Finance 101 For Geothermal Pros
(Image using LoopLink Geothermal Design Software)
The only thing that the geothermal industry needs to worry about is sales. We need more sales. For the most part, we have talented enough engineers and tradespeople to install any project that we could imagine, we just need to sell it first.
In order to sell more, we need to be able to understand the economic benefits of the technology. However, after my attempt to write this article, I can honestly say that it is difficult (compared with solar PV and solar thermal) to accurately calculate the direct financial benefit of ground source heat pumps. I’m not saying it can’t be done, it just takes a lot of work.
This article is a stab at understanding the economics of ground source heat pumps. I wasn’t able to answer all of the questions I wanted to, so I will surely be doing a follow up post on some more specific topics. Also, the basic financial methodologies in this article can provide a solid foundation for anyone interested in advancing the industry. In the end, cash flows and IRRs are cash flows and IRRs.
There are many ways to sell geothermal: it’s more comfortable, especially in cooling mode because it removes a lot of latent heat. There is the foreign oil argument. And then of course, it’s an amazing investment that provides great returns and reduces HUGE fluctuations in energy costs that will happen with other fuel sources. Which argument is the best? Well, that depends on the customer you’re speaking with 🙂
Two of the arguments are subjectively valuable (the comfort and foreign oil arguments) and the other is based on direct economics of the technology. This is not to say that ‘soft’ benefits are worthless. For some customers, they are worth more then direct financial benefit, for others they are not and its all about the $$. However, we can’t put numbers on the subjectives, especially in residential sales. In commercial sales, understanding the raw economics will be critical to the success of any geothermal company.
Understanding the financial implications of a geothermal system is a must for a successful company. You need to understand how to calculate the benefits of the technology, communicate the benefits to clients and understand what the key factors are that will determine a profitable project from a less-profitable project.
This post will help you understand the financial implications of investing in a geothermal system from the clients perspective. It will by no means be an advanced piece but will give good guidance to 1) new professionals to the geothermal industry or 2) companies that are looking to beef up sales.
If you’re new to finance and renewable energy, start by reading the Finance 101 for Renewable Energy Pros piece. All of these analysis assume you can understand the cash investments and savings in a project, performing discounted cash flow analysis, and determine the IRR of the project. The structure of the this post will follow the Finance 101 for Solar PV Pros article.
First, What makes geothermal a little special, and more difficult to perform then other technologies?
The majority of modeling and projections are based on a lot of assumptions. Getting exact measurements in heat loss, heat gain, and the exact cost of a comparable fossil fuel BTU and the cost of a geothermal BTU are all based on models. The models have been getting better, but most are based on a series of assumptions that cannot be measured with 100% confidence. In this way, solar thermal and geothermal are related, and different from solar PV, where exact electric usage can be measured.
In order to calculate the savings from a geothermal system, you need to calculate the cost to deliver a geothermal BTU vs the cost of another BTU. Again, this is based on a lot of assumptions. They are the best assumptions that we have, but I just wanted to be clear that they are not 100% accurate either so it’s always best to be super conservative.
Lastly, installed costs and savings will vary greatly depends on the applications. While geothermal at $9,500 a ton might be a good average, there will be some applications where its $5,000 per ton, and others where it is $15,000 per ton. This is similar in operating savings, geothermal vs oil saves a much larger amount then geothermal vs natural gas. The huge amount of variation makes the economics of the technology hard to average because it’s so specific to each site.
Understanding the benefits of geothermal is really a pain the aXX. The amount of possible scenarios that you can face in each building, heating system, and thus installed and operating costs are truly staggering and are MUCH more numerous then one would deal with in solar PV or SHW. This adds up to a technology that requires lots of time to calculate the benefits.
Understanding the Variables That Impact Geothermal Economics
Before we run through some examples, let’s understand the variables that we need to understand about each installation that will drive the economics of the project.
1. Government Rebates
Residential: 30% ITC for Residential Project. Very straightforward. The owners of the geothermal project will receive 30% of the value of the project in the form of a tax credit that will directly reduce the amount they pay in federal taxes.
Commercial: 10% ITC for Commercial which can be applied in addition to the EPA Act.
Commercial: EPA Act of 2005, Section 179D Tax Deductions: Qualifying energy reducing investments can obtain immediate tax deductions of up to $1.80 per sq. foot. Many specific criteria need to be met from a building perspective, tax perspective, and engineering perspective. Take this free course to learn more. For this article, we’ll use 1.80 per square foot and a corporate tax rate of 20%. It’s possible that a specific system might only receive a $.60 or $1.20 per square foot deduction. The deduction can be used for anything that is directly related to the operation of the geothermal system; loop field, heat pumps, distributions system, pipe, ductwork, etc. For example. The calculation of this is very simple: Building square footage * 1.80 = tax deduction. Tax deduction * corporate tax rate = cash value of the tax credit. If the building was 100,000 square feet * 1.80 deduction per square foot = 180,000 tax deduction * 20% tax rate = $36,000. If you want to learn more about geothermal tax credits, take our free course about geothermal tax credits.
Commercial: MACRS. Same calculation as solar PV, except the basis for commercial geothermal systems is 10%, not 30%. If you want to have a detailed explanation of how to calculate MACRS, see the solar pv financing article.
State, municipal, utility rebates. Utility is common, but the range of rebates very unclear. MassSAVE for commercial electric retrofits is one. As you can see from this utility rebate, the amount of HVAC is “varies widely”. Call your utility is you have any questions. For this sake of this article, we’ll assume that there is no geothermal incentives from state, municipal or utility sources though it’s very likely that there would be.