Electricity from the depths of Africa
Conditions around the East African Rift Valley are ideal for using geothermal energy. Munich Re has developed a new policy to cover the exploration risk and to help ensure that sufficient investors can be found for such sustainable power generation projects.
Deep down inside, the earth is boiling and bubbling – volcanoes, geysers and hot springs are a constant reminder of this. The deeper we go towards the earth’s core, the hotter it becomes, with temperatures reaching around 5,000°C at the centre. Geothermal energy technology harnesses this immense potential. It attempts to locate hot strata in the earth’s crust by drilling exploratory wells at suitable points in order to use the thermal energy present there. Hydrothermal technology uses water or steam from deep hot reservoirs. The primary advantage of geothermal energy over other renewable energy sources is its permanent availability, regardless of weather conditions, time of day and seasons, and therefore its ability to provide base load power.
Geothermal heat offers an immense reservoir of base load energy. However, the early drilling phase for project companies and investors is the most difficult one: if the targeted geothermal reservoir is unable to produce enough output, the project is usually discontinued and the investment is lost. Geothermal projects are therefore difficult to finance. With its Multi Well Exploration Risk Insurance, Munich Re covers the resource risk and helps ambitious projects to be realised. Munich Re’s solution offers various advantages for investors and operators. For investors, the availability of exploration risk insurance makes investments in deep geothermal energy projects considerably safer, more plannable and more attractive. Similarly, operators are in a better position to convince investors of the feasibility of ambitious projects and get them launched, since Munich Re, as a technically experienced and financially sound partner, will assume the risk of unsuccessful exploration.
The risk: Unsuccessful exploration
The main downside of this technology are the enormous initial investment costs of exploration and drilling. The venture only pays off if sufficiently hot and plentiful water reservoirs are actually found. If not, the plants cannot be built or deliver the expected power. Experience has shown that the risk of unsuccessful exploration is not to be underestimated. Uneconomical operation of geothermal plants is a risk that project owners and investors must always consider, despite all their costly preparations and investigations. Munich Re has long promoted renewables as a carbon-free alternative to fossil fuels and has supported geothermal projects since 2004 in its role as an insurer. And now we have developed innovative insurance solutions for deep geothermal ventures. A new project insured in Kenya (Akiira) extends our portfolio to high enthalpy, a field which focuses on power generation. Hot steam is recovered from the depths and used to drive a turbine to generate electricity. Very hot water reservoirs are needed for this purpose; ideally, the water should have a temperature of several hundred degrees Celsius. The world’s hottest geothermal reservoirs with a temperature of 420°C are to be found in Larderello in Tuscany, where steam has been used since 1904. Such reservoirs are primarily found in regions of tectonic activity, such as along the Pacific Ring of Fire (see world map above), in Mexico, Southeast Asia, Turkey and the East African Rift Valley. The reservoirs in this area are located at moderate depths of 1,500 to 3,000 m and can hence be accessed relatively easily for economically viable exploitation. On average worldwide, the temperature increases by only about 3°C for every 100 m into the earth’s crust, with the result that exploratory wells in less favourable areas usually have to be drilled to depths of more than 4,000 m in order to reach economically viable reservoirs.
Insurance covers a minimum yield
For the Kenyan project, Munich Re has implemented a new coverage concept with its Multiple Well Risk Insurance: unlike the case in low-enthalpy regions, such as Germany, the projects comprise a portfolio of several production and injection wells instead of a doublet with just two wells. The minimum energy yield of a complete portfolio of wells is consequently insured in several project phases. Parameters are agreed for each phase between Munich Re and the project; these determine whether the project is to be aborted as being unsuccessful, thus triggering an insurance payment – or whether the promising results achieved merit continuation to the next phase. The process involves a close exchange of information and alignment of interests between Munich Re and the project. An advantageous concept for both sides: balancing the higher risk at the beginning against the lower risk in later phases makes the project insurable and provides investors with comprehensive security for the entire project term. The option of an early exit in the event of failure also serves the interests of both parties, as it limits the investors’ risk of financial loss. A total of eight wells are insured in Kenya, with sets of two or four combined into one phase. Wells are deemed to be productive when the average energy output from all holes taken together reach a previously defined output. This ensures that the more productive wells balance out those with lower output. If the wells’ output is lower than expected, stimulating measures to prevent losses are jointly considered and implemented where appropriate (see diagram on page 26). If the average output reaches – or even exceeds – the reference value, the next set of two or four wells can also be drilled. When all eight wells have been completed, the total output will be compared with the overall target agreed in the policy. Only then is the project deemed to have been successful or not. Ensuring that the insured wells achieve the desired result serves the interests of both the policyholder and Munich Re. However, if they prove unproductive in the initial phase, despite all possible stimulating measures taken, the partners can exercise an exit option. If the very first wells drilled do not deliver the minimum energy yield, it is highly likely that the project as a whole will fail to deliver as expected. Continuing under such conditions would mean both parties incurring high costs that they would prefer to avoid. On the other hand, part of the premium may be refunded if the project proves more successful than assumed. Premiums are calculated individually for each project. The first step is to assess the project operator’s risk; this is then compared with our own assumptions, modified if necessary and transferred to a pricing model. Numerous parameters are taken into account, including the geological conditions in the region, data from adjacent fields and existing wells, as well as the policyholder’s particular needs. Our risk analysis and the subsequent exploration risk insurance play an important part in proving the project’s technical and financial security and hence assuring its financial feasibility. It is frequently only possible to acquire private investors or capital providers for geothermal projects during the planning phase if the project is insured against failure. Exploration risk insurance exclusively covers the minimum energy yield needed to operate a power plant in the first place. The insurance does not cover the risk that the plant will not achieve the cost-efficiency and return on investment expected by the investors or capital providers during its subsequent operation.
Kenya increasingly relying on geothermal energy
The chances are good that the insured Kenyan project will achieve the targeted power plant capacity of 70 MW electricity by the end of 2018. 500 MW from geothermal projects are already installed at the neighbouring Olkaria field, just a few kilometres away. Geologists confirm that the potential for using geothermal energy is high in the area around the East African Rift Valley. The Kenyan government is promoting geothermal projects to cover the growing demand for electric power. According to Kenya’s national electricity company, the rising supply of electricity has already caused prices for private and commercial customers to fall by more than 30% since August 2014 (source: World Bank). The current project is financed by local and international companies, which also receive funds from the development bank KfW, and others.
Fund model in Mexico
This model, which attracts investors at an early stage with the aid of insurance, will also become popular in other countries, too. In Mexico, for instance, Munich Re has launched a similar programme together with the Energy Ministry, the development bank NAFIN and the Inter-American Development Bank. What distinguishes this programme is that Munich Re’s exploration risk insurance has been enhanced to form a unique complete financial package for project developers:
- Liability for the first commercial, non-insurable exploratory wells is transferred to a risk fund financed by the Inter-American Development Bank and Clean Technology Fund. Munich Re takes over liability for the subsequent wells.
- The insurance premiums for these exploratory wells are partly subsidised by a premium subsidisation fund financed by the Energy Ministry.
- The development bank NAFIN grants the projects a package of low-interest loans to finance all phases of the project; commercial banks would be unable to offer a package in this form.
Ultimately, all parties profit from such a public-private partnership, as it gives investors an attractive and comprehensive “turnkey” liability and finance package; at the same time, it opens the door to geothermal projects in so far unexplored regions.