley to its service area.

Provisions within the Energy Policy Act and BLM Planning Efforts May
Address Leasing and Royalty Issues

Provisions within the Act are aimed at streamlining or simplifying the
federal leasing system, principally by mandating competitive geothermal
lease sales every 2 years, by combining prospective federal lands into a
single lease, and by improving coordination between DOI and the Department
of Agriculture, which manages lands in the National Forest System. Since
companies can nominate tracks of federal land for sale, some geothermal
companies see the competitive sale provision as a mechanism to jump start
leasing in areas where it has stalled in recent years. BLM officials speak
positively of both this provision and the provision that allows combining
prospective lands into a single lease, saying that these provisions make
it more likely that companies with the financial resources to develop the
lands can do so. The Act also requires the Secretary of the Interior and
the Secretary of Agriculture to enter into a memorandum of understanding
that establishes an administrative procedure for processing geothermal
lease applications and that establishes a 5-year program for leasing of
Forest Service lands and reducing its backlog of lease applications, as
well as establishing a joint data retrieval system for tracking lease and
permit applications. A senior official with the Forest Service's
Geothermal Program said that, since the Forest Service already has a
memorandum of understanding with BLM, drafting the new memorandum should
not be difficult.

The Act also contains provisions that simplify federal geothermal
royalties on resources that generate electricity and simplify and or
reduce royalties on resources put to direct use. For electricity
production, the Act defines three types of leases and provides different
incentives for each. For the first type-leases that currently produce
electricity-the Act allows lessees to negotiate a royalty rate equal to a
percentage of gross sales revenues, instead of using the significantly
more complex process known as "netback." For the second type of
lease-those that were issued prior to the Act and will first produce
electricity within 6 years following the Act's passage-lessees can elect
for the first 4 years of production to pay 50 percent of the royalties
that would have been due. For the third type of lease-those that have not
yet been issued-lessees will pay according to a schedule in which
royalties are equal to certain percentages of gross sales revenues. In
addition, the Act significantly changes royalties due in the future on
direct use applications. The Act directs the Secretary of the Interior to
establish a schedule of fees, in lieu of the current complicated system,
that encourages the development of direct use resources.

BLM's 5-year strategic plan for its geothermal program also attempts to
address some challenges to federal leasing. The plan calls for annual
workforce planning documents to reflect the skills and staffing necessary
to implement an active geothermal program. A BLM official within the
Geothermal Program said that this provision will allow the state and field
offices to identify current budgetary needs so that they can process
geothermal applications and permits in a timely manner. The strategic plan
also calls for BLM to develop an inspection and enforcement plan, which it
currently does not have. Such a program could help in ensuring that the
federal government collects the correct royalty revenues from the sale of
electricity generated from geothermal resources.

Geothermal Royalty Disbursements Will Change Significantly, and Changes in
Electricity Prices Could Alter Total Royalty Collections

Under provisions of the Act, geothermal royalties retained by the federal
government will be cut in half because half of the royalties that
originally were retained by the federal government will now have to be
disbursed to the counties in which the federal leases are located.
Although provisions within the Act may change the royalties due on
specific types of leases, the overall revenue impact of these provisions
should be minor if electricity prices remain relatively stable and if the
Secretary of the Interior relies on past royalty histories in determining
future royalties. However, it is not possible to predict with reasonable
assurance how electricity prices will change in the future, and price
changes could significantly impact future royalty collections if they are
not accounted for in royalty calculations.

The Energy Policy Act Redistributes a Greater Portion of Federal Royalties

A royalty provision of the Act redistributes the federal royalties
collected from geothermal resources-cutting in half the overall geothermal
royalties previously retained by the federal government. Set by the
Geothermal Steam Act of 1970, as amended, the prior distribution provided
for 50 percent of geothermal royalties to be retained by the federal
government and the other 50 percent to be disbursed to the states in which
the federal leases are located.8 The Act changes this disbursement. While
the Act provided that 50 percent of federal geothermal royalties will
continue to be disbursed to the states in which the federal leases are
located, an additional 25 percent will now be disbursed to the counties in
which the leases are located, leaving only 25 percent to the federal
government.

