Interested in geothermal energy. Check out this write-up on 5 Clean-Energy Stocks to Buy in 2017.
Mounting global concerns about climate change have made the development of renewable and clean energy a major priority for the future. One largely ignored source of near limitless, carbon-free energy is geothermal power, which a 2006 MIT study concluded has the theoretical capability of powering the US for 130,000 years.
That being said, despite the immense potential geothermal energy has to help supply the world with baseload clean energy, investing in this sector can be rather challenging. Here's why.
Image source: Getty Images.
Harsh realities of economic costs
The impressive statistic above needs to be taken with a grain of salt, as the economic feasibility of tapping into the Earth's enormous heat reserves is much smaller, although still enormous. For example, a 2008 USGS report concluded that just 13 western states have sufficient economically viable Enhanced Geothermal System, or EGS, potential to generate 345-728 GW of constant, baseload power.
To put that in perspective, in 2011 America's nuclear power industry -- the nation's current leading carbon-free baseload power source -- generated 99 GW of summer capacity, meaning that EGS could replace America's nuclear power fleet many times over and potentially become one of America's largest power sources.
However, in recent years advances in wind and solar power have caused the levelized cost -- which includes estimated lifetime costs such as construction, financing, fuel, maintenance, taxes, insurance, and government subsidies -- of these competing renewable energy sources to fall quickly and low enough to potentially threaten the future growth of geothermal energy.
As data from analyst firm Lazard shows, with or without government subsidies, geothermal is at a substantial cost disadvantage to utility scale solar and wind energy -- meaning that only its ability to generate baseload power (which can be generated all the time, regardless of what the weather is doing) works in its favor.
Huge theoretical potential but slim investing pickings
Another challenge with geothermal investing is that most companies involved with geothermal power are so well diversified that geothermal makes up just a token amount of their business, or they're highly speculative penny stocks that most investors should steer clear of.
For example, Chevron (CVX 0.44%) is one of the world's largest suppliers of geothermal power, with major stakes in geothermal power projects -- totaling over 1.3 GW of capacity, about 2 nuclear power plants worth -- in Indonesia and the Philippines. However, as a portion of its overall business this business segment is so small that it's a stretch to call Chevron a geothermal investment.
A similar problem exists for Calpine (NYSE: CPN), a wholesale electricity producer that proudly proclaims itself America's "largest generator of electricity from natural gas and geothermal resources." However, with only 1.5 GW of geothermal capacity -- 5% of its overall power capacity -- Calpine can hardly be called a potential large geothermal growth story.
There are companies that derive a substantial amount of business from geothermal, such as LSB Industries, (LXU -0.37%), a diversified chemical company that also supplies geothermal heat pumps to major industrial, commercial, and residential customers. In the last 12 months 22% of LSB's sales have come from geothermal heat pumps, however, this business segment has faced stagnant sales growth over the last four years and management is focusing 97% of 2015 capital investment on its chemical division, indicating that this is also a pretty weak geothermal investment.
That being said, there is one company that represents a large enough pure play in geothermal energy that it might be worth keeping on your investing radar.
Ormat Technologies: your best bet in geothermal stocks
Ormat Technologies (ORA -0.28%) is a Nevada-based company that has 50 years of experience designing, operating, and building geothermal projects around the world.
Over the past eight years the company has posted 11% annual sales growth and managed to outperform the S&P 500.
ORA Revenue (Annual) data by YCharts
I view Ormat as the best in breed geothermal stock for three main reasons. First, it has a competitive advantage courtesy of its long history in the sector, which means more and better international relationships in the industry as well as 69 patents that allow it to generate strong margins by offering customers superior service.
In fact, between 2012 and 2014 Ormat has been able to improve its overall gross margins from 25.7% to 36.4%. Better yet, in 2014 it was able to generate 35.5% gross margins on its 647 MW of power capacity from its 18 geothermal power plants -- most of which are under long-term PPA contracts to local utilities.
Finally, beyond its strong patent portfolio and diversified portfolio of steady cash-flow-generating power plants, Ormat has extremely high insider ownership meaning that management is eating the majority of its own cooking and more likely to be thinking about long-term growth as opposed to Wall Street's quarterly earnings expectations.
Despite enormous theoretical global potential, invest with caution
Geothermal energy has the potential to play an enormous role in the world's future green energy portfolio. However, due to a large -- and growing -- cost disadvantage to competing renewable energy sources such as wind and utility scale solar, long-term investors need to be careful and highly selective about how they invest in this sector.
