Good morning, and welcome to the Ormat Technologies third quarter 2022 earnings conference call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. If you would like to ask a question, please press star one on your telephone keypad. Please note that this event is being recorded. I would now like to turn the conference over to your host, Sam Cohen with Alpha IR. Please go ahead.
Thank you, operator. Hosting the call today are Doron Blachar, Chief Executive Officer, Assi Ginzburg, Chief Financial Officer, and Smadar Lavi, Vice President of Investor Relations and ESG Planning and Reporting. Before beginning, we would like to remind you that information provided during this call may contain forward-looking statements relating to current expectations, estimates, forecasts, and projections about future events that are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally relate to the company's plans, objectives, and expectations for future operations and are based on management's current estimates and projections future results or trends. Actual future results may differ materially from those projected as a result of certain risks and uncertainties.
For a discussion of such risks and uncertainties, please see risk factors as described in Ormat Technologies' annual report on Form 10-K and quarterly reports on Form 10-Q that are filed with the SEC. In addition, during the call, the company will present non-GAAP financial measures, such as Adjusted EBITDA. Reconciliations to the most directly comparable GAAP measures and management reasons for presenting such information is set forth in the press release that was issued last night, as well as in the slides posted on the website. Because these measures are not calculated in accordance with GAAP, they should not be considered in isolation from the financial statements prepared in accordance with GAAP.
Before I turn the call over to management, I would like to remind everyone that a slide presentation accompanying the call may be accessed on the company's website at ormat.com under the presentation link that's found on the Investor Relations tab. With all that said, I would like to now turn the call over to Doron. Doron, the call is yours.
Thank you, Sam, and good morning, everyone. Thank you for joining us today. Ormat's third quarter operating performance and financial results demonstrated strong growth to our consolidated top line, driven by continued momentum in our electricity and energy storage segment, along with a notable improvement in our product segment. This marked our fourth consecutive quarter of revenue growth, which continues to expand both operating and net income, which grew by 8.1% and 21.5% respectively. We are seeing positive momentum and progress in line with our strategic initiative, which is evidenced by solid growth across our three business segments. The significant milestones we have reached since the beginning of this year with the addition of 73 megawatts of new capacity, supported the continued growth in our electricity segment.
Additionally, newly signed contracts within the product segment have improved our margins while simultaneously strengthening our backlog by 150%. After the prolonged impact of the COVID-19 pandemic on our product segment, we are pleased to see this positive trend in development and the momentum that it is creating across the business. In the storage segment, we continue to capture the benefits from high energy prices in all of our markets as we advanced our strategy of building an energy storage portfolio balanced between contractual, fixed revenue, and merchant exposure. We recently signed a 15-year PPA, which I will elaborate on later in the call. We expect the positive momentum in our storage segment to continue in 2023 as we benefit from the regulatory tailwind created by the Inflation Reduction Act and the availability of ITC credits for storage projects.
We continue to see strong global tailwinds from renewables, specifically in the US and Indonesia. The elevated global price environment for fossil fuels and an increased focus on energy security support our long-term plans, and we are confident in our ability to continue delivering on our healthy revenue and earnings growth trajectory. We expect our combined geothermal, energy storage, and solar generating portfolio to reach approximately 1.5 gigawatts by the end of 2023, and to deliver an annual Adjusted EBITDA of approximately $500 million on a run rate basis towards the end of 2024. Now, before I provide further updates on our operations and future plans, I will turn the call over to Assi to review the financial results. Assi?
Thank you, Doron. Let me start my review of our financial highlights on slide five. Total revenue for the third quarter was $175.9 million, up 10.7% year-over-year, reflecting strong growth across our electricity, product, and energy storage segments. Third quarter 2022, total gross profit was $61.1 million. This resulted in a gross margin of 34.7%, up 475 basis points from an adjusted gross margin of 30% in the third quarter of 2021. When excluding the $15.5 million insurance settlement proceeds related to the Puna power plant that were recorded as a reduction to cost of goods sold in Q3 2021.
Net income attributed to the company's stockholders was $18.1 million or 32 cents per diluted share in the second quarter. This compares favorably to the results of $14.9 million or 26 cents per diluted share in the same quarter last year. On an adjusted basis, net income attributed to the company's stockholders was $18.8 million or 33 cents per diluted share. With net income attributed to stockholders up 5.3% and diluted adjusted DPS up 2.5% versus the same period last year. The increase in net income and adjusted net income was mainly as a result of a strong increase in operating income, driven by all three operating segments.