The Act also changes how the federal government's share of geothermal
royalties can be used. Prior to passage of the Act, 40 percent of the
federal government's share was deposited into the reclamation fund created
by the Reclamation Act of 1902, and 10 percent was deposited into the
general fund of the Department of the Treasury. For the first 5 fiscal
years after passage of the Act, the federal government's share is now to
be deposited into a separate account within the Department of the Treasury
that the Secretary of the Interior can use without further appropriation
and fiscal year limitation to implement both the Geothermal Steam Act and
the Act. DOI officials explained that some of these funds could be used
for activities such as issuing geothermal leases, conducting environmental
reviews, collecting geothermal royalties, and inspecting geothermal
leases.

Provisions of the Energy Policy Act Are Likely to Have Little Impact on
Overall Royalty Revenues Only if Electricity Prices Remain Relatively
Constant

Despite several provisions of the Act that alter the amount of royalties
due on both the generation of electricity and direct use operations,
federal geothermal royalties could remain about the same, but only if
electricity prices remain stable. However, electricity prices are not
possible to predict with certainty, and price changes could significantly
impact royalty revenues on electricity sales, which account for about 99
percent of total geothermal royalty revenues. The Act contains provisions
for each of three specific types of leases that generate electricity: (1)
leases that currently produce electricity, (2) leases that were issued
prior to passage of the Act and will first produce electricity within 6
years following the Act's passage, and (3) leases that have not yet been
issued. There is also a provision in the Act that replaces the current
method of calculating royalties due on direct use operations with a
schedule of fees that shall encourage the development of geothermal
resources. Since direct use royalties accounted for less than 1 percent of
total geothermal royalties from 2000 through 2004, the financial impact of
the switch to a schedule of fees is likely to be minimal.

For leases that currently produce electricity, the Secretary of the
Interior is to seek to collect the same level of royalties over the next
10 years but under a simpler process. Prior to passage of the Act, lessees
of 13 of the 15 geothermal electricity projects paid federal royalties
according to a provision within MMS's geothermal valuation regulations
referred to as the "netback process." To arrive at royalties due under
this process, lessees are to first subtract from the electricity's gross
sales revenue9 their expenses for generation and transmission and then
multiply that figure by the royalty rate specified in the geothermal
lease, which is from 10 to 15 percent.10 The Act simplifies the process by
stating that within the 18 months after the effective date of the final
regulations issued by DOI, lessees who were producing electricity prior to
passage of the Act have the option to request a modification to their
royalty terms. This modification allows for royalties to be computed as a
percentage of the gross sales revenues from the electricity so long as
this percentage is expected to yield total royalty payments equal to what
would have been received for comparable production under the royalty rate
in effect before passage of the Act. MMS has already implemented a
procedure similar to this provision for the two projects that produce
electricity at The Geysers, setting their future royalties equal to a
percentage of gross sales revenues based largely on past royalty histories
and future projections.

Royalty revenues from a geothermal lease currently producing electricity
will remain the same if the lessee elects not to convert to the new
provision within the Energy Policy Act. In this case, the lessee will
continue to calculate and pay royalties just as the lessee did before
passage of the Act. Royalty revenues from a geothermal lease currently
producing electricity should also remain about the same if the lessee does
convert to the simpler method of calculating royalties in the Act,
provided that DOI negotiates with the lessee a future royalty percentage
based on past royalty history and provided that electricity prices remain
relatively constant. This situation is illustrated in table 4, which uses
data based on actual royalty data from a geothermal project on federal
lands. According to table 4, the lessee pays royalties equal to $20,000
under the netback process. Royalties are equal to the production of 8,000
megawatt hours times the sales price of $100 per megawatt hour less
$600,000 in expenses times the statutory royalty rate of 10 percent.
Figures in table 4 represent averages over a 5-year period and show that
royalties are equal to 2.5 percent of gross sales revenue. If production
remains the same and if electricity prices average $100 per megawatt hour,
future royalty revenues will remain the same whether royalties are
calculated under the netback process or if royalties are calculated at 2.5
percent of gross sales revenues.

Table 4: Example of Royalties Due under the Netback Process

                                        

Production Sales    Gross Expenses      Net Statutory Royalties  Royalties 
              price    sales             sales   royalty       due       as a 
                     revenue           revenue      rate           percent of 
                                                                        gross 
                                                                        sales 
                                                                     revenues 
8,000       $100 $800,000 $600,000 $200,000       10%   $20,000       2.5% 

Source: GAO.

Note: Production is in megawatt hours, and sales price is dollars per
megawatt hour.

