Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
INFORMATION REGARDING FORWARD LOOKING STATEMENTS
This document contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve a number of risks and uncertainties. We caution readers that
any forward-looking statement is not a guarantee of future performance and that
actual results could differ materially from those contained in the
forward-looking statement. These statements are based on current expectations of
future events. You can find many of these statements by looking for words like
"believes," "expects," "anticipates," "intend," "estimates," "may," "should,"
"will," "could," "plan," "predict," "potential," or similar expressions in this
document or in documents incorporated by reference in this document. Examples of
these forward-looking statements include, but are not limited to:
º our business and growth strategies;
º our future results of operations;
º anticipated trends in our business;
º the capacity and utilization of our geothermal resources;
º our ability to successfully and economically explore for and develop
geothermal resources;
º our exploration and development prospects, projects and programs, including
construction of new projects and expansion of existing projects;
º availability and costs of drilling rigs and field services;
º our liquidity and ability to finance our exploration and development
activities;
º our working capital requirements and availability;
º our illustrative plant economics;
º market conditions in the geothermal energy industry; and
º the impact of environmental and other governmental regulation.
These forward-looking statements are based on the current beliefs and
expectations of our management and are subject to significant risks and
uncertainties. If underlying assumptions prove inaccurate or unknown risks or
uncertainties materialize, actual results may differ materially from current
expectations and projections. The following factors, among others, could cause
actual results to differ from those set forth in the forward-looking statements:
º the failure to obtain sufficient capital resources to fund our operations;
º unsuccessful construction and expansion activities, including delays or
cancellations;
º incorrect estimates of required capital expenditures;
º increases in the cost of drilling and completion, or other costs of
production and operations;
º the enforceability of the power purchase agreements for our projects;
º impact of environmental and other governmental regulation, including delays
in obtaining permits;
º hazardous and risky operations relating to the development of geothermal
energy;
º our ability to successfully identify and integrate acquisitions;
º our dependence on key personnel;
º the potential for claims arising from geothermal plant operations;
º general competitive conditions within the geothermal energy industry; and
º financial market conditions.
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All subsequent written or oral forward-looking statements attributable to us or
any person acting on our behalf are expressly qualified in their entirety by the
cautionary statements contained or referred to in this section. We do not
undertake any obligation to release publicly any revisions to these
forward-looking statements to reflect events or circumstances after the date of
this document or to reflect the occurrence of unanticipated events, except as
may be required under applicable U.S. securities law. If we do update one or
more forward-looking statements, no inference should be drawn that we will make
additional updates with respect to those or other forward-looking statements.
The U.S. dollar is the Company's functional currency; however some transactions
involved the Canadian dollar. All references to "dollars" or "$" are to United
States dollars and all references to $ CDN are to Canadian dollars.
General Background and Discussion
The following discussion should be read in conjunction with our unaudited
consolidated financial statements for the period ended December 31, 2009 and
notes thereto included in this report.
U.S. Geothermal Inc. ("the Company") is a Delaware corporation. The Company's
common stock trades on the Toronto Stock Exchange under the symbol "GTH" and on
the NYSE Amex LLC under the trade symbol "HTM."
For the quarter year ended December 31, 2009, the Company was focused on:
1) optimizing the operation of the wellfield at the Raft River, Idaho
geothermal project ("Raft River Unit I");
2) planning and permitting for drilling at the Gerlach Joint Venture;
3) planning and permitting drilling and field development activities at
Neal Hot Springs in Oregon;
4) finalizing and executing the PPA for the Neal Hot Springs Project and
negotiating a PPA for the San Emidio Repower Project;
5) optimizing the operation of the San Emidio (formerly Empire) power plant
in Nevada, and planning for repowering the existing plant;
6) continuing due diligence for the Department of Energy Section 1703 loan
guarantee program for the Neal Hot Springs Project; and
7) the evaluation of potential new geothermal project acquisitions.
Project Overview
The following is a list of projects that are in operation, under development or
under exploration. Projects in operation have producing geothermal power plants.
