-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-930T		

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

DATE:   07/11/2006 
				                                                                         
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GAO-06-930T

     

     * Background
     * Current Geothermal Development Is Limited, and Estimated Pot
     * Geothermal Development Faces Many Challenges
     * Efforts by Federal, State, and Local Governments to Address
     * Geothermal Royalty Disbursements Will Change Significantly,
     * Conclusions
     * Contact and Acknowledgments
          * Order by Mail or Phone

Testimony

Before the Committee on Energy and Natural Resources, United States Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 2:30 p.m. EDT

Tuesday, July 11, 2006

RENEWABLE ENERGY

Increased Geothermal Development Will Depend on Overcoming Many Challenges

Statement of Jim Wells, Director Natural Resources and Environment

GAO-06-930T

Mr. Chairman and Members of the Committee:

We are pleased to participate in the Committee's hearing to discuss the
development of geothermal energy on federal lands and the role of
geothermal resources in the nation's portfolio of alternative energy
sources. We previously testified that fossil fuels, such as coal, oil, and
natural gas, provide about 86 percent of our nation's total energy
consumption, with the rest coming from other sources, including nuclear
energy and renewable resources, such as hydroelectric energy, wind, solar
energy, and geothermal resources.1 Our nations' long-standing reliance on
imported crude oil and natural gas and disruptions in their supply
highlight the need to develop renewable energy sources. Among these
sources is geothermal energy. Geothermal energy is a unique 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. Because many areas that have the potential to produce additional
geothermal energy are located on federal lands, the federal government
plays a major role in the future development of geothermal energy.

Harnessing geothermal energy, however, is not easy. Developers of
geothermal energy face many challenges, including the high risk and
uncertainty of developing geothermal power plants, lack of sufficient
capacity to transmit electricity from these plants to consumers,
inadequate technology, and delays in leasing federal lands, which supply
about 50 percent of the geothermal resources used to generate electricity.
To address these and other challenges, the Congress included detailed
provisions in the Energy Policy Act of 2005.

My testimony today is based on a report we recently completed entitled
"Renewable Energy: Increased Geothermal Development Will Depend on
Overcoming Many Challenges." In this report, we addressed: (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 Energy Policy Act are likely to affect federal geothermal royalty
disbursements and collections. In addressing these issues, we reviewed key
studies on the extent and potential of geothermal development, interviewed
a variety of government and industry officials, reviewed substantial
supporting documentation and the Energy Policy Act, analyzed geothermal
royalty data, and toured geothermal electricity plants and other
facilities in California, Idaho, Nevada, and Oregon.

1See Meeting Energy Demand in the 21st Century: Many Challenges and Key
Questions, GAO-05-414T (Washington, D.C.: March 16, 2005).

In summary, we found the following:

           o  Although locally important, geothermal resources produce a very
           small portion of our nation's total electricity and heating needs.
           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 district heating systems, fish farms,
           greenhouses, food drying plants, spas, and resorts. The most
           recent estimates of future electricity generation from geothermal
           resources suggest that the current production of 2,500 megawatts
           of electricity-enough to supply 2.5 million homes-could increase
           to as much as 12,000 megawatts in 11 years. Although the future
           potential of other geothermal applications is less known, about
           400 undeveloped geothermal wells and hot springs could supply heat
           and hot water directly to a variety of businesses and other
           organizations.

           o  The developers of geothermal resources face significant
           financial, technical, and logistical challenges. Geothermal
           electric power plant developers face a capital intensive and risky
           business environment in which obtaining financing and securing a
           contract with a utility are difficult, where recouping the initial
           investment takes many years, and where transmission expenses could
           be costly due to remote locations or capacity constraints on the
           electric grid. These developers must also use exploration and
           drilling technologies that are inadequate for the unique
           attributes of geothermal reservoirs. Developers of electric power
           plants on federal lands face additional administrative and
           regulatory challenges and a complicated royalty payment system.
           Businesses and individuals trying to tap geothermal resources for
           direct use face unique marketing, financing, and technical
           challenges and, in some cases, must contend with remote locations,
           restrictive state water rights, and high royalties.

