| Title | An Economic Analysis of Royalties: Application to Geothermal Development |
|---|---|
| Authors | Sam MALAFEH, Basil SHARP |
| Year | 2015 |
| Conference | World Geothermal Congress |
| Keywords | geothermal, economics, property rights, access policy, sustainability, depletion, renewable, free market, royalties, tax |
| Abstract | Sustainable development of renewable resources is aimed at meeting the needs of the current generation while providing for future generations. Under certain conditions, competitive markets may lead to efficient allocation of resources. However, the market simply fails when those conditions are not met. Market failure in taking care of scarce natural resources may be corrected by imposing quantity restrictions, taxation or the use of other economic instruments. Environmental taxes can be used as a depletion charge to encourage wiser planning and use and development of more efficient technologies. About 60 years’ experience in geothermal development for electricity production shows that geothermal resources are not sustainable if extracted rapidly. Although taxes and royalties are used in different countries to charge for externalities, there is no evidence of geothermal royalties or taxes being used to control the depletion rate of geothermal resources. This paper investigates different forms of royalties that can be applied to geothermal developments for electricity generation. An economic model is introduced to test a firm’s reaction to royalty charges and the impact on resource. The result shows that ad valorem royalties can encourage firms to develop the resource in a more sustainable manner. Despite the effectiveness of ad valorem royalties in reducing plant size and depletion rates, they do not offer any incentive to firms to take more efficient and preventive approaches, for instant by investing in new technology. A variable ad valorem royalty was introduced as the ratio of the temperature at time ‘t’ to the original temperature. Application of the variable royalty showed a significant change in firm’s investment planning, with lower depletion, compared to the application of non-variable ad valorem royalties. This royalty scheme is linked to depletion and therefore encourages planning that intends to lower the depletion rate. Indeed, the variable ad valorem royalty penalises those who deplete the resource and rewards those attempting to reduce the depletion rate. |