Projects under development have at least a geothermal resource discovery or may
have wells in place, but require the drilling of new or additional production
and injection wells in order to supply enough geothermal fluid sufficient to
operate a commercial power plant. Projects under exploration do not have a
geothermal resource discovery occurrence yet, but have significant thermal and
other physical evidence that warrants the expenditure of capital in search of
the discovery of a geothermal resource. Due to inflation and marketplace
increases in the costs of labor and construction materials, previous estimates
of property development costs may be low.
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Projects in Operation
Generating Contract
Project Location Ownership Capacity Power Expiration
(MW)(1) Purchaser
Raft River (Unit I) Idaho JV(2 ) 13.0 Idaho 2032
Power
Company
San Emidio (Existing) Nevada 100% 3.6 Sierra 2017
Pacific
Power
Corp.
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(1) Based on the designed annual average net output. The actual output of the
Raft River Unit I plant currently varies between 7.1 and 10.0 megawatts and
output of the Empire plant is approximately 2.6 megawatts.
(2) As part of the financing package for Unit I of the Raft River project, we
have contributed $16.5 million in cash and approximately $1.5 million in
property to Raft River Energy I LLC, the Unit I project joint venture
company. Raft River I Holdings, LLC, a subsidiary of The Goldman Sachs
Group, contributed $34 million to finance the construction of the project.
Additional investment may be required for Unit I to operate at design
capacity.
Projects Under
Development
Target Projected Capital
Development Commercial Required Anticipated
Project Location Ownership (MW) Operation ($million) Power
Date Purchaser
San Emidio Nevada 100 5.4 4th $30 NV Energy
(Repower) Quarter
2011
San Emidio Nevada 100 26 3rd $127 TBD
(Expansion) Quarter
2012
Neal Hot Springs 1 Oregon 100 22 2ndQuarter $121 Idaho Power
2012
Neal Hot Springs Oregon 100 28 3rd $154 TBD
II Quarter
2013
Raft River I Idaho JV 3 3rd $7 Idaho Power
(Repower) Quarter
2010
Raft River (Unit Idaho 100 26 4th $134 Eugene
II) Quarter Water
2013 and
Electric
Board
Raft River (Unit Idaho 100 32 2nd $166 TBD
III) Quarter
2015
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Additional Properties
Project Location Ownership Target Development (MW)
Gerlach Nevada 60% To be determined
Granite Creek Nevada 100% To be determined
Resource Details
Resource
Property Size Temperature Potential
Property (square miles) (°F) (MW) Depth (Ft) Technology
Raft River 10.8(1) 275-302(2) 127.0(1) 4,500-6,000 Binary
San Emidio 35.8 289-305(2) 68.0(4) 1,500-2,000 Binary
Neal Hot Springs 9.6 311-347(3) 50.0(5) 2,500-3,000 Binary
Gerlach 5.6 TBD 18.0 TBD Binary
Granite Creek 8.5 TBD 25.0(6) TBD Binary
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(1) A third party resource assessment of 94 MW was based on 6.0 square miles.
The Company acquired additional acreage. The resource estimate of 127.0 MW
is an internal estimate.
(2) Actual production temperatures for existing wells.
(3) Probable reservoir temperature as measured with a geothermometer.
(4) A third party resource estimate with respect to 49.0 MW, remainder is an
internal estimate.
(5) A third party resource estimate with respect to 22.0 MW, remainder is an
internal estimate.
(6) Internal estimate.
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Raft River Update
Raft River Energy Unit I is located in Idaho and has a 13 megawatt geothermal
power plant in operation.
In early January 2009, production well RRG-7 underwent a temperature decline
that has reduced the inlet fluid temperature to the power plant by approximately
4 degrees Fahrenheit. At the same time of the temperature change, fluid flow
increased. Power generation has been reduced by an estimated 1megawatt due to
the lower temperature fluid. It was determined that the cement in a lap joint
had failed and a mechanical packer was installed to reduce the cold water
inflow, but was unsuccessful. A remediation program is planned that will
"squeeze" cement into the lap joint and plug off the cold water flow to return
the well temperature and increase power plant generation.
Raft River Unit I operated through the third quarter at 99.1 percent
availability and generated in a range of 7.7 to 9.9 net megawatts during the
three month period averaging 8.8 megawatts. The reduction in output for the
period compared to the planned generation was due to the loss of temperature
from production well RRG-7.