           o  To address the many challenges of developing geothermal
           resources, federal, state, and local governments have implemented
           a number of incentives and initiatives, many of which show
           promise. However, it is too early to assess their overall
           effectiveness. To address the capital intensive and risky nature
           of developing geothermal power plants, the Energy Policy Act
           grants developers a federal tax credit. Some states also encourage
           the production of electricity from renewable energy by granting
           various tax credits or by passing laws or adopting policies
           requiring that public utilities provide a minimum percentage of
           their electricity from renewable energy. To address technological
           challenges, the federal government and the state of California
           awarded research and development grants through the Department of
           Energy's Geothermal Technologies Program and the California Energy
           Commission, respectively. The Energy Policy Act gives the Federal
           Energy Regulatory Commission new authorities to address
           transmission limitations and contains provisions designed to
           improve the efficiency of federal geothermal leasing and to
           simplify or reduce federal geothermal royalties.

           o  How federal royalties are shared will change significantly
           since passage of the Act, and the total amount of royalties
           collected could change significantly if electricity prices also
           change. While the Act continues to provide that 50 percent of
           federal geothermal royalties will 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 directs for most leases that the Secretary of the
           Interior seek to maintain the same level of royalty revenues as
           before the Act, but our analysis suggests that this will be
           difficult because of two factors. First, because lessees in
           certain situations will have the option of choosing a different
           formula for calculating royalties, changing electricity prices
           could significantly affect the percentage of future royalty
           revenues that they pay. Second, the Minerals Management Service
           (MMS) does not routinely collect from royalty payors the gross
           sales revenue figures for the electricity they sell so MMS cannot
           determine if or how these future royalty revenues differ from what
           lessees would have paid before the Act. We have made
           recommendations to the Secretary of the Interior to instruct the
           appropriate managers within MMS to collect from royalty payors the
           gross sales revenue figures from electricity sales. MMS has agreed
           to do so.

           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 naturally to the
           surface 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.

           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. In 2005, MMS collected $12.3 million in geothermal royalties,
           almost all of which was derived from the production of
           electricity.

           Geothermal resources currently account for about 0.3 percent of
           the annual electricity produced 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 Hawaii's
           electricity, 5 percent of California's electricity, and 9 percent
           of northern Nevada's electricity. As of January 2006, 54
           geothermal power plants were producing electricity, and companies
           were constructing 6 additional geothermal power plants in
           California, Nevada, and Idaho that collectively will produce
           another 390 megawatts of electricity. Over half of the nation's
           electricity generated from geothermal resources comes from
           geothermal resources located on federal lands in The Geysers
           Geothermal Field of northern California; 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.

           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. Estimates published since 1999 by the Department of
           Energy, the California Energy Commission, the Geothermal Energy
           Association, the Western Governor's Association, and the Geo-Heat
           Center at the Oregon Institute of Technology 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. A more comprehensive and detailed study
           of electricity generation from all geothermal resources in the
           United States was published in 1978 by the U.S. Geological Survey
           (USGS). This assessment estimated that known geothermal resources
           could generate 23,000 megawatts if all of them were developed. The
           USGS estimate is greater because it did not consider how much
           electricity could be economically produced, given competing
           commercial sources of electricity. In addition, the USGS estimated
           that undiscovered resources could generate an additional 72,000 to
           127,000 megawatts. In short, geothermal resources that could
           generate electricity are potentially significant but largely
           untapped.

           In 2005, over 2,300 businesses and heating districts in 21 states
           used geothermal resources directly for heat and hot water. Nearly
           all of these are on private lands. About 85 percent of these users
           are employing geothermal resources to heat homes, businesses, and
           government buildings. 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. The next most
           plentiful direct use application is for use by resorts and spas,
           accounting for over 10 percent of sites. About 244 geothermally
           heated resorts and spas offer relaxation and therapeutic
           treatments to customers in 19 states. Two percent of geothermal
           direct use applications consist of heated greenhouses in which
           flowers, bedding plants, and trees are grown. Another two 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. Other
           direct use geothermal applications include dehydrating vegetables,
           like onions and garlic, and melting snow on city streets and
           sidewalks.