However, if electricity prices increase and royalties are based on
historic percentages of gross sales revenues, royalty revenues will
actually decrease relative to what the federal government would have
collected prior to passage of the Act. More revenue would have been
received under the netback process because expenses for generation and
transmission do not increase when electricity prices increase and the
higher 10 percent statutory royalty rate would have applied to all of the
increase in sales revenues. This impact is illustrated in table 5. Using
the historic average of 2.5 percent computed in table 4, the royalties
will actually be $12,000 less than what would have been collected under
the netback process when the average price increases by $20 per megawatt
hour. On the other hand, if average electricity prices drop by $20 per
megawatt hour, royalty revenues will increase by $12,000 relative to what
would have been collected under the netback process.

Table 5: Impact of Changing Electricity Prices on Royalties Due under the
Energy Policy Act and the Netback Process

                                        

Sales Change in Gross sales    Royalties due under Royalties due Change in 
price     sales     revenue                the Act under netback royalties 
             price                                                        due 
$100         $0    $800,000                $20,000       $20,000       $ 0 
$120       +$20    $960,000                $24,000       $36,000 - $12,000 
$80        -$20    $640,000                $16,000        $4,000  +$12,000 

Source: GAO.

Note: This example is for currently producing leases for which the lessee
elects to change royalty to a percentage of gross sales revenue. The sales
price is per megawatt hour. The example assumes constant production of
8,000 megawatt hours, constant expenses of $600,000, royalty rate equal to
2.5% of gross sales revenue under the Act, and 10% under netback.

For the second type of lease-leases that were issued before the Act and
that will first produce electricity within 6 years after the Act's
passage-royalty revenues are likely to drop somewhat because lessees are
likely to take advantage of an incentive within the Act. The Act allows
for a 50 percent decrease in royalties for the first 4 years of production
so long as the lessee does not elect to pay royalties based on a
percentage of gross sales revenues and continues to use the netback
process.11 Because of the substantial reduction in royalties, it is likely
that lessees owning leases issued before passage of the Act will elect to
pay only 50 percent of the royalties due on new production for the 4-year
period allowed by the Act. This incentive also applies to sales revenues
from the expansion of a geothermal electricity plant that exceeds 10
percent. Owners of geothermal electricity plants currently paying
royalties under the netback process may elect to take the production
incentive for new plant expansions if they perceive that the royalty
reduction is worth the additional effort and expense in calculating
payments under the netback process and worth the possibility of being
audited. BLM officials said that leases in Utah, California, and Nevada
may become subject to the royalty reduction provisions within the Act for
new production and new plant expansions.

It is difficult to predict exactly how royalty revenue from the third type
of lease-leases that have not yet been issued-will change, but it appears
that revenue impacts are likely to be minor, based on our review of
historic royalty data. The Act specifies that the Secretary of the
Interior should seek to collect the same level of royalty revenues over a
10-year period as before passage of the Act, but it will be difficult for
DOI to compare an estimate of what royalty revenue would have been without
the Act with royalty revenues after the Act because the production and
expenses of future plants could vary substantially due to their unique
geological, engineering, and economic attributes. The Act provides that,
for future leases, royalties on electricity produced from federal
geothermal resources should be not less than 1 percent and not greater
than 2.5 percent of the sales revenue from the electricity generated in
the first 10 years of production. After 10 years, royalties should be not
less than 2 percent and not greater than 5 percent of the sales revenue
from the electricity.

We attempted to analyze the revenue impact on future leases by using
historic royalty data maintained by MMS and sales revenue data maintained
by BLM. A detailed description of our methodology is in appendix II.
First, we attempted to analyze revenue impacts on the first 10 years of
electricity production, but we had difficulty obtaining relevant royalty
data so we could not complete this analysis. Next, we examined the impact
on royalties after the first 10 years of production by analyzing data for
seven geothermal projects from 2000 through 2004. In analyzing royalty
data, we found that MMS did not maintain gross sales revenue data so we
used data that BLM supplied to MMS. We also found that 40 percent of the
royalty data maintained by MMS was erroneous or missing so we corrected or
obtained these data as necessary. We then calculated royalties paid as a
percentage of gross sales revenues for each project. This analysis showed
that lessees were paying a wide range of percentages-from 0.2 to 6.3
percent. Three of the seven projects paid under the minimum 2 percent
royalty rate prescribed in the Act, suggesting that some projects in the
future could pay more under the Act's new provisions than they would
otherwise have paid. On the other hand, one project paid greater than the
maximum 5 percent prescribed in the Act, suggesting that it is possible
for a plant to pay less in the future than it would otherwise have paid.
However, both the royalty revenue that the one plant would have overpaid
and the total of the royalty revenues that the three plants would have
underpaid are small-about 0.2 percent and 0.01 percent, respectively, of
all geothermal royalties reportedly paid during the period of our
analysis.

