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Testimony: 

Before the Committee on Energy and Natural Resources, United States 
Senate: 

United States Government Accountability Office: 

GAO: 

For Release on Delivery Expected at 2:30 p.m. EDT: 

Tuesday, July 11, 2006: 

Renewable Energy: 

Increased Geothermal Development Will Depend on Overcoming Many 
Challenges: 

Statement of Jim Wells, Director: 
Natural Resources and Environment: 

GAO-06-930T: 

GAO Highlights: 

Highlights of GAO-06-930T, a testimony to Pete Domenici, Chairman, 
Energy and Natural Resources Committee, U.S. Senate 

Why GAO Did This Study: 

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. 

What GAO Found: 

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. 

Figures: Glenwood Hot Springs, Colorado (left) and geothermal power 
plant at the Geysers, California (right). 

Source: GAO. 

[End of Figures] 

What GAO Recommends: 

GAO concluded that it will be difficult for the Department of the 
Interior (DOI) to demonstrate that it intends to collect the same level 
of geothermal royalties as called for in the Energy Policy Act because 
the Minerals Management Service (MMS) does not systematically collect 
sales revenue data from electricity sales. Therefore, GAO recommends 
that the Secretary of the Interior instruct the appropriate managers 
within MMS to systematically collect these data, and DOI agreed. 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-06-930T]. 

To view the full product, including the scope and methodology, click on 
the link above.
For more information, contact Jim Wells at (202) 512-3841 or 
wellsJ@gao.gov. 

[End of Section] 

Mr. Chairman and Members of the Committee: 

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.[Footnote 1] 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. 

Background: 

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. 

Current Geothermal Development Is Limited, and Estimated Potential for 
Additional Development Varies: 

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. 

Geothermal Development Faces Many Challenges: 

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. 

Efforts by Federal, State, and Local Governments to Address the 
Challenges of Developing Geothermal Resources Show Promise: 

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. 

Geothermal Royalty Disbursements Will Change Significantly, and Changes 
in Electricity Prices Could Alter Total Royalty Collections: 

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.[Footnote 2] 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[Footnote 3] 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.[Footnote 4] 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.[Footnote 5] 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. 

Conclusions: 

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. 

Contact and Acknowledgments: 

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. 

FOOTNOTES 

[1] See Meeting Energy Demand in the 21st Century: Many Challenges and 
Key Questions, GAO-05-414T (Washington, D.C.: March 16, 2005). 

[2] 30 U.S.C. § 191 (a). The State of Alaska is an exception to this 
provision, receiving 90 percent. 

[3] The valuation regulations 30 C.F.R. § 206.352 (c) (1) (ii) actually 
call for using gross proceeds, not sales revenue, in this calculation. 
The Energy Policy Act also refers to the term gross proceeds. Gross 
proceeds are all financial compensation accruing to the lessee from the 
sales of electricity. Since sales revenues are generally the largest 
component of gross proceeds, we use the two terms synonymously in this 
report for simplicity. 

[4] Deductions are estimates that are to be recalculated at the 
beginning of each year. Prior year's deductions are to be adjusted 
based on actual costs during that year. 

[5] Pub. L. No. 109-58 § 224 (2005). 

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