           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. USGS preformed the first
           national study of low-temperature geothermal sites in 1982, but
           this study was not specific enough to identify individual sites
           for development. In 2005, the Geo-Heat Center at the Oregon
           Institute of Technology identified 404 wells and springs that
           might be commercially developed for direct use applications-sites
           that had the appropriate temperatures and are within 5 miles of
           communities.

           Geothermal heat pumps have become a major growth segment of the
           geothermal industry. They make use of the earth's warmer
           temperature in the winter to heat buildings and use 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. 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, constitute the most
           widespread geothermal application and represent the greatest
           potential for future development.

           The development of geothermal resources for electricity production
           faces major challenges, including high risk and financial
           uncertainty, insufficient transmission capacity, and inadequate
           technology. Geothermal groups reported that most attempts to
           develop geothermal resources for electricity generation are
           unsuccessful, that costs to develop geothermal power plants can
           surpass $100 million, and that it can take 3 to 5 years for plants
           to first produce and sell electricity. Although some geothermal
           resources are easy to find because they produce tell-tale signs
           such as hot springs, 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 risks and high initial costs associated with
           exploring for and developing geothermal resources limit financing.
           Moreover, few lenders will finance a geothermal project until a
           contract has been signed by a utility or energy marketer to
           purchase the anticipated electricity. Geothermal industry
           officials describe the process of securing a contract to sell
           electricity as complicated and costly. In addition, lack of
           available transmission creates a significant impediment to
           developing geothermal resources for electricity production. In the
           West where most geothermal resources are located, many geothermal
           resources are far from existing transmission lines, making the
           construction of additional lines economically prohibitive,
           according to federal, state, and industry officials. Finally,
           inadequate technology adds to the high costs and risky nature of
           geothermal development. For example, geothermal resources are hot
           and corrosive and often located in very hard and fractured rocks
           that wear out and corrode drilling equipment and production
           casing.

           Developing geothermal resources for direct use also faces a
           variety of business challenges, including obtaining capital,
           overcoming specific challenges unique to their industry, securing
           a competitive advantage, distant locations, and obtaining water
           rights. While the amount of capital to start a direct-use business
           that relies on geothermal resources is small compared to the
           amount of capital necessary to build a geothermal power plant,
           this capital can be substantial relative to the financial assets
           of the small business owner or individual, and commercial banks
           are often reluctant to loan them money. Challenges that are unique
           to certain industries include avoiding diseases in fish farms;
           combating corrosive waters used in space heating; and controlling
           temperature, humidity, and light according to the specifications
           of the various plant species grown in greenhouses. Even when
           overcoming these unique challenges, successful operators of direct
           use businesses may need to secure a competitive advantage, and
           some developers have done so by entering specialty niches, such as
           selling alligator meat to restaurants and constructing an "ice
           museum" in Alaska where guests can spend the night with interior
           furnishings sculptured from ice. Furthermore, developing direct
           uses of geothermal resources is also constrained because
           geothermal waters cannot be economically transported over long
           distances without a significant loss of heat. Even when these
           resources need not be moved, obtaining the necessary state water
           rights to geothermal resources can be problematic. 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 may have
           already been appropriated to prior users, and additional water may
           not be available.

           Developing geothermal power plants on federal lands faces
           additional challenges. Power plant 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. Delays in finalizing the resource and
           forest management plans and in conducting other environmental
           reviews have resulted in backlogs of lease applications in
           California and Nevada, particularly when the public has raised
           more environmental issues. Geothermal applications, permits, and
           environmental reviews are also delayed by a lack of staff and
           budgetary resources at the BLM state and field offices that
           conduct the necessary work and when BLM must coordinate with the
           Forest Service, which manages land in some project areas. In
           addition, developers of geothermal resources for both power plants
           and direct uses faced a challenging federal royalty system prior
           to the Energy Policy Act. While developers of geothermal power
           plants generally did not consider the federal royalty system to be
           a major obstacle in constructing a geothermal power plant, some
           described paying royalties as burdensome and reported expending
           considerable time and expense on royalty audits. On the other
           hand, some developers of geothermal resources for direct use
           stated that the federal royalty system was a major obstacle and no
           longer economically feasible.

