Renewable Energy Investing, Magma Heating up Geothermal Space
Commodities / Renewable Energy Oct 16, 2009 - 02:01 AM GMT
Today, geothermal represents a tiny piece of the global energy mix, but it is growing rapidly in some western U.S. states and more than 20 other countries where the ground is literally hottest. According to the Canadian Geothermal Energy Association, global geothermal production may triple over the next 10 to 30 years as demand for clean power increases. In this exclusive interview with The Energy Report, entrepreneur extraordinaire Ross J. Beaty talks about how he intends to offer investors a heretofore unavailable opportunity to ride that growth wave, what sparked his interest in the geothermal arena, and where he sees many similarities between mining for metals and capturing the energy from the magma beneath the earth's crust. (Hot water and steam from the magma are piped to the surface to drive turbines to generate electricity). Ross, who has earned himself a sterling reputation and world renown for scratch-building wealth-creating resource companies, is applying his considerable expertise and team of experts to a new enterprise, Magma Energy Corp. The company just went public in a heavily oversubscribed IPO in July.
The Energy Report: You come from a mining background, primarily silver and copper now you've moved to geothermal. What motivated you to jump into the geothermal arena?
Ross Beaty: After having built a number of public mining companies for 23 years, I retired from my silver company in 2007 and sold my copper companies by early 2008. I was looking around for something else to do and I wanted to build a green company. I've always been a closet environmentalist and thought this was a good thing to do with the next part of my life. Then I looked at specific areas where I could use my experience that would work. The more I looked at geothermal, the more I liked it. It is very much like mining.
TER: In what respects?
RB: You're dealing with a subsurface resource. To develop it successfully, you need to move it through early stage exploration, advanced exploration, feasibility, permitting, financing, construction, and then operation. You deal in the same geological environment that you look for gold and silver deposits in and you largely deal in the same countries that I've dealt with through most of my career—North and South America, Pacific Rim and so forth.
So it's an area I am very comfortable with. I understand the science. And as with mining, you need a lot of capital in this business, so public markets are very appropriate. The big difference is that you sell electricity instead of metals.
TER: Some observers considered the IPO of Magma Energy Corp. (TSX:MXY) the hottest deal of the year, with your international book three times oversubscribed. You raised almost double what some experts had expected—and in a tough economic environment. And now, barely three months since, your market cap has more than doubled—from a pre-IPO total in the neighborhood of $200 million to about $450 million. You've also announced an $18.2 million plan to double Soda Lake's gross generating capacity from 11 megawatts to 23 megawatts, presumably using some of the proceeds from your tremendously successful IPO.
RB: Yes. We're already drilling production wells at Soda Lake, and have acquired three geothermal leases on adjacent property—about 13,200 acres—at a U.S. Bureau of Land Management auction. A fourth lease we obtained adds approximately 3,600 acres to our McCoy Hot Springs advanced exploration property. All told, we picked up 67,950 acres on seven leases for just under $2.6 million.
TER: Relatively few companies are making much headway in the geothermal sector, and there seem to be few opportunities for investors despite the drive for cleaner, greener energy.
RB: It's interesting to see who's in the space. Some very large companies—such as Chevron Corporation (NYSE:CVX), MidAmerican Energy and Italy's national energy company, Enel (Ente Nazionale per l'Energia eLettrica)(ENEA) (NYSE:EN; MI:ENEL)—play in that space, but it's impossible for equity investors to buy to get geothermal exposure in those stocks.
At the other end of the spectrum are some very tiny companies, but I don't feel they have the business model necessary to succeed in this business. Before starting Magma, really only one mid-tier geothermal company seemed to be doing it right and that's Ormat Technologies Inc. (NYSE: ORA) with a market cap of just under $2 billion. Ormat produces about 500 megawatts of geothermal power, and was essentially the only go-to stock in the States.
TER: And now we have another one.
RB: Before starting Magma, I thought that if we were really focused, if we put our heads down, applied the same business principles that have worked for me in the past, we could build the world's preeminent geothermal energy company. For an entrepreneur like me, that's a very cool thing to focus on. I felt it was achievable and I'm absolutely determined now to realize that mission.
TER: Ormat is pretty vertically integrated, with a lot of operations and leasing as well as production. Do you envision Magma evolving that way?
RB: No. Ormat isn't really a true pure play on geothermal energy. Ormat produces electricity and it produces technology—it builds very good binary geothermal plants. So it's split in its focus. What I aim to deliver to equity investors is a company that's totally focused on geothermal power. I don't care what technology we use. We simply want to build the biggest, the most profitable, the longest lasting and the best managed company with the best exploration prospects on the planet.
TER: One difference between geothermal and metals seems to be that geothermal relies on serving a smaller, somewhat restricted geographical area. But you've established an international strategy already. For instance, thanks to a recent transaction, Magma now owns 43% of H.S. Orka, a geothermal energy company in Iceland. Could you tell us a bit about your geographic strategy?