Adjusted EBITDA of $102.2 million increased 0.6% in the third quarter compared to $101.6 million in the third quarter last year. The small increase was largely driven by an 8.1% increase in operating income, driven by the good performance of our three segments, as well as the reduction in the G&A expenses caused by lower legal expenses versus last year. This increase was offset by the absence of insurance settlement proceeds received in the third quarter last year. Excluding the $15.8 million insurance settlement proceeds, adjusted EBITDA was higher by 19.1%. Moving to slide six. Breaking the revenues down at the segment level. Electricity segment revenue increased 7.1% to $552.8 million.
This increase was driven by higher revenue at Puna due to higher generation and electricity rates. The commercial operation in July 2022 of CD4 and the contributions from the Tungsten enhancement project, which began commercial operation in April 2022. Revenues in this segment were partially offset by the ongoing shutdowns at our Heber 1 plant. In the product segment, revenue increased 35.1% to $14.2 million and represented 8.1% of total consolidated revenue in the third quarter. The growth in our product segment revenues was primarily due to our project in New Zealand, which we started to record revenues in the third quarter of 2022. Energy storage segment revenues increased 56.2% to $8.8 million when compared to the third quarter of 2021.
This meaningful increase was driven primarily by higher energy rates in most of our storage assets due to the higher overall merchant prices, coupled with added capacity in CAISO from the new 5 MW, 20 MWh Tierra Buena facility. Moving to slide 7. The gross margin for the electricity segment was 36.5%. Excluding the one-time business interruption insurance proceeds of $15.5 million related to our Puna project that was recorded in the third quarter of 2021, the third quarter of 2022 electricity gross margin increased by 4.5%. In the product segment, gross margin was 18% in the quarter, compared to 12.8% in the same quarter last year. The increase in gross margin was driven by new agreements, of which we were able to capture stronger margins.
The energy storage segment reported a gross margin of 31.5% compared to gross margin of 12.2% in the third quarter last year. This increase was positively impacted by the significantly higher rates and availability at most of our storage assets. Looking at slide 8, the electricity segment generated 95% of total consolidated adjusted EBITDA in the third quarter. The product segment generated 1%, and the energy storage segment generated about $4 million of EBITDA, representing almost 4% of the total adjusted EBITDA. Reconciliation of EBITDA and adjusted EBITDA are provided in the appendix slides. Looking at slide 9, our net debt as of September 30 was $1.8 billion.
Cash, cash equivalents, and restricted cash and cash equivalents as of September 30, 2022, was approximately $253 million compared to $387 million as of year-end 2021. The slide breaks down the use of cash for the nine months illustrates Ormat's ability to reinvest in the business, service our debt, and return capital to our shareholders in the form of cash dividends and share buyback. We note that this use of cash has been funded from cash generated by operations and our strong liquidity profile that we keep and maintain. Our total debt as of September 30, 2022, was approximately $2 billion, net of deferred financing costs, and its payment schedule is presented on slide 30 in the appendix. Our average cost of debt is down to 3.9%.
We think it is important to note that as we prepare to deploy capital to fund our multi-year growth, nearly all of our debt liabilities remain fixed rate in nature, which we believe will help continue to position Ormat competitively in a rising global interest rate environment. Particularly, as we execute our Puna strategic plan to deploy capital and progress towards our multi-year target. In addition, we expect to finance part of our future CapEx plan with the support of the ITC and PTC under the new IRA, the Inflation Reduction Act, which leads me to the next slide. Let's move to slide 10. On August 16 of this year, a new Inflation Reduction Act was signed, and we expect to benefit from it in many aspects.
This act, combined with the recently signed PPAs for our geothermal and our storage assets, is expected to improve economics in both segments, reduce capital needs in the U.S. even further than anticipated. First, the IRA extended the tax credits for geothermal by 3 years at potentially higher rates than before, which enable Ormat to get into tax equity transaction and fund higher percentage of our investment. This should reduce our capital needs and increase project economics. We expect the geothermal project that will start operation in the next 5-6 years should be eligible for production tax credits. Second, for the first time, our investment in our storage segment going forward will be eligible for between 30 and up to 50% of ITC at commercial operation, versus no incentive prior to the act.
The expected ITC proceeds will reduce significantly our capital needs and should improve the economics of the project. All projects under construction with COD of 2023 and beyond should be eligible to benefit from the Inflation Reduction Act. Lastly, the IRA significantly simplified our ability to sell the tax credit to third party, enabling us to capture potential higher value of the tax benefits. Moving to slide 11. Year to date in 2022, we have invested nearly $408 million in CapEx to advance our goals. We have $750 million of cash and available line of credit. Our total expected capital for the last quarter of 2022 includes approximately $160 million for capital expenditures, as detailed in slide 31 in the appendix.
