Tuesday, December 13, 2016

Hot Rocks, Warm Stock

There are ‘high fives’ all around in Iceland these days as well drillers reach unprecedented depths beneath the earth’s surface.  Only this well in southwest Iceland is not seeking oil or gas or even water.  Developers are in a quest to tap exceptionally hot steam for energy generation.  Recently, the well reached five kilometers down where temperatures are over 900 degrees Fahrenheit (near 500 degrees centigrade).  The idea is that by tapping extreme temperatures, more power can be produced with fewer well sites.  Theoretically a well at such great depth could have an energy capacity of 50 megawatts  -  as much as ten times the typical geothermal well.  Additionally, less surface infrastructure would be needed for geothermal energy production.  The reduction in footprint is expected to reduce overall environmental impact as well as reduce capital costs. 

Iceland Geothermal Sites
Iceland is no stranger to geothermal energy.  About a quarter of the country’s total electricity production comes from geothermal sources.  Additionally, there is a significant network for space heating using steam in residential and commercial properties.  This is made possible by a high concentration of volcanoes in Iceland.  The Hellisheidi Power Plant, also in southwest Iceland, is the second largest geothermal power station in the world with a capacity of 213 megawatts of electricity.
The recent project to drill a deep well is made possible by a consortium of government, businesses and scientific organizations.  Iceland’s leading geothermal power producer, HS Orka, is leading the geological work with help from other Iceland power producers, including Landsvirkjun, Okuveita Reykjavikur and Orkustofnun.  Of course the Iceland government is involved along with a group of organizations in the U.S. and Europe.
For investors the most interesting member of the consortium is Statoil (STL: SW or STO:  NYSE), the Norwegian oil and gas developer.  While the company is built on fossil fuels, it has taken considerable interest in renewable energy in recent years.  As oil prices reached new lows Statoil increased its investment in renewable energy.    In February 2016, Statoil launched New Energy Solutions, a new venture capital fund focused exclusively on renewable energy and pledge $200 million in new capital for renewable energy by the year 2022.  The company wasted no time in making good on its promise.  In April 2016, Statoil bought a 50% stake in EON SE’s Arkona wind farm off the Germany shore.  The project is expected to require $1.4 billion in funding and when completed will produce enough power to 400,000 households in Germany.  The collaboration with Iceland’s geothermal experts takes Statoil even further into renewable energy development.
Of course, a stake in Statoil is a roundabout way to channel capital into geothermal energy.  Current revenue and earnings are exclusively generated from petroleum-related business. Importantly, Statoil has begun efforts to make its fossil fuel businesses more sustainable.  In 2014, the company entered into collaboration with General Electric (GE:  NYSE) in projects to reduce the carbon dioxide emissions, reduce water usage and increase fuel efficiency in oil and gas production processes.  The motivation may have been as much for cost savings as environmental benefit.  Either way shareholders benefit.
Recent investment decisions by management have been made in the shadow of lower crude oil prices.  In 2015, Statoil reported a loss for the first time in years as low oil prices eroded sales value.  The company reported USD$67.6 billion in total sales in 2015, well below the previous year.  In the first nine months of 2016, results were similar as the oil and gas sector continued to lurch along with weak markets.  However, Statoil managed to return to profitability and reported positive cash flow of USD$7.0 billion in the first nine months of 2016.
Strength in cash flow generation apparently gave Statoil leadership the confidence to increase the quarter dividend to USD $0.22 per share.  A strong dividend payout is a good reason for a long position in any company.  The fact that Statoil has made plans to transition its business lines to a mix of fossil fuels and renewable energy production could be consolation for those investors who want to avoid unsustainable businesses.     

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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