           The Energy Policy Act of 2005 includes a variety of provisions
           designed to help address the challenges of developing geothermal
           resources, including the high risk and financial uncertainty of
           developing renewable energy projects and the lack of sufficient
           transmission capacity. Provisions within the Act address high risk
           and financial uncertainty by providing tax credits and other
           incentives. For example, starting on January 1, 2005, 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 Act also provides a
           financial incentive for tax-exempt entities, such as
           municipalities and rural electric cooperatives, by allowing the
           issuance of clean renewable energy bonds 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. Another provision in the Act may
           decrease the high risk of geothermal exploration by directing the
           Secretary of the Interior to update USGS's 1978 Assessment of
           Geothermal Resources, which is in need of revision because
           significant advancements in technology have occurred since its
           publication. The Act addresses transmission challenges by
           providing the Federal Energy Regulatory Commission (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 when a state fails to issue a permit within 1
           year of a company's filing of an application, and companies that
           acquire FERC permits for transmission facilities can acquire
           rights of way through eminent domain proceedings. In November
           2005, FERC initiated the rulemaking process for establishing these
           rates.

           State governments are also addressing the financial uncertainty of
           developing renewable energy projects 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, although not all states have
           significant geothermal resources. 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.

           To address technological challenges, the state of California and
           the Department of Energy provide financial assistance and grants
           to the geothermal industry. California's Geothermal Resources
           Development Account competitively awards grants to promote
           research, development, demonstration, and commercialization of
           geothermal resources. California's Public Interest Energy Research
           Program also funds awards for renewable resource projects,
           including geothermal projects. On the federal side, the Department
           of Energy's Geothermal Technologies Program competitively awards
           cost-sharing grants to industry for research and development. In
           the past, program funds have been used to pioneer new drill bits,
           demonstrate the large scale use of low-temperature geothermal
           resources to generate electricity, 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 Geothermal
           Field. The program's budget was $23 million in fiscal year 2006.
           However, the President's budget contains no funding for fiscal
           year 2007, and the House's proposal for fiscal year 2007 is to
           appropriate a substantially reduced amount of $5 million. In
           contrast to these funding decisions, the Senate Energy and Water
           Appropriations Subcommittee just recently approved a budget of
           $22.5 million for geothermal research and development. While the
           future impacts of reduced or eliminated funding for geothermal
           technology is uncertain, industry representatives believe that
           this funding is necessary to address the near-term need to expand
           domestic energy production and the long-term need to find the
           breakthroughs in technology that could revolutionize geothermal
           power production.

           The Energy Policy Act also contains provisions aimed at addressing
           the challenges of developing geothermal resources on federal
           lands. Specific provisions are aimed at streamlining or
           simplifying the federal leasing system, combining prospective
           federal lands into a single lease, and improving coordination
           between DOI and the Department of Agriculture. 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. Finally, the
           Act also contains provisions that simplify and/or reduce federal
           geothermal royalties on resources that generate electricity and on
           resources put to direct use. MMS is in the early stages of
           implementing these provisions, and hence it is too early to assess
           their overall effectiveness.

           A royalty provision of the Energy Policy Act redistributes the
           federal royalties collected from geothermal resources-cutting in
           half the overall geothermal royalties previously retained by the
           federal government. Established by the Geothermal Steam Act of
           1970, as amended, the prior distribution provided that 50 percent
           of geothermal royalties be retained by the federal government and
           the other 50 percent be disbursed to the states in which the
           federal leases are located.2 While the Energy Policy Act continues
           to provide that 50 percent of federal geothermal royalties 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 Energy Policy Act.

           While, for most leases, the Energy Policy 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 future royalty revenues
           collected. Electricity prices are not possible to predict with
           certainty, and as discussed below, changing prices could
           significantly impact royalty revenues because electricity sales
           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.