Even though provisions within the Act may decrease royalties on direct use
applications, the impact of these provisions is likely to be small because
total royalty collections from direct use applications are minimal. In
fiscal years 2000 through 2004, MMS reported collecting annually about
$79,000 from two direct use projects, or less than 1 percent of total
geothermal royalties. In addition, MMS reported collecting an additional
$222,000 during this period in settlement for royalties owed on a direct
use project from 1987 through 2003. While a provision within the Act may
encourage the use of federal geothermal resources for direct use by
lowering the federal royalty rate, we believe based on challenges facing
developers that it is unlikely that this royalty incentive alone will
stimulate substantial new revenues to compensate for the loss in revenue
due to the lower royalty rate. We believe that, in order to substantially
increase the development of federal direct use applications, developers
must overcome the relatively high capital costs for investors, unique
business challenges, and water rights issues.

MMS Does Not Routinely Collect the Royalty Data Necessary to Maintain the
Same Level of Royalty Collections

MMS does not routinely collect meaningful data on the revenue from
electricity sales. Since the Act requires the Secretary of the Interior to
seek to achieve the same level of royalty revenues when issuing new
royalty regulations, these data are necessary to know how future royalties
will compare with what would have been collected before passage of the
Act. To make these comparisons, MMS needs to calculate the percentage of
gross sales revenues that lessees pay in royalties. MMS requires royalty
payors to record sales revenue data on Form MMS-2014 under the data field
"sales value." MMS's Geothermal Payor Handbook instructs royalty payors
using the netback method to record in this field its net sales revenue,
which is equal to gross sales revenues less deductions for expenses such
as generation and transmission. As such, this sales value cannot be used
as one of the factors to calculate the percent of gross sales revenues
paid in royalties.

In preparing an analysis for the Royalty Policy Committee, MMS obtained
gross sales revenue data from BLM for many of the geothermal projects.
While BLM regulations require geothermal plant operators to report to BLM
the amount of electricity produced, these regulations do not require the
reporting of gross sales revenues. Nevertheless, BLM officials said that
they collect the sales revenue data. BLM officials in Nevada and southern
California reported examining the production and gross sales revenue data
for reasonableness and patterns in order to check on the accuracy of
royalty reporting. A BLM official also reported collecting sales revenue
and production data at The Geysers in northern California, but he said
that BLM lacked the resources to examine these data and was unable to
compile these data either for MMS or for us. These data from The Geysers
are important because they represent about 61 percent of total federal
geothermal royalties. Some royalty data from The Geysers were obtained and
audited by the state of California, but an MMS official said that it would
be more efficient and timely if MMS collects gross sales revenue data
directly, rather than having to ask BLM or the states for these data. The
official also said that MMS could use the gross sales revenue data in the
future to conduct general compliance audits by comparing the percent of
gross sales revenue paid in royalties with percentages prescribed within
the Act and by examining trends in the data, without having to undertake
lengthy and expensive on-site visits to the geothermal plants.

Conclusions

The Energy Policy Act of 2005 addresses a wide variety of challenges
facing developers of geothermal resources. The Act incorporates many of
the lessons learned by state governments and federal agencies in an
attempt to make federal processes more efficient and provide financial
incentives for further development. However, the Act is new and
insufficient time has passed to assess its effectiveness. Several of the
Act's major provisions will be left to the federal agencies within DOI for
implementation, and the drafting and public comment period for regulations
that implement these provisions will take time. Agencies will also need to
spend considerable time and effort in working out the details for
implementation and securing the necessary budgets to implement the new
system. To assist in these efforts, the Congress has authorized the
agencies to use the federal government's share of royalty collections to
implement the geothermal program for 5 years.

All the while, the Act directs the Secretary of the Interior to seek to
maintain the same level of geothermal royalty revenues over the next 10
years as would have been collected prior to the Act. This is a tall
mandate, as one of the factors that can most affect geothermal royalty
revenue-the price of electricity-is outside the control of the managing
agencies. Although it is impossible to predict with reasonable assurance
how these prices will change in the future, the federal agencies must make
their best effort to mitigate the impact of changing prices if federal
royalty revenue are to remain the same. This mitigation can only be
achieved if there is timely and accurate knowledge of the revenues that
lessees collect when they sell electricity. Without such knowledge, MMS
will have difficulty collecting the same level of royalties from lessees
that elect to use the new royalty process.