In the second calendar quarter of 2010, we anticipate commencement of drilling
in order to increase Unit I's net generation to the plant's 13MW nameplate
capacity. We anticipate that drilling will be complete in the third calendar
quarter of 2010 with an anticipated capital cost of $7 million.
As shown in the table above, Raft River Unit II is anticipated to cost
approximately $134 million and Raft River Unit III is anticipated to cost
approximately $166 million, 75% of which we believe may be funded by a
Department of Energy loan, with the remainder funded through equity financing.
Raft River Unit II is anticipated to begin construction in the fourth calendar
quarter of 2010 with commercial operations commencing in the fourth calendar
quarter of 2013. Raft River Unit III is anticipated to begin construction in the
first calendar quarter of 2014 with commercial operations commencing in the
second calendar quarter of 2015.
Raft River Operating Agreement
We hold a 50% interest in Raft River Energy I LLC, which owns Raft River Unit I
("Unit I"). Construction of Unit I required substantial capital, and partnering
with a co-venturer allowed us to share the risks of ownership. The joint venture
has also allowed the project to take advantage of production tax credits which
would not otherwise have been available to us. When Unit I operates at full
capacity of 13 megawatts, we estimate we will receive cash payments totaling
approximately $1.6 million for the first four years of its operations. While
Unit I generates at less than full capacity, our annual cash payments from the
Raft River I project will be lower. See Note 4 "Investment in Subsidiary" in the
financial statements for detail of cash payments from RREI.
The Company's interests in the RREI as defined in the partnership agreements are
summarized as follows:
Years 1 - 4 Years 5 - 10 Years 11 - 20 Years 20 - 25
RECs 70% (1)
GAAP Income 1% (2) 49% 80%
Lease 100%
Cash Flow Payments, O&M
Services &
Royalties
Distributions Guaranteed min. 1% (3) 49% 80%
payment
Tax Benefits 1% (2) 49% 80%
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(1) U.S. Geothermal allocates 70% of income and receives 70% of available
cash from RECs sold to third- parties. After year 10, REC income is
shared with Idaho Power Co. For additional details, see U.S.
Geothermal's Form 10-Q filed on August 10, 2009 (Exhibit 10.36).
(2) Flip to next tier occurs after the later of 10 years or Raft River I
Holdings' target IRR is achieved.
(3) Flip to next tier occurs after Raft River I Holdings' target IRR is
achieved.
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Neal Hot Springs Update
Neal Hot Springs is a promising geothermal resource located in Eastern Oregon.
On February 26, 2009 U.S. Geothermal submitted an application for the Neal Hot
Springs project to the DOE's Energy Efficiency, Renewable Energy and Advanced
Transmission and Distribution Solicitation loan guarantee program under Title
XVII of the Energy Policy Act of 2005. The Company was notified that its project
application is complete, the power plant technology choice qualifies as new or
improved under the program, and the project has been selected to proceed in the
project loan process.
Although we have not yet received approval, the DOE loan is expected to provide
up to 80% of the $121 million estimated capital cost of Stage I up to a maximum
loan amount of $107 million. The capital cost has increased to $121 million from
prior estimates of $106 million due to costs of labor, updated vendor pricing
and construction materials. Detailed design of a binary cycle power plant
utilizing significantly improved technology is currently in progress with
construction expected to begin in mid 2010. The new plant, designed to deliver
approximately 22 megawatts ("MW") of power net to the grid is scheduled to begin
commercial operations in early 2012. The DOE loan is anticipated to be a
combined construction and term loan and provide the project with a low cost
annual interest rate. We expect that we will be required to drill up to 8 wells
as a condition precedent to drawing on the DOE loan, if it is approved.
At our Neal Hot Springs project, an infill geophysical program was carried out
to increase the density of data to highlight suspected geologic targets and
structures. Applications for four additional exploration wells to further
delineate the geothermal resource with production and injection targets were
approved by the state of Oregon on September 11, 2009 and drilling of the second
production well, NHS-5, began on September 18, 2009. October 15, 2009, the
Company successfully completed well NHS-5, the second full size production well
at the Neal Hot Springs project located in eastern Oregon. NHS-5 encountered
several lost circulation zones within the targeted horizon and intercepted a
large aperture fracture at 2,796 feet resulting in a total loss of circulation.
