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Avinash Gandhi

ORA AT A GLANCE

P/E ► 26.0 AVG EV/EBITDA ► 15.3 VERY HIGH ROA ► 4.6% AVG ROE ► 7.6% AVG Debt to Equity ► 1.04 AVG Current Ratio ► 1.54 AVG Interest Coverage Ratio ► 6.88 AVG

 

 

 

 

 

 

Ormat is the largest pure-play geothermal energy company in the world. It builds plants that use hot underground water to spin turbines and generate electricity. This method of power generation is environmentally clean and able to produce 24/7, making it an ideal source of "base-load" energy. Ormat's geothermal facilities release very few greenhouse gases, and conserve underground resources by reinjecting used water back into the Earth to be reheated and used again.

Currently, the commercial viability of geothermal energy is dependent on renewable energy government legislation that subsidizes the costs of constructing geothermal plants, since startup costs for geothermal average $2500 per kilowatt installed^[1] - around $1000 more per kilowatt installed than a regular gas turbine steam plant^[2]. Constructing plants is the most expensive part of geothermal energy, as plants must drill deep into the earth to access hot water. As geothermal energy companies often use the same drilling technology that oil companies use to prospect for oil, it can be expensive for them to procure the necessary equipment when oil prices are high and drill rigs are occupied drilling for oil.

Ormat's market is limited by geology - only certain regions have sufficient reserves of hot water beneath the ground to make a plant viable, and even then the power output per plant is typically much lower than for a typical natural gas or coal powered plant.

While Ormat is one of the only pure-play geothermal energy companies in the world, but it competes with large energy producers that dabble in geothermal, like ChevronTexaco and Calpine Corporation.

Business and Financials

Ormat has two business segments. It makes most of its money (72.7% in 2006) by selling and leasing energy and power plants to electric utilities. Its main customers are Southern California Edison, Hawaiian Electric Industries (HE), and Sierra Pacific Resources (SRP); in 2006, these companies made up 30.0%, 15.1%, and 12.8% of Ormat's revenues, respectively.^[3] Ormat likes to enter into long-term power purchasing agreements with utilities companies because it hedges both parties against fluctuating electricity prices by setting a single, fixed price for the energy sold by Ormat during the contractual period.

The rest of its revenues stem from the sale of products like remote power units (which generate up to 4500 watts of power for thirty years in harsh environments^[4]) and recovered energy generators (which convert "waste" heat from industrial operations into electricity).

Source: Company 2006 Annual Report^[5][6]

Both revenues and gross margins increased steadily over the past few years, though international electricity growth outpaced U.S. electricity growth. Until 2006, little significant revenue in the Products segment stemmed from U.S. sales; for 2006, $10.5 million was earned in the U.S. from products sales.

At the end of 2006, Ormat had 294 MW of capacity installed in the U.S. and 113 MW installed internationally, in countries like the Philippines, Kenya, Guatemala, and Nicaragua^[7]. By the end of the third quarter of 2007, the company had 210 MW of capacity in installation^[8], with 112 MW planned to be completed by the end of 2008 in Utah, Nevada, California and Kenya^[9]. While this is a large amount of capacity by geothermal standards, it should be noted that a single U.S. nuclear plant generates anywhere from 500 to 1300 MW^[10].

Trends and Forces

Renewable Energy Legislation Provides Subsidized Growth Opportunities for Ormat's Technology

Governments worldwide have implemented legislation to encourage alternative energy production, due to political pressure from public concerns about climate change, oil prices, and energy independence. Examples include:

• Renewable Portfolio Standards that set varying targets for the amount of energy to be obtained from renewable sources by certain dates have been enacted by 26 states. For example, California (the state with the most major Ormat customers, including Southern California Edison) has targeted reaching 20% renewable energy usage by 2010; Hawaii, the state with Ormat's 2nd largest customer, has targeted 20% by 2020^[11].
• The European Union has stated that its goal is to get 22% of its energy from clean sources by 2010.
• China passed a Renewable Energy Law aiming to raise the total percentage of renewable energy used in the country to 10% by 2020.