Recommendation for Executive Action

To assist in achieving the same level of geothermal royalties as would
have been collected prior to the Energy Policy Act of 2005, we recommend
that the Secretary of the Department of the Interior instruct the
appropriate managers within the Minerals Management Service to take the
following two actions:

o Correct erroneous and missing royalty data, when necessary, so that it
will have an accurate baseline of royalty collections for each payor; and

o Routinely collect from royalty payors the gross sales revenues for
electricity sold in order to compare these revenues with past royalty
collections and to verify compliance with the percentages prescribed
within the Act for leases to be issued in the future.

Agency Comments and Our Evaluation

We provided a draft of this report to the Department of the Interior for
review and comment. DOI provided written comments, which are presented in
appendix II. DOI agreed with our recommendations and emphasized the
importance of correct and relevant data in fulfilling the requirement to
collect the same level of geothermal royalties as would have been
collected prior to the Energy Policy Act of 2005. Specifically, DOI stated
that MMS plans to take steps to correct erroneous and missing royalty
data, including initiating an audit and directing payors to correct data.
DOI also stated that MMS is drafting new geothermal regulations as part of
implementing the Act and that these regulations will refer to instructions
that require payors to report to MMS the gross sales revenues for
electricity sold. MMS also provided several technical comments that we
have incorporated in the report.

As agreed with your office, unless you publicly announce the contents of
this report earlier, we plan no further distribution until 15 days from
the report date. At that time, we will send copies to other interested
congressional committees. In addition, we will send copies of this report
to the Secretary of the Interior, the Director of BLM, the Director of the
Minerals Management Service, the Secretary of the Department of
Agriculture, the Chief of the Forest Service, and the Secretary of Energy.
We also will make copies available to others upon request. In addition,
the report will be available at no charge on the GAO Web site at
http://www.gao.gov .

If you or your staff have any questions about this report, please contact
me at (202) 512-3841 or [email protected] . Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last page
of this report. Key contributors to this report are listed in appendix
III.

Jim Wells Director, Natural Resources   and Environment

Objectives, Scope, and MethodologyAppendix I

In this report, we discuss (1) the current extent and potential for
geothermal development; (2) challenges faced by developers of geothermal
resources; (3) federal, state, and local government actions to address
these challenges; and (4) how provisions of the Energy Policy Act of 2005
(Act) are likely to affect federal geothermal royalty collections.

To describe the current extent and potential for geothermal development,
we reviewed key studies on the extent and potential of geothermal
development that were published by the Department of Energy, the
California Energy Commission, the U.S. Geological Survey, the Western
Governors' Association, the Geo-Heat Center at the Oregon Institute of
Technology, the Geothermal Energy Association, and the state of Utah. We
contacted and visited the authors of the studies prepared by the
Department of Energy in Golden, Colorado; the California Energy Commission
in Sacramento, California; and the Geo-Heat Center in Klamath Falls,
Oregon. We also visited the Geothermal Resources Council in Davis,
California. We obtained statistics on federal geothermal leases from the
Bureau of Land Management (BLM) and data on geothermal heat pumps from the
Geothermal Heat Pump Consortium, the Department of Energy's Geothermal
Technologies Program, and the General Services Administration.

To identify the challenges facing geothermal developers and to assess
actions taken by federal, state, and local governments, we interviewed a
variety of government and industry officials, reviewed substantial
supporting documentation and the Act, and visited geothermal facilities.
We interviewed BLM officials in Washington, D.C.; California; Nevada; and
Utah, as well as Forest Service officials in Washington, D.C.; Minerals
Management Service (MMS) officials in Lakewood, Colorado; and Department
of Energy officials in Washington, D.C.; and Golden, Colorado. We
contacted state officials in California, Nevada, and Idaho. We also
interviewed geothermal industry representatives in Washington, D.C.;
California; Nevada; and New Mexico and toured geothermal electricity
plants in California and Nevada and direct use facilities, including
heating districts, food processing plants, greenhouses, aquaculture
operations, and a spa in Idaho, Nevada, Oregon, and Colorado. Specifically
to assess financial challenges faced by the geothermal industry, we also
interviewed officials with public utilities and officials who specialize
in arranging financing for geothermal plants. In assessing challenges
specific to federal lands, we also reviewed processes for approving lease
applications and conducting environmental analyses under the National
Environmental Policy Act of 1969; examined federal regulations addressing
leasing, geothermal operations, and royalty valuation for both electricity
production and direct use; and read the 148-page Geothermal Valuation
Handbook.