RB: Sure. Like mining, geothermal energy is a global business. There are now 250 geothermal plants running in 28 different countries, producing over 10,000 megawatts of power. And as with mining, certain countries are better for geothermal operations than others. When I say better, I mean not only better in terms of resources but more enjoyable places to work—better politically, socially and environmentally. So—again, this is exactly like mining—we screen for all of those things when we look at a potential acquisition.
We've already looked in at least 30 countries for geothermal projects and we've selected two or three. We are currently very active, of course, in the United States, mainly in Nevada. We have properties and very small budgets for Peru and Argentina, but most of our work in Latin America is in Chile, which is a great country for geothermal. And as you mentioned, we've taken a stake in a large producing geothermal plant in Iceland.
The common threads in all of those areas are large opportunities, good profitability for geothermal production and plenty of upside via long-term growth. So those are the sort of things we look for, but we'll be very selective about where we actually end up.
TER: You mentioned early on that the big companies with geothermal operations, such as Chevron, don't really let investors play in the geothermal space per se, and the tiny companies don't have the right business model. Is it your intention to roll up some of those smaller companies to become the dominant player in geothermal?
RB: Our mission with Magma is to build the planet's preeminent geothermal power company. In only one year, including our Icelandic power production, we now produce 86 megawatts of power. That makes us the second-largest company, after Ormat, in the States.
So we've grown quickly already, but we have an awful long way to go. By swinging for the fence, trying to hit a home run and going big, we mitigate one of the biggest negatives in the business. We have lots of assets spread over many different geographic regions, which means less risk in the drilling stage. Size and spread give us better ability to withstand the failure of a dry hole and give us opportunity for many, many successes because we have so many projects in the pipeline.
Going for scale in this business also lowers our cost of capital. Geothermal energy is all about margins. It's a business that can generate very large EBITDA and cash flow. But if you pay too much for capital, you end up giving all of the upside to the providers of capital. That's another one of the negatives that's held back some of the small players in this space. The larger the company, the lower the cost of capital, and the lower the cost of capital, the better the cash flows you get for your shareholders.
Also, as you get bigger in public markets, you generally achieve better multiples. Your company has better liquidity on share markets and your enterprise value to EBITDA ratios are better. You have better access to larger capital pools to sustain your growth. They're all wealth-creating reasons for going big.
TER: So should investors who are intrigued by geothermal's potential area wait for smaller companies to roll up into larger ones? Or do you see any plays in these smaller companies?
RB: I can't speak about the investment qualities of other companies. I can only tell you to look at what Magma has done. We came out of nowhere in early 2008 and have already built a company with 86 megawatts of producing power and in excess of 500 megawatts of confirmed resources on land holdings around the world. We have 25 properties in all stages of development in the geothermal business. With properties in Nevada, Utah, Oregon, Chile, Peru, Argentina and Iceland, Magma has one of the largest property bases of any company in the business. We have a large pool of talent, a world-class management team. We've raised $162 million. I think we also have one of the most liquid stocks in the geothermal industry.
We've had success at advancing our business plan, but we have just begun. Over the next few years, I'm not sure whether we will grow more by acquisition—and there are plenty of acquisition opportunities in the geothermal world—or whether we will grow more by developing our own assets. But if we put our heads down, work hard, focus on adding value to shareholders through discovery, building good projects, operating plants well and buying well, we can deliver great shareholder wealth.
Over time I think you're going to see superior financial performance and superior shareholder returns with Magma.
TER: You mentioned your world-class team. Tell us about some of your people.
RB: The team is world-class, without a doubt. It includes some people I've worked with for years and others who are on board with me for the first time. The President of our U.S. Operations is Dr. Frank Monastero, who supervised development and operation of the 270-megawatt Coso geothermal power project at China Lake, California. Frank has been deeply involved in the industry for more than 20 years.
Monte Morrison, as VP of Operations, has overall responsibility for Magma's domestic and international power plant operations, as well as maintenance and support of development and acquisition activities. During his 24 years in the industry, Monte's managed many geothermal plants in Nevada, California and Hawaii.
Rich Hoops' experience in the geothermal arena dates back even further—34 years. Rich, who worked in various U.S. Department of the Interior agencies and serves now as Magma's Project Manager, probably ranks as the singular expert on geothermal leasing and resource management in the U.S.
It's also great to be working again with some of my colleagues from past enterprises. Sandra Lim, our CFO, for instance, was my CFO at Lumina Copper, too. And John Selters, who ran Lumina's Chilean operations, is now with Magma in that same capacity. It's a great team.
TER: Magma's in its first phase as a growth company. As it matures, could you address whether it might be a dividend-yielding investment?
RB: Absolutely. That's precisely our objective and it can't happen quickly enough! We are in the fast growth years right now. We're putting our shareholders' equity into growth, into expanding our power production, buying new operations, building our business as a long-term, sustainable cash-generating business.
At some point—in the medium term—we will morph into a value investment, an income-generating company that will be valued against other independent power producers, other utilities, other energy generators. We'll be valued based on our cash flow and our income—the financial metrics that measure value in large companies.
As far as I'm concerned, that can't happen too soon because that will be the most tangible symbol of achieving our business plan.
TER: How does Magma's business plan differ from those of your previous companies?
