Steamy Investments in British Columbia
By: Robby O'Brien
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Geothermal power is a sustainable, environmentally friendly source of electricity created by harnessing the Earth’s naturally occurring heat deep underground. The US is the global leader in installed commercial geothermal power capacity, representing nearly 30% of worldwide capacity. Moreover, 97% of US installed capacity is in the western states of California, Nevada, and Oregon, which share the geology of the North American Cordillera with British Columbia and the Yukon. Although Canadian power companies already operate geothermal power plants internationally, there are no geothermal power plants in Canada. The Canadian Geothermal Energy Association (CanGEA), a collective interest group, suggested that as many as 27% of US projects have Canadian companies involved. Given that the technology is proven, and that Canadian companies are experienced owners and operators, it is surprising that geothermal power generation has not yet come north of the 49th parallel.
Borealis GeoPower (Borealis) is a Canadian company working to build Canada’s first geothermal power plant. The company has two active projects in British Columbia (BC): one at Lakelse Lake and another at Canoe Reach. The company is currently undercapitalized and lacks the internal capabilities necessary for successful project development, such as capital budgeting, legal counsel, and procurement. As its Canoe Reach project transitions from resource characterization to project development, Borealis should seek a joint venture with a larger partner who has the capabilities that Borealis is missing. Borealis needs to act quickly however, because the window of opportunity for gaining the right partner is closing.
Pillars for Success
Developing a geothermal project in Canada is highly risky and expensive, as the resource potential has been largely unexplored. Successful geothermal projects depend on three pillars of development; geotechnical resources and expertise, financing, and stakeholder acceptance. Industry expert Catherine Hickson emphasizes that “to be successful, a project must bring these three components together in a harmonious fashion.” The geothermal project site must have sufficiently accessible terrain and proximity to power transmission lines and power consumers. A feasible geothermal project begins with a relatively inexpensive geological study, which identifies a hot, porous, water bearing rock formation. Once a potential resource has been identified, expensive test wells need to be drilled into the formation to assess the geothermal potential. In perspective, a geothermal project has the risks and upfront costs similar to mineral exploration, with the long, steady payback of a utility.
Digging into Borealis
Due to the high up-front capital costs, high risks, and a history of failure, securing capital from traditional equity and debt investors is difficult for geothermal power developers in Canada. Borealis received a $2.4M grant from Sustainable Development Technology Canada in February 2013, and a geothermal exploration permit for the Lakelse Lake area in January 2014. The project is currently planned to enter the pre-feasibility stage in early 2015. Borealis has found success at Lakelse Lake by creating a three-way joint venture between themselves, the Kitselas First Nation (Kitselas), and the oil pipeline company Enbridge. This joint venture, called LL Geothermal, plans to build a 15MW binary cycle power plant south of Terrace, BC.
All of the parties receive different benefits from the partnership. Borealis provides the technological expertise to execute and receives the capital to go ahead with the project. The Kitselas holds land rights for the area, which Borealis now gains access to in addition to lower regulatory scrutiny. The Kitselas gain capital and return for the tribe in an environmentally friendly manner aligned with their core principles. Enbridge is very large compared to the project size (C$50B market cap) and is the primary financier. Enbridge provides Borealis access to its company resources for purchasing, capital budgeting, legal counsel, and brings expertise and relationships from the prior development of the 23 MW Neal Hot Springs power plant in Malheur Country, Oregon, where it performed a similar role as an equity partner to US Geothermal. The Lakelse project is fairly small for Enbridge and appears unrelated to its core business. However, at the same time this project was being initiated, Enbridge was trying to gain federal approval of the Northern Gateway pipeline project and was up against significant local and First Nations opposition.
The Northern Gateway pipeline is proposed to run very close to the Lakelse Lake site, and earning the approval of coastal communities and First Nations groups are key for this pipeline’s success. Building pipelines requires extensive consultation and negotiation with several First Nations groups along the route. Enbridge has had bad relations with area First Nations groups in the recent past. By co-investing with a prominent local First Nation band, the Kitselas, Enbridge was probably hoping to repair its tarnished image in the area. Three months after Enbridge announced its joint venture with Borealis, the federal government approved the Northern Gateway pipeline.
The Canoe Reach project for a 15 MW plant south of Valemount, BC is at a similar stage in development as the Lakelse project, and will also enter pre-feasibility study in early 2015. With the right partners, Borealis could replicate the success of its Lakelse Lake JV at Canoe Reach. The Simpcw First Nation currently own the land rights in Canoe Reach and would make an appropriate First Nations partner, but Borealis still needs to find a large equity partner. Due to the distance from the Northern Gateway proposed pipeline, another partnership with Enbridge is unlikely. Fortunately for Borealis, there is a different proposed oil pipeline near the Canoe Reach project – Kinder Morgan’s Trans Mountain Expansion.
Finding a Kindred Spirit
Trans Mountain Pipeline
Kinder Morgan is a large company with similar capabilities as Enbridge ($85B market cap), has large liquid capital reserves, and is used to investing in energy infrastructure. Though Kinder Morgan has not made investments in renewable energy before, renewable energy development is similar in nature to the pipelines Kinder Morgan has experience investing in and in this case would complement an important pipeline expansion project. The company’s proposal to expand the Trans Mountain pipeline by about 200% currently stands before Canada’s National Energy Board (NEB). This pipeline expansion would generate an additional $720M in revenue per year. Moreover, the expansion represents about one-third of Kinder Morgan’s proposed total capital investment, so it’s important for Kinder Morgan to see its expansion get approved. A partnership with Borealis and local First Nations in a renewable energy joint venture represents a small investment that can only help Kinder Morgan get approval for its pipeline project.
Investment Benefits
The NEB plans to make a decision on the Trans Mountain Expansion in January 2016, leaving Borealis little time to get a deal done with Kinder Morgan. The likely more impactful benefit to Kinder Morgan is the relationship with the First Nations population. Company President Ian Anderson has reiterated the importance of First Nations relations to the pipeline’s success in recent press releases. Borealis has already gained a permit to conduct geotechnical exploration of the area, which indicates a strong existing relationship with Simpcw, making the facilitation of a partnership likely. By partnering with Simpcw and Borealis, Kinder Morgan has a similar opportunity as the Enbridge deal to materially expand its First Nations relations. As a member of the Union of British Columbia Indian Chiefs, Simpcw has a voice among other First Nation’s peoples in the province and would provide Kinder Morgan with the opportunity to engage in dialogue on how to solve the points of opposition concerning the Trans Mountain project. With backlash from First Nations in Burnaby, more buy-in from neighbouring tribes can help alleviate the resistance.
Doing the Deal
The Canoe Reach project will likely cost $90M-105M in total, of which $2-10M will be needed by mid-2016 to undertake pre-feasibility and feasibility well drilling. The project is likely to take another five years to complete at a minimum. Kinder Morgan should contribute $40M in the venture, retaining a 40% equity stake. Given the 15MW production, assuming a 90% capacity factor and a cash flow of $55 per MWh, the project will earn around $6.5M annually ($2.6M net to Kinder Morgan). This implies a payback of around 15.4 years for the investment.
Outlook for Geothermal Location
Industry insiders size the total opportunity for geothermal power generation in Canada as magnitudes higher than is likely to be created in the next decade. BC Hydro has estimated the number as high as 700MW, and CanGEA even higher at 5000MW. No matter what the vision is for the industry, geothermal must first prove its viability in Canada to increase investor appetite. Using large capital partners that derive external non-financial benefits from the project, Borealis will be able to reduce its development risk, increase its development capability, and successfully construct Canada’s first geothermal power plant.