To assess how provisions within the Act will affect federal geothermal
royalties, we interviewed MMS employees in Lakewood, Colorado, and BLM
employees in California, Utah, and Nevada and reviewed a report authored
by the Royalty Policy Committee. We reviewed in detail how provisions of
the Act address the disbursement of federal geothermal royalties and
specifications for geothermal royalty collections from leases that are
currently producing electricity, leases that will first start to produce
electricity within the 6 years following passage of the Act, and leases
that have not yet been issued.

To assess how provisions of the Act could impact royalty revenue from the
sale of electricity, we started by trying to obtain monthly geothermal
royalty data and sales revenue data from MMS for January 2000 through
December 2004 for 10 geothermal projects paying royalties according to the
netback process. We discovered that MMS does not require payors to submit
gross sales revenue data but instead collects these data from BLM. We
assessed whether MMS's royalty data and BLM's sales revenue data were
complete enough and accurate enough for MMS to determine what percentage
of gross sales revenues is equivalent to the current level of royalties
being paid, should lessees elect to convert to paying a percentage of
gross sales revenues, as allowed by the Act. We reviewed MMS's and BLM's
data for reasonableness and completeness. While we found BLM's data to be
reasonably complete and accurate for the 10 geothermal projects, we found
that BLM could not furnish us with sales revenue data for the 2 steam
projects at The Geysers Geothermal Field in northern California. We also
found that about 40 percent of the monthly royalty data maintained by MMS
for the 10 projects was missing or erroneous. The most common error,
accounting for 73 percent of erroneous and missing data, was not paying
the 0.1 percent minimum royalty required by MMS regulations. This error
did not result in significant monetary underpayments; monthly
underpayments for this type of error generally amounted to less than $500.
After assuming that the correct royalty due was 0.1 percent of net sales
revenue for those months in which underpayments were less than the minimum
royalty calculation, we determined that royalty data was reasonably
accurate and complete for January 2000 through December 2004 for 6 of the
projects and for January 2003 through December 2004 for one additional
project.

Comments from the Department of the InteriorAppendix II

GAO Contact and Staff AcknowledgmentsAppendix III

Jim Wells (202) 512-3841

In addition to the individual named above, Dan Haas, Assistant Director;
Jeanne Barger; Ron Belak; John Delicath; Randy Jones; Frank Rusco; Anne
Stevens; and Barbara Timmerman made key contributions to this report.

(360566)

www.gao.gov/cgi-bin/getrpt? GAO-06-629 .

To view the full product, including the scope

and methodology, click on the link above.

For more information, contact Jim Wells at (202) 512-3841 or
[email protected].

Highlights of GAO-06-629 , a report to the Ranking Minority Member,
Committee on Energy and Natural Resources, U.S. Senate

May 2006

RENEWABLE ENERGY

Increased Geothermal Development Will Depend on Overcoming Many Challenges

The Energy Policy Act of 2005 (Act) contains provisions that address a
variety of challenges that face the geothermal industry, including the
high risk and uncertainty of developing geothermal power plants, lack of
sufficient transmission capacity, and delays in federal leasing. Among the
provisions are means to simplify federal royalties on geothermal resources
while overall collecting the same level of royalty revenue. The Act also
changes how these royalties are to be shared with local governments
(disbursements). This report describes: (1) the current extent of and
potential for geothermal development; (2) challenges faced by developers
of geothermal resources; (3) federal, state, and local government actions
to address these challenges; and (4) how provisions of the Act are likely
to affect federal geothermal royalty disbursement and collections.

What GAO Recommends

GAO found that it will be difficult for the Department of the Interior to
demonstrate that it intends to collect the same level of royalties as
called for in the Act because the Minerals Management Service (MMS) does
not systematically collect the necessary revenue data from electricity
sales. Therefore, GAO recommends that the Secretary of the Interior
instruct the appropriate managers within MMS to systematically collect
future sales revenues for electricity, and Interior agreed.