Overall, Ormat is very well positioned from a capital resource perspective, with excellent liquidity and ample access to additional capital at attractive rates to fund future growth initiatives. On November second, 2022, our board of directors declared, approved and authorized the payment of a quarterly dividend of $0.12 per share to all holders of the company's issued and outstanding shares of common stock as of November sixteenth, 2022, payable on November thirtieth, 2022. That concludes my financial overview. I would like now to turn the call over to Doron to discuss some of our recent developments.
Thank you, Assi. Turning to slide 14 for a look at our operating portfolio. Generation growth was positively supported by the inclusion of CD4 and the generation of the Dixie Valley Power Plant and the increase in operation of Puna. This was partially offset by the Heber 1 fire. As you can see on slide 15, we added 73 MW this year to the electricity segment portfolio, a 7.2% increase in total generating capacity. As noted on slide 16, in the third quarter, our Puna Geothermal Power Plant operated at an approximate 23 MW level. Currently, PPA prices continue to be elevated as a result of higher global energy prices. We are still in discussions with HELCO to improve fixed rate PPA pricing within our existing contract. Turning to slide 17.
First, in our Olkaria Power Plant in Kenya, we're currently starting our drilling campaign, which should allow us to increase plant production during 2023. Second, with respect to Heber 1, we are currently optimizing the complex through repowering work, which is expected to be fully completed in the second quarter of 2023. Finally, the Dixie Valley Power Plant is back in service and is performing at a higher capacity than before. Turning to slide 18 for an update on our backlog. We saw a 150% increase compared to last quarter. We were able to sign contracts totaling approximately $100 million during the quarter in Indonesia and New Zealand, and expect improved margin on these contracts. Moving to slide 19.
The energy storage segment delivered another strong quarter, supported by the high energy prices at most of our energy storage assets and higher capacity in California. Despite short-term delays for some of our energy storage assets, we see improvement in the profitability as a result of the higher merchant market. As I mentioned earlier, we signed with the California Utility our first-ever battery storage PPA, also called the tolling agreement. This 15-year agreement secures 100% of revenue of the 80 MW, 320 MWh Bottleneck facility, and the agreement is subject to the CPUC approval. The Bottleneck project is our largest project currently under construction, and we expect revenues and EBITDA from this project to align with our growth plans outlined in our March investor day.
We also expect this project to benefit from the ITC from the Inflation Reduction Act. The fixed nature of the Bottleneck PPA supports our long-term growth objective of building a balanced energy storage portfolio, which will mitigate our risk exposure to merchant prices and will shift the portfolio more towards contracted fixed revenue arrangements. Moving to slide 21 and 22. As we have communicated all year, 2022 is a significant build-up year for Ormat. The foundation we lay this year will support our robust growth plans, which are expected to increase our total electricity generation to approximately 1.2 gigawatts by the end of 2023. Growth across all segments have been impacted by supply chain delays, availability of raw materials, including batteries, and low availability of local contractors, among other items.
These have caused some delays in projected commercial operation dates, and we may need to shift some of our goals and targets further in the year to account for those impacts. Even with these challenges, we are still on track to reach 273 megawatts, which is 640 megawatt hour in our battery storage portfolio by the end of 2023, and expect continued positive growth in our other segments. Slides 23 and 24 display the six geothermal and five hybrid solar PV projects currently underway. We are on track with COD of North Valley and Heber Two, both of which we expect to bring online by the first quarter of 2023. Heber One is expected to be completed in Q2 2023. In Guadeloupe, we received the required permits to start our construction.
At Ijen in Indonesia, we have made meaningful progress and have already started the design of the power plant. In our solar PV portfolio, we completed the Tungsten Solar project and released the Steamboat Hills solar unit for construction. Moving to slides 25 and 26. The third layer of our growth plan comes from the energy storage segment. Slide 25 demonstrates the energy storage facilities that have started construction. Upton is close to completion, with several other projects planned for completion in Q1 of 2023. As you can see, there are slight delays in commercial operation dates, but we are on track with our year-end 2023 growth targets. Please turn to slide 27 for a discussion of our 2022 guidance. In the first nine months of 2022, Ormat has delivered meaningful year-over-year growth across our revenue, operating income, and adjusted EBITDA.
Heading into the close of the year, we are updating and narrowing our guidance ranges to reflect our performance through three quarters and expectations for the fourth quarter. We now expect full-year revenue to range between $720 million and $735 million, increasing our midpoint of the range. In turn, we are slightly narrowing Adjusted EBITDA guidance within the previously articulated range, anticipating results to be between $430 million and $442 million. We remain confident in our ability to manage our business and assets to deliver on our guidance and to drive future growth in 2023 and beyond as we execute our integrated business model. I will end our prepared remarks on slide 28. This was a solid quarter demonstrated by continuous financial and operating momentum with strong progress against our long-term goals.