           For leases that currently produce electricity, future geothermal
           royalty revenues will depend on electricity prices. The Act
           specifies that the Secretary of the Interior is to seek to collect
           the same level of royalties from these leases over the next 10
           years as it had before the Act's passage but under a simpler
           process. Prior to passage of the Act, lessees of most 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 revenue3 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.4 The Act simplifies the process by allowing lessees,
           within a certain time period, the option to request a modification
           to their royalty terms if they were producing electricity prior to
           passage of the Act. This modification allows for royalties to be
           computed as a smaller percentage of the gross rather than the net
           sales revenues from the electricity so long as this percentage is
           expected to yield total royalty payments equal to what would have
           been received before passage of the Act. Royalty revenues from a
           geothermal lease currently producing electricity will remain the
           same if the lessee elects not to convert to the new provision of
           the Act. On the other hand, if the lessee converts to the new
           provision, royalty revenues should remain about the same only if
           DOI negotiates with the lessee a future royalty percentage based
           on past royalty history and if electricity prices remain
           relatively constant. If royalties are based on historic
           percentages of gross sales revenues and electricity prices
           increase, however, royalty revenues will actually decrease
           relative to what the federal government would have collected prior
           to passage of the Act. The federal government will receive less
           revenue under this situation because expenses for generation and
           transmission do not increase when electricity prices increase, and
           the higher royalty rate specified in the lease is not applied to
           the increase in sales revenues.

           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 continues to use the netback process.5 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, so long as the expansion exceeds 10 percent of the plant's
           original production capacity. 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.

           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. The Act also simplifies the
           calculation of royalty payments by providing 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. Our analysis of data for seven
           geothermal projects showed that lessees were paying a wide range
           of percentages after 10 years of production-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, neither the
           amount that the one plant would have overpaid nor the amounts that
           the three plants would have underpaid are significant.

           Even though provisions of the Energy Policy 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. While a provision of 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.

           Finally, MMS does not routinely collect data from the sales of
           electricity that are necessary to demonstrate that MMS is seeking
           to maintain the same level of royalty collections from geothermal
           resources, as directed by the Energy Policy Act. For most
           geothermal leases, MMS will need to calculate the percentage of
           gross sales revenues that lessees will pay in future royalties
           from electricity sales and compare this to what lessees would have
           paid prior to the Act. However, MMS does not routinely collect
           these data. Accordingly, we are recommending that the Secretary of
           the Interior instruct the appropriate managers within MMS to
           collect from royalty payors the gross sales revenues from the
           electricity they sell. MMS has agreed to do so.

           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 provide financial incentives for
           further development and make federal processes more efficient.
           However, the Act was only recently adopted, 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 not occur
           overnight. Agencies will also need to spend considerable time and
           effort in working out the details for implementation and securing
           the necessary budgets. Hence, the fate of a significant portion of
           our nation's geothermal resources depends on the actions of these
           federal agencies.

           Mr. Chairman, this concludes my prepared statement. I would be
           pleased to respond to any questions that you or other Members of
           the Committee may have at this time.

           For further information about this testimony, please contact me,
           Jim Wells, at 202-512-3841 or [email protected] . Contributors to
           this testimony include Ron Belak, John Delicath, Dan Haas, Randy
           Jones, Frank Rusco, Anne Stevens, and Barbara Timmerman.

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                                   Background

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

                  Geothermal Development Faces Many Challenges

 Efforts by Federal, State, and Local Governments to Address the Challenges of
                  Developing Geothermal Resources Show Promise

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

230 U.S.C. S: 191 (a). The State of Alaska is an exception to this
provision, receiving 90 percent.

3The valuation regulations 30 C.F.R. S: 206.352 (c) (1) (ii) actually call
for using gross proceeds, not sales revenue, in this calculation. The
Energy Policy Act also refers to the term gross proceeds. Gross proceeds
are all financial compensation accruing to the lessee from the sales of
electricity. Since sales revenues are generally the largest component of
gross proceeds, we use the two terms synonymously in this report for
simplicity.

4Deductions are estimates that are to be recalculated at the beginning of
each year. Prior year's deductions are to be adjusted based on actual
costs during that year.

5Pub. L. No. 109-58 S: 224 (2005).

                                  Conclusions

                          Contact and Acknowledgments

(360734)

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