The well was completed to a depth of 2,896 feet. An initial 16 hour flow test
completed using air lift produced fluid at a rate of 1,500 gallons per minute
and resulted in a down hole flowing temperature of 286º F (141º C).
The reservoir-hosting fracture zone intersected in NHS-5 is 509 feet deeper in
the geologic system than the large producing fracture intersected by NHS-1 which
is located approximately 600 feet to the southeast. Both wells were instrumented
with pressure and temperature equipment during the flow test. Geologic
information and flow data from the drilling and flow test has been incorporated
into the ongoing development of a reservoir model of the Neal Hot Springs
geothermal system.
In addition to the drilling program for production-sized wells, the company has
continued a temperature gradient ("TG") drilling program utilizing a small
diameter drill hole. Nine TG holes ranging in depth from 500 to 1,060 feet have
been completed, and are providing valuable temperature gradient data for the
overall area that hosts the Neal Hot Springs reservoir. Currently, another five
to eight TG holes will be drilled with a number of the holes planned to reach a
depth of 2,000 feet as the size of the geothermal anomaly is defined.
The Company received the Conditional Use Permit from the Malheur County Planning
Commission for construction of its proposed 22 net megawatt power plant at Neal
Hot Springs in eastern Oregon. The Conditional Use Permit received unanimous
approval at a September 24, 2009 Planning Commission meeting and was issued on
October 28, 2009. All of the Federal Energy Regulatory Commission ("FERC")
mandated transmission studies have been completed by Idaho Power Company. An
interconnection agreement was signed with the Idaho Power Company in February
2009. Private right-of-ways for the transmission line have been acquired and
preliminary engineering designs have been initiated as well as surveying of the
route.
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The power purchase agreement ("PPA") for the project was signed on December 11,
2009 with the Idaho Power Company. The PPA has a 25 year term with a starting
price of $96 per megawatt-hour and escalates at a set percentage annually. Idaho
Power Company submitted the PPA to the Idaho Public Utilities Commission on
December 28, 2009. IPUC approval is expected within 60-90 days from the date of
submittal.
The total development cost of Neal Hot Springs Stage II is anticipated to be
$154 million. Construction is anticipated to begin in the third quarter of 2011
with commercial operations commencing in the third quarter of 2013.
San Emidio Update
The San Emidio geothermal power plant has been producing power since 1987 and
sells electricity to Sierra Pacific Power Corporation under an existing power
purchase agreement that extends through 2017. Deeper wells with higher
temperatures were drilled in 1994 to supply the plant after output declined due
to cooling of the original, shallow production wells. The current configuration
of the plant consists of four 1.2 gross megawatt Ormat Energy Converters
("OEC"), five production wells (two wells in use and three on stand by), and
four injection wells (three wells in use and one on standby). A cooling tower
was added in 1998 to improve summer peak power generation. Power sales from the
San Emidio plant for the quarter averaged 2.2 megawatts.
A System Feasibility Study was initiated with Sierra Pacific Power Corporation
to begin the FERC mandated transmission study process for the San Emidio
replacement in July 2008. The study is examining two levels of power generation,
15 megawatts and 45 megawatts, several transmission routes and the costs
associated with each level of generation. The System Impact Study, the second
phase of interconnection study process, was completed in July and confirmed that
the existing transmission system was able to handle up to 15 megawatts of
transmission. Subsequent to the end of the quarter, the third phase study, the
Interconnection Facilities Study for the 15 megawatt option, was completed in
October. A draft interconnection agreement is expected from Sierra Pacific Power
before the end of the first calendar quarter of 2010.
On October 30, 2009, the Company was awarded $3.77 million in Recovery Act
funding for the exploration and development of its San Emidio geothermal power
project using advanced geophysical exploration techniques. This award was
categorized under the "Innovative Exploration and Drilling Projects" section of
the American Recovery and Reinvestment Act. The project at San Emidio will apply
innovative, seismic and satellite imagery techniques along with state-of-the-art
structural modeling, to locate large aperture factures that represent
high-productivity geothermal drilling targets.
