Cash in on the 'green' power under your feet

The world is racing to find cost-efficient alternatives to fossil fuels. Wind and solar power have serious drawbacks. But there is one renewable energy source that works - and may be about to break through into the mainstream. Nick Hanna investigates geothermal energy, and picks the best bets in the sector.

We live on a planet with an iron core that rotates with such ferocious energy that it can burst through the earth's skin and consume cities. So why do we waste so much time playing around with solar panels and wind turbines? Is it really so hard to harness the earth's energy? Well no, as it turns out.

Here's how it works. You drill two parallel holes in the ground, hundreds of metres apart, until you hit hot rock (say, 200 degrees). Then you pump cold water down one hole. As the superheated water spouts up the other, you use the steam to power a generator.

This is geothermal power. And it's one renewable energy source that may be about to break through. It has many advantages. It allows power plants to run around the clock, so providing reliable 'baseload' electricity. Since most of the activity takes place underground, they take up hardly any land. And while it has high start-up costs, operating and maintenance costs are relatively low, making it very cost-competitive.

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Traditionally, power plants have been based in areas where tectonic plates meet (such as in Indonesia, the Philippines, New Zealand, Iceland and California) because the heat from the earth's core is nearer to the surface and easier to reach less drilling is needed to reach the reservoirs of super-heated water.

And it works. Oil giant Chevron is the biggest player in the sector it has four sites in south-east Asia, generates 1,273 megawatts of electricity a year, enough to meet the needs of 16 million people in the region.

But geothermal has been left behind as a renewable energy source as governments and private capital have balked at the start-up costs. That's about to change. New technologies are changing the scope of where such power can be generated. Binary cycle plants, for instance, harvest energy from areas with much lower temperatures.

Moreover, money will soon start to flow into the sector in the US from the American Recovery and Reinvestment Act, which has allocated $350m to geothermal technologies. A simultaneous adjustment to US production tax credits could also benefit geothermal projects.

Impax Asset Management's Jon Forster thinks this could give the sector a much-needed boost. "Projects need to be in the ground by 2011 in order to qualify for these benefits, so if credit markets ease which they seem to be doing and once there's more clarity around the stimulus money in the US, then geothermal companies could see a ramp-up in their business over the next two to three years," he says. In the UK, Conservative party leader David Cameron pledged support for geothermal energy last month.

There's another aspect to geothermal too. It's less hi-tech, but is potentially a big growth area: domestic ground source heat pumps. These systems take advantage of the constant temperature of the earth beneath your house and, via a conduction loop, use it for heating or cooling. A heat pump can reduce energy bills by anything between 20%-40% and costs around £5,000, so it has a payback period of about five years. The European market alone is worth around €800m a year and growing at around 25%-30% a year. But there are no pure plays on this aspect of geothermal. The market leader is Sweden's Nibe, which also makes a wide range of other heating products. For now, investors should focus on geothermal plants. We have a look below at the best ways to play this energy growth story.

The best bets in the sector

Ormat (NYSE: ORA) has been building geothermal plants for more than 40 years. Last month it reported record first quarter results. Revenues were $99.9m (up 44.0% on the year) and net income rose 45.2% to $14.5m. Last year, Ormat's electricity-generating portfolio grew by 109 megawatts (MW) to 505MW. It expects to add a further 34 MW in 2009. It has plants in America, New Zealand, Kenya, Guatemala, and Nicaragua; developments are underway in Indonesia and Costa Rica. It has also developed a technique for turning waste heat into electricity.

The potential for this recovered energy generation system extends across a wide range of industries from gas processing to cement manufacturing, giving Ormat a significant foothold in another form of renewable energy generation. The forward p/e of 24 is not unreasonable for such a fast-growing stock, and it yields 0.6%.

Those willing to take more risk could look at US Geothermal (Amex: HTM). The group is at the review phase for an $85m Department of Energy loan to develop its geothermal project in eastern Oregon. The $106m binary cycle power plant is expected to begin commercial operations in late 2011. The share price could bounce if the project is approved.

Nick Hanna is a freelance writer and specialist in green investing. He owns shares in Orma