Is Geothermal Energy Making a Comeback?

Renewed Interest?

Once considered a promising renewable energy source, steep drilling costs hampered geothermal energy development. The energy source, however, is now poised for a breakout and could play a critical role in the Biden administration's plans for a clean energy transition. Interest in the energy source is gaining traction as the Biden administration looks to decarbonize the electric grid, technological innovation lowers geothermal drilling costs, and federal funding helps make expensive geothermal projects more economically viable.

What Is Geothermal Energy?

According to the U.S. Energy Information Administration, geothermal energy taps into heat within the Earth's subsurface from the decay of naturally occurring radioactive isotypes. After drilling miles below the Earth's crust to access high-temperature water reservoirs, geothermal energy is extracted from the subsurface in the form of naturally occurring hot water and steam and used to generate electricity. Because higher temperatures are required to produce electricity, and drilling to the required depth is expensive, most geothermal projects are usually located near tectonic plate boundaries where subterranean heat and hot water can be found at shallow depths.

Geothermal plants typically emit low carbon emissions when generating electricity, releasing primarily excess steam and small amounts of carbon dioxide and sulfur dioxide. In comparison to similarly sized fossil fuel power generation facilities, geothermal facilities emit fewer carbon emissions. In some cases, the difference can be 99% less. The environmental effects and carbon emissions of geothermal energy, however, largely depend on how the energy is extracted or converted into power. Some newer geothermal technologies are designed to reinject the produced steam or water into the geothermal reservoir to mitigate carbon emissions. Other emerging geothermal technologies, such as closed-loop geothermal power plants, emit no carbon emissions.

Outside of being an energy source, some geothermal facilities produce solid materials and brines containing critical minerals, including lithium, zinc, sulfur, and silica. Critical minerals are in high demand throughout many industries and essential to many emerging clean energy technologies. Extraction and resale of these minerals can increase the cost-effectiveness of geothermal production and also provide the critical mineral sector with a more sustainable supply option. 

Geothermal energy production requires relatively low water and land usage. By 2050, the U.S. Department of Energy ("DOE") estimates that the energy source could amount to 8.5% of electricity generation in the United States but only 1.1% of power-sector water withdrawals. Additionally, many of these water withdrawals could use non-freshwater sources. When it comes to land use, geothermal power plants have a smaller footprint compared to other energy sources. 

Current State of Geothermal Energy

Despite leading the world in geothermal electricity generation, only seven states in the United States had operational geothermal power plants in 2022, and they produced less than 1% of the country's total utility-scale generation. Interest in geothermal energy, however, has seen a resurgence, especially from the oil and natural gas industry. 

Although geothermal development still faces many obstacles, such as environmental-,
 permitting-, and capital-related challenges, innovation in drilling technologies and methodologies, largely attributable to the recent U.S. shale boom, has softened the high cost of accessing deeper, hotter rock. Drilling expenditures can amount to more than half of a geothermal project's total cost, and leveraging the petroleum sector's experience will aid the energy source's expansion. While both sectors use similar concepts and techniques to extract energy from the subsurface, there are still major differences in their drilling operations, such as temperature, flow rates, and recovered products.

Where gaps still exist in geothermal exploration and drilling, the federal government is trying to facilitate solutions. The Biden administration wants to exploit geothermal energy and believes it could support the United States in achieving the administration's climate goals. As a result, the DOE is prioritizing the energy source, aiming to reduce the cost of geothermal energy 90% by 2035. This year, DOE announced a funding opportunity of up to $74 million for up to seven pilot projects testing the scalability of enhanced geothermal systems and a $13 million initiative to develop community geothermal heating and cooling systems. Last year, DOE set aside $165 million for geothermal energy deployment, $15 million to improve geothermal drilling rates, and $44 million to advance enhanced geothermal systems. Moreover, Congress passed the Biden administration's Inflation Reduction Act ("IRA"), which includes increases to geothermal federal tax credits.

Geothermal Provisions in the IRA

Geothermal energy projects are eligible for the investment tax credit ("ITC") or the production tax credit ("PTC"). The ITC equates to a percentage of the cost of a project placed into service during the tax year, and the PTC is a per kilowatt-hour tax credit for electricity generated by a qualifying technology. Geothermal electric, direct-use, and heat pump technologies are eligible for the ITC, whereas only geothermal electric technologies qualify for the PTC. The IRA extends the construction commencement deadline for ITC- and PTC-eligible geothermal facilities, allowing tax credits for projects where construction starts before January 1, 2025. If the IRA's requirements on wages and workforce are met, eligible geothermal facilities may qualify for an ITC or PTC that is five times the base credit amount. Geothermal projects may also qualify for additional tax credits if they are constructed in energy communities (e.g., areas with significant fossil fuel-related employment) or in accordance with the IRA's domestic content requirements (including certifying that the project's steel, iron, and other manufactured projects are domestically produced).

In addition to extending the ITC and PTC, the IRA created two additional new federal tax credits, the Clean Electricity Investment Credit ("CEIC") and the Clean Electricity Production Credit ("CEPC"), for projects placed in service after 2024. Although these new tax credits are similar to the ITC and PTC, they are technology neutral and apply to any eligible electricity generation facility. The CEIC applies to investments in eligible zero-emissions electricity generation facilities, and the CEPC applies to eligible electric generation facilities with anticipated emissions rates that do not exceed zero. These tax credits are subject to a phase-out schedule starting in 2032 or when the U.S. Treasury Secretary determines that the country's greenhouse gas emissions from electricity generation are equal to or less than 25% of 2022 levels.

Under the IRA, renewable energy developers may monetize these energy tax credits by transferring them to an unrelated party in exchange for cash compensation. One sale of the tax credits is allowed, and the buyer and seller have no deduction or taxable income. The transferability of these energy tax credits not only benefits existing renewable energy project developers, who often cannot utilize these large income tax credits, but makes renewable energy project development more attractive to unconventional project developers and new market participants. As a result of these changes, geothermal project financing could swell. For additional information on tax credit provisions in the IRA, see Jones Day's White Paper.

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