Renewable Energy: Increased Geothermal Development Will Depend on Overcoming Many Challenges
Published: 2006-07-11T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Energy Policy Act of 2005 (Act) contains provisions that address challenges to developing geothermal resources, 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 revenues. This testimony summarizes the results of a recent GAO report, GAO-06-629 . In this testimony, GAO 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.
section_title: What GAO Found
paragraphs: 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 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 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. The challenges to developing geothermal electricity plants include a capital-intensive and risky business environment, technological shortcomings, insufficient transmission capacity, lengthy federal review processes for approving permits and applications, and a complex federal royalty system. Direct-use businesses face numerous challenges, including challenges that are unique to their industry, 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 to streamline federal leasing and 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 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. Finally, MMS does not collect sales data that are necessary to monitor these royalty collections.

section_title: Letter
paragraphs: 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. 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.
In summary, we found the following:    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.
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.
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.
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.
subsections: section_title: Background
paragraphs: 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.
section_title: Current Geothermal Development Is Limited, and Estimated Potential for Additional Development Varies
paragraphs: 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.
section_title: Geothermal Development Faces Many Challenges
paragraphs: 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.
section_title: Efforts by Federal, State, and Local Governments to Address the Challenges of Developing Geothermal Resources Show Promise
paragraphs: 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.
section_title: Geothermal Royalty Disbursements Will Change Significantly, and Changes in Electricity Prices Could Alter Total Royalty Collections
paragraphs: 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. 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 revenue 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. 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. 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.
section_title: Conclusions
paragraphs: 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.
section_title: Contact and Acknowledgments
paragraphs: For further information about this testimony, please contact me, Jim  Wells, at 202-512-3841 or wellsj@gao.gov. Contributors to this testimony  include Ron Belak, John Delicath, Dan Haas, Randy Jones, Frank Rusco,  Anne Stevens, and Barbara Timmerman.
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