While the global markets are experiencing challenges related to supply chain disruptions and raw material shortages, including batteries and solar panels, we continue to benefit from the acceleration in demand for renewable energy in the U.S. and globally and from our own improvements in operations. The broader migration towards renewable electricity sources, supported by the recently approved Inflation Reduction Act, should enable us to capture additional tax benefits in the U.S., which will further boost the economics and validate our decision to allocate the majority of our capital to be invested in the U.S. in both our electricity and storage segments.
With growing pipeline and numerous projects under development, we remain confident in our long-term plans to increase our combined geothermal energy storage and solar generating portfolio to approximately 1.5 gigawatts by the end of 2023 and to deliver an annual Adjusted EBITDA of approximately $500 million run rate. This concludes our prepared remarks. Now I would like to open the call for questions. Operator, please.
We will now begin the Q&A session. If you would like to ask a question, please press star followed by one on your touch tone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, please press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly to allow questions to generate in queue. The first question is from the line of Noah Kaye with Oppenheimer. Please proceed.
Good morning, and thanks for taking the questions. Could we start with just some clarification around the statement in slide 10
The new geothermal project receiving up to 33.75 cents per kilowatt hour based on the new law. Can you help folks walk through that a little bit? What requirements have to be met and how many of your projects under development do you think would actually qualify for that level of subsidy?
Noah, first, good morning, and thank you for the question. This is Assi. When we look at the new PTC regulation, it looks like Ormat on all of its broad projects will be eligible for $27.5 per megawatt over 10 years of production for PTCs. That's basically 5 times the minimum rate that was established by the regulator. The reason why we are able to get the 5 times minimum rate is 'cause we do plan, and we will use contractors that meet all the regulation, including the rates that we'll have to pay them and the amount of basically observers that we have as part of our operation and the time that we build the project.
The 27.5 is already a higher number versus where we are today. There are two other ways to get to a higher rate. One can take you to around $30 per megawatt, and one can get you around $33 per megawatt. We assume that most of our projects will not be eligible for 30 and 33. In order to get to $30 per megawatt, what we will have to do is to utilize the local contractors and have local content as part of our construction. We all know that we are using equipment that comes from overseas, but there are some exceptions that if you do not produce the equipment locally, you may be able to get a higher amount. This is one option to get higher.
The second option is to operate in an area that was in the past impacted by the energy community that is actually in most cases these are energy communities that used to have coal in them or natural gas that didn't have any operation going forward, and then you can get a higher rate. I will say that in our plan, and as we see it now, most likely that we will get $27.50 for all project that will start in the next few years, and we will finish probably in the next 5 to 6 years. I will just tell you that if you take the 10 years of PTCs on a nominal basis, they are equivalent to more than 50% of the cost to build a power plant.
That's incredibly helpful, Asi. So yeah, 33 per megawatt, that actually I think sounds like 3.3 cents per kilowatt hour if I'm dividing it correctly. That just may be a typo there. That certainly I understand the higher benefit potential capture there and the impact. If we talk a little bit about you know project timing you know I think the solar panel battery storage those supply chain delays that are industry-wide are well known. Can you talk to us a little bit about you know the geothermal side and what you're seeing in terms of you know timing for projects?
It looks like maybe a little bit of shift on a few projects here and there, but at this point, do you see any significant either supply chain or permitting hurdles to meeting your year-end 2023 goals, and what should we be watching for?
Hi, Noah. Thanks for the question. It's Doron. We don't see a supply chain or material supply chain issues on the geothermal part. This is obviously something that we are leading and well aware with the different suppliers and making sure that we have the right inventory as needed. Permitting is always a challenge, and interconnection is always a challenge in the U.S. We do see some small delays in maybe in North Valley. In general, on what we have on the plan, these are things that we expect that we'll meet and should not be impacted by supply chain issues.
Okay. That's very helpful. Then last congratulations on inking the $100 million in products. Can you talk to us a little about a kind of the timeline for converting that backlog into revenues? That really more of a 2023 story in terms of the inflection it seems like that may be? Then just the potential depth of demand behind that, what the pipeline looks like in products for additional contracts.
