TER: By how much?

JM: Right now I would say the Polaris site—the one in Nicaragua—has probably about a 500-megawatt potential. They’ve already drilled production wells equivalent to about 70 megawatts. Now it’s a matter of installation of the pipes and turbines, and attaching them to the wells. In about a year and a half, they’ll be producing 82 megawatts.

TER: What comes next? Would they enter into an agreement with an electric utility, a government, a grid operator?

JM: That’s right. Union Fenosa is the grid operator in Nicaragua and that’s their customer.

TER: Where would you expect to see this stock trade? Do you have a buy recommendation out on Polaris?

JM: I actually haven’t published any formal recommendations since coming to Jacob & Company. But they’re all fabulous buys by virtue of the fact that they’re about a quarter of their annual highs. They’ve all at or below their tangible book value. Some of them, like Sierra, trades at about its cash.

TER: What’s the risk with these companies? That they wouldn’t be able to get an agreement with the utility?

JM: I don’t see that as a risk because everybody needs power. Take Nicaragua. They’re only 50% electrified. All of their electricity comes from foreign oil, diesel and gas, so that’s a huge balance of payments problem for them. In the U.S. most states have renewable portfolio standards (RPS) that vary by state. The average target is to achieve 20% renewable by 2020. There will be continual pressure to add renewables to a utilities portfolio. So I don’t see that as a big risk. The real risk has been prices for cement and steel. The price per megawatt has gone from about $3 million to $4 million over the last three years.

TER: This is the cost to produce?

JM: Cement and steel appear to have peaked and are starting to come down, so maybe we’ll get some breaks on that in the future. That’s the construction risk. The resource risk is the other one. You need good geologists and engineers to figure out the resource itself because you can get a dry well just like in oil and gas. However, getting a dry well isn’t necessarily a useless thing because, you also need injection wells.

TER: Injection wells send your water down to hit this heat and create the steam.

JM: Right. You’ve got water super heated above the boiling point, which is 100° C. A lot of this water is roughly 200° C, so it’s twice the boiling point, but it still exists in a water state because it has no room to expand into steam. Steam requires a lot more space. Once it hits the surface, it turns into steam and that’s what rotates the turbine. So once you’ve done that, you re-condense the steam into water and pour it back down another hole. So getting a dry hole isn’t necessarily a bad thing as long as it’s close enough to the reservoir to be used as a reinjection well.

TER: Got it. So we’re saying $3 to $4 million per megawatt?

JM: Yeah, it’s running about $4 million now. Actually, three years ago it was about $3 million.

TER: It’s a commodity price that can come down. But let’s use $4 million. So going to Polaris saying that they’re going to have 82 megawatts, theoretically that’s going to cost them $328 million?

JM: Yes, roughly. That’d be a little bit on the high end for them because things are cheaper in Nicaragua, especially the labor costs. But that would be an accurate figure for some of the U.S. developments.

TER: I’m trying to understand the financial model. So I’ve got to spend $300 million to build this thing.

JM: Right.

TER: You’re saying that one could expect a 10% to 12% profit on what I’m going to sell this for?

JM: I think you’re looking at about a mid-to-high teens IRR.

TER: Internal rate of return.

JM: If you can get the proper amount of debt leverage you’d get closer to 210%.

TER: Could these become REITs?

JM: These are classic models for a REIT. In fact, if you look at the Canadian Power Trusts, most of them have heavy renewable components.

TER: So have any of these geothermal stocks converted to that status?

JM: No.

TER: Do you think they will?

JM: In Canada, no new company can become a REIT. In fact, all the existing trusts have to convert to corporates in 2011. However, they could become high dividend paying stocks. So rather than being a utility that pays out 4%, you could probably get an 8 or 9% yield out of these things and they’d be very attractive that way.

TER: You think that’s what’s going to happen? For instance, take Polaris, where do they grow, how do they grow?

JM: If you’ve reached the end of your development pipeline, then that’s probably what you do.

TER: So they’ll be taking that money and developing more geothermal megawatts.

JM: Yes.

TER: How do investors look at that then? That’s a growth company?

JM: Oh, yes, absolutely. In fact, the way to really look at these things is as high growth consumer staples that will trade anywhere from 10 to 20 times enterprise value to EBIDA. Take pharmacies for example. If you are willing to pay 12 times for a pharmacy with an 8% growth rate, which is typical, then why wouldn’t you pay closer to 20 times for one that has a 25% growth rate? After food and shelter, you need power.

That’s the problem with these things when they were brand new, power utility analysts ended up covering them. They are not power utilities; they are a high growth consumer staple.

TER: And they’re green.

JM: Yes.

By arrangement with: www.theenergyreport.com

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