RB: The main difference between geothermal power and the metals business is that geothermal is based on long-term power purchase agreements that are locked in, whereas with metals, you deal with cyclical world markets you can't control. So with geothermal you have long-term sustainable cash flow. Banks love that. It's a business you can leverage up much more significantly than with most mining projects. So once we transition from being a growth stock to a value stock we expect to generate very large cash flows and, obviously, pay significant dividends to our shareholders.
TER: Another big difference between geothermal and mining—and apparently one of the environmental pluses that drew you to geothermal in the first place—is with mining it's typically a depleting resource. With the recycling of water into geothermal reservoirs, in contrast, you'd have a sustainable resource that theoretically could go on forever.
RB: Absolutely. That's a huge difference and it's one of the reasons I love it. All mines ultimately are non-renewable. Geothermal is inherently renewable. This is a form of power that can go on for literally thousands and thousands of years; and once you get these plants going, in terms of human lifetimes, they typically go forever.
The other nice thing about it is that once you pay the high capital cost of developing a geothermal plant, operating costs are typically very low—a fraction of the revenue base of these plants. So, again, the cash flow is very significant.
TER: Pretty exciting. Could you comment on how you expect the space to evolve? For example, back in 2003 and 2004, there were maybe 20 uranium companies. And all of a sudden that became a hot space and by 2007 there were hundreds—500, 600, 700—uranium companies. Do you see this happening in geothermal? Or is it too capital intensive?
RB: As I said before, two negatives at the front end will keep out lots of people. Number one, drill holes are expensive and high-risk. It has better odds than in the mining industry, but there is still significant drilling risk.
Number two, the capital costs to go to production in geothermal energy are quite high, about $4 million per megawatt. That keeps out an awful lot of entrants, so you're not going to see the proliferation of companies the way you saw in the uranium business. Having said that, in due course you will likely see more companies in this space and I think that's great—because ultimately they'll be feeder companies for us to acquire if they're successful.
TER: Tell us about a few companies outside the geothermal arena that you're still keeping an eye on.
RB: Well, 95% of my time is really on building Magma right now. It's the focus in my life. But I'm still a large investor in the Lumina Group, a tremendous management team that worked with me to successfully acquire and divest our four copper companies in 2006–2008. We've put money into Anfield Nickel Corp. (TSX-V:ANF), which I think has a lot of upside, and Ventana Gold Corp. (TSX:VEN), one of the top performing companies this year in Canada. And I've personally invested in a number of copper companies because I happen to like the future of copper.
TER: So you still like copper.
RB: Yes. Actually, copper is an energy metal as much as geothermal is an energy source. Copper has a great future because it's the second-most conductive metal, with incredible applications in energy transmission and generation. What's mostly driving copper right now is the build-out of China's energy infrastructure. So I still like the copper space. And I'm still very much into silver.
TER: Of course. You're still chairman of Pan American Silver Corp. (TSX:PAA; NASDAQ:PAAS), and that's a terrific story, described earlier this year as one of the best success stories to come out of Vancouver in the past 30 years.
RB: Really, the model for what I'm doing in Magma is Pan American's. It's a great model for me to use in Magma's growth.
TER: Any parting comments, Ross?
RB: As I said, Magma is the focus of my life, but I love copper. I love silver, I love gold. And on the whole, I'm very bullish about most commodities. The world is still growing very actively and the consumption of commodities is growing very significantly. We are in a long-term commodity bull market that will stay with us for quite a few years.
TER: Our readers will appreciate your insights and we look forward to watching another of your dreams come true.
RB: It's all about creating shareholder wealth and part of that is making sure people understand what you're doing and where you're going. So I sure appreciate your interest, this will help in getting us there.
DISCLOSURE: Ross Beaty
I personally own all of the companies mentioned in this interview.
Ross J. Beaty is a geologist and eminent entrepreneur who currently serves as Chairman and CEO of Magma Energy Corp. and Chairman of pure-play silver giant Pan American Silver Corp. He founded Magma in 2008 and Pan American in 1994. He also founded and divested a number of other public mineral resource companies—including Da Capo Resources Ltd., a gold exploration company with properties in Bolivia, and Altoro Gold Corp., a gold and platinum exploration company with projects in Bolivia and Brazil. All of them left their mark on the industry and created substantial stockholder wealth. While still actively running Pan American, copper captured Ross' attention. In 2002, when copper prices were on the upswing for the first time in several years, he started acquiring properties through Lumina Copper Corp. and watched copper climb from 80 cents to $4 per pound. In 2005, Lumina split into four publicly traded companies, Regalito Copper, Northern Peru Copper, Continental Copper and Lumina Resources. Bottom line: parlaying an $80 million investment into a $1.2 billion profit.
Born in Vancouver, Ross has degrees from the Royal School of Mines, University of London, (M.Sc., Distinction in Mineral Exploration, 1975), the University of British Columbia (LL.B. [Law] 1979 and B.Sc. [Honors Geology] 1974). Working in 50-plus different countries during the course of 37-plus years in the international minerals industry, he speaks English, French and Spanish, as well as some Russian, German and Italian.
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