The San Emidio expansion will take place in two phases, repower and expansion.
The repower will utilize the existing wells with a new, more efficient power
plant. As shown in the table above, the repower is anticipated to cost
approximately $30 million and the expansion is anticipated to cost $127 million,
75% of which we believe may be funded by a Department of Energy loan, with the
remainder funded through equity financing. The repower phase is anticipated to
begin construction in the first calendar quarter of 2010 with commercial
operations commencing in the fourth calendar quarter of 2011. The expansion
phase is anticipated to begin construction in the second calendar quarter of
2010 with commercial operations commencing in the third calendar quarter of
2012. The Company hopes to utilize Investment Tax Credits in connection with
both the repower and the expansion. Both phases will require an amendment to the
Sierra Pacific Power Purchase Agreement.
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Granite Creek Update
The Granite Creek assets are comprised of three BLM geothermal leases totaling
approximately 5,414 acres (8.5 square miles) located about 6 miles north of
Gerlach, Nevada along a geologic structure known to host geothermal features
including the Great Boiling Spring and the Fly Ranch Geyser. A first stage
gravity geophysical program was completed in the third quarter of 2008 and will
be used to evaluate the resource potential, and help determine where to drill
temperature-gradient exploration wells.
Regulatory Update
In January 2009, Congress extended the federal production tax credit ("PTC") for
renewable energy power plants for all projects initiating commercial production
prior to December 31, 2013. The PTC enhances the annual revenues of the projects
by about 25 percent per year for the first 10 years. Additionally, Congress
provided that for power plants that begin construction before the end of 2010,
the Company may elect to use the 30% Investment Tax Credit ("ITC") in lieu of
the PTC. Application for the cash ITC payment may be made 60 days after the
start of commercial generation and would be paid directly from the Department of
Treasury.
Operating Results
For the three months ended December 31, 2009, the Company reported a net loss of
$1.4 million dollars ($0.02 loss per share) which represented a 54% increase
over the same period in 2008. Notable favorable variances were noted in energy
sales at San Emidio and land, water and mineral rights leases. Unfavorable
variances were noted in corporate administration and development, professional
and management fees and plant operations at San Emidio.
For the nine months ended December 31, 2009, the Company reported a net loss of
$4.3 million dollars ($0.07 loss per share) which was fairly consistent with the
same period in 2008. A notable favorable variance was noted in travel and
promotional costs. Unfavorable variances were noted in the reduction in the gain
from investment in one of the Company's subsidiaries Raft River Energy I, LLC
("RREI"), and professional and management fees. For the San Emidio plant, some
of the performance improvements realized during the first six months of 2009
were reduced by high costs incurred in the last quarter ended December 31, 2009.
Travel and Promotional Costs
For the three months ended December 31, 2009, no significant variance was noted.
For the nine months ended December 31, 2009, the Company's travel and
promotional costs decreased $249,697 (54.0%) as compared to the same period in
2008. Overall, the Company reduced its travel and promotional budget for the
2009-10 fiscal year. A notable cost savings of $175,000 was realized by
canceling services for investor relations services provided by MJD Media LLC.
Gain on Investment in Subsidiary (Raft River Energy I, LLC)
The Company's portion of the net operating loss of RREI for the nine months
ended December 31, 2009 was a gain of $234,124 ($92,981 for the three months).
RREI's net operating loss was $1,966,047 for the nine months ended December 31,
2009, which was $1,953,687 higher than loss from the same period in 2008. This
was primarily due to both planned and unplanned maintenance and repairs that led
to lower revenues and increased costs. The entire plant was shut down for
planned maintenance from April 1, 2009 to April 13, 2009 to replace a turbine
damaged during startup. The shut down reduced energy production for that time
period. Overall, energy revenue was down approximately $609,000 for the nine
months ended December 31, 2009 from the same period in 2008. In addition to the
shut down, production was down due to loss in temperature as a result of a lap
joint leaking at one production well and two pump failures. Repair costs were
incurred due to a pump failure and issues related a leak in a production pump
column that exceeded $1.4 million. The pump repairs are believed to have been
substantially complete at September 30, 2009. Chemical treatment cost savings of
approximately $680,000 was realized for the nine months ended December 31, 2009