Emissions caps and clean energy mandates that are supported by subsidies and tax cuts make geothermal energy relatively cheaper. This makes it likely that corporations and utilities companies will turn to clean energy sources to generate electricity for manufacturing facilities and power plants. Geothermal generation benefits heavily from legislative help because it is a "base-load" power source - it generates a consistent amount of electricity 24 hours a day, seven days a week, 365 days a year, making it ideal for utilities and industrial processes that must run constantly. At an average startup cost of $2500 per kilowatt, however, installation of geothermal plants is very expensive - though once installed, hot water from the earth is free and is reinjected into the ground to be sustainable, and maintenance costs only run $0.01 - $0.03 per kWh^[12]. With coal, the traditional source of base-load power in the U.S., costing $0.02 - $0.03 per kWh^[13], geothermal can be very competitive - especially if initial construction is supported by the government.

Ormat Competes with Oil Companies for Drilling Resources

Ormat doesn't just find an empty patch of ground and throw down a power plant. Geothermal energy companies must engage in exploration for underground resources - underground wells of extremely hot water - much in the same way that oil companies do. Herein lies the catch: aside from making geothermal more attractive as a source of energy, when oil prices are high (in early 2008 they are pushing $100 a barrel) there is increased demand for oilfield services, pushing up dayrates for onshore exploration and drilling contractors like Nabors Industries Ltd. (NBR). Higher dayrates for drilling contractors affect geothermal energy companies as well as oil and gas companies, but geothermal companies can't pass on this cost with higher prices for their products as oil refineries can. Hence, the fall in margins from rising exploration costs offsets some of the increased revenues that companies like Ormat feel when oil prices rise (because of demand shifting to alternative energy). In late 2006, Ormat purchased its own drilling rig in order to offset some of these rising costs; the rig was delivered in mid-2007, but any effects it has had on Ormat's margins have yet to be seen.

Ormat's Power Plants Lack Certain Advantages Held by Traditional Coal and Natural Gas Plants

A city the size of Seattle uses about 1,100 MW of electricity^[14]. A traditional natural gas plant produces an average of 250 MW of electricity, while a traditional coal plant produces 500 MW. Ormat's geothermal plants average 35 MW, less than ideal to generate the electricity needed by the average city. Furthermore, coal and natural gas plants can be placed independently of where their fuels are extracted; coal mined in West Virginia and natural gas drilled in the deepwater off the coast of Brazil can be used in plants in China and Alaska. Ormat's geothermal plants, however, are driven by extremely hot underground water and steam; these hydrothermal resources cannot be extracted and moved, so Ormat's plants are limited to regions where such resources exist, like the Western United States, Hawaii, and Alaska. Though technology does exist to harness the heat generated in the Earth (which, unlike underground water, exists everywhere), Ormat does not currently deal in this "direct-use" technology. Thus, even if coal and natural gas are displaced in the future as the primary sources of base-load power, Ormat's geothermal applications will only be viable replacements in certain geological regions, like countries on the "ring of fire", limiting the company's current technology's long-term growth potential. For example, only about a quarter of the U.S. has enough underground heat to generate electricity from Ormat's current geothermal portfolio^[15].

Rising Energy Prices and Concerns About Emissions Means an Emerging Market for Ormat's Recovered Energy Power Generation Business

Recovered Energy Power Generation (REG) allows electricity to be generated from the excess heat, which would otherwise dissipate into the atmosphere, created in industrial processes. Companies can use Ormat's proprietary REG technology, Ormat Energy Converter (OEC) to increase their energy efficiency, getting more power out of every dollar spent on fuel and cutting relative emissions of greenhouse gases and other pollutants. Furthermore, Ormat doesn't just sell REG facilities, it also builds and operates them, and sells the electricity generated from the "wasted" heat of others to its utilities customers. REG has a wide range of potential applications, from reducing natural gas plants' dependency on electric utilities to increasing the efficiency and lowering the cost of industrial processes, and with output capacities ranging from 200 kW to 22 MW^[16], OEC's potential energy production seems to be an economical way for companies to significantly increase energy efficiency and cut greenhouse emissions.