Geothermal resources currently produce about 0.3 percent of our nation's
total electricity and heating needs and supply heat and hot water to about
2,300 direct use businesses, such as district heating systems, fish farms,
greenhouses, food-drying plants, spas, and resorts. Recent assessments
conclude that future electricity production from geothermal resources
could increase by 25 to 367 percent by 2017. The potential for additional
direct use businesses is largely unknown because the lower temperature
geothermal resources that they exploit are abundant and commercial
applications are diverse. One study has identified at least 400
undeveloped wells and hot springs that have the potential for development.
In addition, the sales of geothermal heat pumps are increasing.

Developers of geothermal electricity plants face many challenges including
a capital intensive and risky business environment, developing technology,
insufficient transmission capacity, lengthy federal review processes for
approving permits and applications, and a complex federal royalty system.
Direct use businesses face unique business challenges, remote locations,
water rights issues, and high federal royalties. The Act addresses many of
these challenges through tax credits for geothermal production, new
authorities for the Federal Energy Regulatory Commission, and measures
that streamline federal leasing and that simplify federal royalties, which
totaled $12.3 million in 2005. In addition, the Department of Energy and
the state of California provide grants for addressing technology
challenges. Furthermore, some state governments offer financial
incentives, including investment tax credits, property tax exclusions,
sales tax exemptions, and mandates that certain percentages of the
electricity within the state be generated from renewable resources.

Under the Act, federal royalty disbursement will significantly change
because half of the federal government's share will now go to the counties
where leases are located. Although the Act directs the Secretary of the
Interior to seek to maintain the same level of royalty collections, GAO's
analysis suggests this will be difficult because changing electricity
prices could significantly affect royalty revenues. Also, MMS does not
collect sales data that are necessary to monitor these royalty
collections.

Glenwood Hot Springs, Colorado (left) and Geothermal Power Plant at The
Geysers, California (right)

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In assessing revenue impacts from leases that were currently issued and
producing electricity, we considered MMS's past history of approving
royalty calculations based on a percentage of gross sales revenues at The
Geysers. We also reviewed MMS's calculations of the percentages of gross
sales revenues that appear in the report to the Royalty Policy Committee.
Based on these considerations, we assumed that MMS could determine a
percentage of gross sales revenues equal to what would have been collected
prior to the Act if electricity prices do not change. We also determined
the impact of changing prices on royalty revenues as illustrated in table
5. In assessing revenue impacts from leases that were currently issued and
not producing, we contacted BLM officials to ascertain the likelihood for
these leases to first start producing in the next 6 years and the
likelihood of producing leases to expand their production by more than 10
percent. We also discussed with industry officials their opinions on
paying royalties according to the netback process.

To assess how royalty collections from future leases could be impacted, we
began to examine royalty data from the first 10 years for the 15 federal
geothermal projects, all of which first started producing prior to 1987.
We abandoned this attempt after conversing with MMS officials. MMS
officials noted that contracts for the sale of electricity prior to 2000
were different and would probably not be representative of future
situations. In addition, sales in the 1980s often involved the sale of
geothermal resources such as steam and hot water rather than electricity,
complicating the use of MMS's royalty data. Although some industry
officials said that their projections suggest that royalties during the
first 10 years of a project's life are substantially less than the
royalties during the remainder of the project's life, we could not verify
this estimate without actual royalty data.

To assess how royalty collections from future leases could be impacted 10
years after they first produce, we proceed with examining royalty data for
7 of the projects from our original sample of 10 geothermal projects. We
calculated royalties as a percentage of gross sales revenues from January
2000 through December 2004 and compared their range with the range of
percentages prescribed within the Act for production after the first 10
years. We also compared royalties as the percentages of gross sales
revenues for five of the flash plants with royalties as a percentage of
gross

sales revenues for two of the binary plants.1 We found that flash plants
paid royalties from 0.6 to 6.3 percent of gross sales revenues while
binary plants paid from 0.2 to 2.6 percent of gross sales revenues. It
appeared to us that each project, whether flash or binary, faces unique
geological, economic, and engineering situations that can combine to yield
different percentages of gross sales revenues. In addition, the small
number of observations and the significant overlap in range of the data
indicated to us that generalizations about the difference in percentages
between the two types of plants would be inaccurate.

To determine the impact of the Act on royalties from direct use of
geothermal resources, we obtained direct use royalty data from MMS and
reviewed the calculations on an alternative to the current calculation of
direct use royalties that appears in the report to the Royalty Policy
Committee.
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