Ormat's International Operations are Subject to Political Risk

Ormat has major operations in the Philippines, Nicaragua, Guatemala, and Kenya. Currently, there is civil war in Kenya and both the Philippines and Guatemala are privatizing their electric utilities; in the not-too-distant past of 2006, the Nicaraguans were experiencing labor unrest. Furthermore, much of Ormat's production occurs in Israel, a country that is constantly in a state of political unrest due to its disagreements with its neighbors. Damage to the company's Kenyan facilities, increased competition in the Philippines and Guatemala, and terrorist attacks on its production lines in Israel would all cause major damage to the company's revenues and margins.

Competition

Ormat's industry competitors include U.S. Geothermal Inc., Nevada Geothermal Power Inc., Polaris Geothermal Inc., Geothermal Resources Ltd., and Western Geopower Corp. None of these companies are nearly as large as Ormat, so Ormat really competes with other major renewable power generation companies:

• ChevronTexaco (CVX) - With an installed geothermal capacity of 1,273 MW in Indonesia and the Philippines, Chevron supplies 13% of the world's current geothermal energy supply - and is the largest private geothermal energy company in the world^[17].
• Calpine Corporation (CPN) - Calpine is a power company with 24,000 MW of generating capacity, including 60 natural gas powered facilities across the U.S. and 17 geothermal plants in the Northern California Geysers region^[18].

As a producer of renewable energy, Ormat also competes with companies that produce other renewables; because most renewable sources have similar advantages (low pollution, low greenhouse gases, self-renewing), they must compete on scale and cost advantages. Solar power, though more expensive and less efficient than other sources, is currently a leading source of small-scale power, with companies like SunPower, First Solar and Suntech Power Holdings leading the pack. Wind energy is a growing source of renewable large-scale power, though the fact that wind does not blow all the time makes it less reliable than other sources; companies like Suzlon, Gamesa, Vestas and GE Wind are the major players in the wind industry. Other major sources of renewable energy include biofuels, ethanol and cellulosic ethanol, biomass, tidal, and hydrogen. These are all young, though growing, sources of power, giving geothermal, which is already well-established (though limited in scope), a significant head start.

Notes

1. ↑ U.S. Department of Energy, Energy Efficiency and Renewable Energy: Geothermal FAQ
2. ↑ http://www.memagazine.org/mepower03/bbuster/bbuster.html
3. ↑ ORA 10-K 2006, Item 1A, Page 48
4. ↑ Ormat Description of Remote Power Units
5. ↑ ORA 10-K 2006, Item 6, Page 65
6. ↑ ORA 10-K 2006, Item 7, Page 73
7. ↑ Reuters.com, Full Description: Ormat Technologies
8. ↑ Ormat.com Press Release: Ormat Technologies, Inc. Reports Third Quarter 2007 Results
9. ↑ http://library.corporate-ir.net/library/18/181/181999/items/268724/OrmatTechnologiesQ307.pdf
10. ↑ Wikipedia: Watt
11. ↑ Descriptions of State Renewable Portfolio Standards
12. ↑ U.S. Department of Energy, Energy Efficiency and Renewable Energy: Geothermal FAQ
13. ↑ Response to “Costs of Solar to match coal by 2010?”, Richard Graves, April 11th, 2007
14. ↑ http://epw.senate.gov/107th/pat_0914.htm
15. ↑ U.S. Geothermal Resources Map
16. ↑ Ormat.com, Recovered Energy » Our Technologies » The OEC
17. ↑ Chevron Geothermal Website
18. ↑ CPN 2007 10-K, Overview, Page 2

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