In general I would say EPC projects that we sign, and that's what the projects in New Zealand are. EPC projects usually are between 18-24 months. Extended more evenly to the first 12 months compared to the second 12 months. Supply contracts are usually within 1 year, but the big project we had in New Zealand is an EPC, so it will spread a bit over 18-24 months. In the pipeline, we have a few potential projects that we are discussing with the customers. I think the largest or the most interesting place is New Zealand. There's a lot of
Growth potential. We have a very big player there. We have build actually quite a few pipelines there and see some more opportunities there.
I'd say the next large place that we see a lot of potential is in Indonesia. We see quite a lot of drilling and development done by various developers, including ourselves, but we're talking about the product side. We expect to see quite a few tenders coming out over there in the next few months and quarters. I'd say these are the two, and there are obviously also other places, but I think these are the two large ones.
Okay. I mean, it's just, it's good to see that turning from really kind of a revenue headwind that it had been for several years into a tailwind, it looks like over the next couple of years, and we'll look for more. Thanks for taking the questions.
Thank you.
Thank you. The next question comes from the line of Mark Strouse with JP Morgan. Please proceed.
Yes. Thank you very much for taking our questions. Just a couple on energy storage, if I can. So it looks like some of the CODs that you were projecting for Q4 are now in early 2023. You're not surprised, as Noah said, just given the industry headwinds. Curious about the year-end 2023 target, now seems to be at the lower end of the range that you were previously expecting. Is that really just because of kind of the slower start to 2023, or are you kind of signaling that you're expecting the supply constraints to last longer?
No, I think the lower range is mainly because of what you and Noah said. You know, we see some issues with the supply chain. We have the project that should come online, and we also discuss Bottleneck that we have secured through a contract all the batteries, so it should be online by the end of 2023. Apart from that, we are continuing with our plans. As I said, the main issues here are supply of batteries, but also permitting is a major barrier in the U.S. that we are dealing across our segments.
Okay. More of a modeling question for my follow-up. Just going back to your comments around the profitability of your BESS storage business benefiting from the higher merchant pricing. Any commentary you can provide over the coming quarters, how we should think about margins for that business?
Firstly, good morning. It's Assi. I will say that third quarter really enjoyed the higher prices due to natural gas price increase in the East Coast. PJM market was our leading market, and month by month, we see us. You know, when you look year-over-year, our revenue is up over 50% with almost no increase in assets. We only added the 5 MW of Tierra Buena. q4 we already gave you guys guidance of $30 million for the year. As you can see, it's not gonna be as good as the Q3 because prices are not as high as at least the first month of the fourth quarter. I will say we are expecting slightly lower margins in Q4.
I will say, though, that when we look forward as a company, we should see an overall increase as we increase our capacity in our gross profits and EBITDA margin. You can look, for example, on the Bottleneck project which we just signed. We gave an example in our Investor Day of an 80 MW, 320 MWh project, and the one in the analyst day is roughly $16 million of revenue and almost $13 million of EBITDA. When we look forward, I will tell you that the EBITDA margins for this segment should continue and grow high every year as we move forward. Q4, I don't expect it to be as good as Q3. You know, but things can change. You know, commodities are moving really fast.
At least October, we have seen better markets than last year, but not as good as Q3.
Makes sense. Thank you very much.
Thank you. The next question comes from the line of Ryan Levine with Citi. Please proceed.
Good morning. Thanks for taking my question. In terms of the delays in the storage and solar segment, what are the implications in terms of your contractors and partners with the timing delays? Is there any recovery or penalties associated with any of these time shifts? How does that impact your financing plan and other capital plans?
Hi, Ryan. Thank you for joining us. What we see at least today are relatively small delays of a few weeks or maybe a month or two on the construction. however we are able to manage it. We are not releasing today projects before we know that we have secured the batteries, which is the main component for the, obviously for the energy storage. On the contracting side, it is a
It's many times a challenge. However today, when we have the ITC and you're required to pay the right wages, I hope it will make it a bit more easier to find the contractors because people will be more willing to work. Regarding LDs, this is something that is not a material impact. It's. Sometimes we have some LDs with with our suppliers. However, in most cases, we have long-term relationship with our suppliers, and it's a dialogue that we have. This is not a major part. On the financing part that you asked, we haven't yet financed a standalone. Only once we've financed a standalone storage project.
We don't see that as an issue yet.
Okay. Then in terms of the product backlog, I think you highlighted the 150% increase over last quarter. Can you delineate as to what region you're seeing the growth in or what types of customers you're seeing the biggest increase in your backlog?
I think the main two areas that we see the growth today is in New Zealand and in Indonesia. These are the two places that are pushing forward geothermal projects. I think in the short term, it's more New Zealand. In the longer term or the medium term, it would be Indonesia. These are the two large ones. On top of that I can tell you that we are responding to some issues in Taiwan, in Japan, and in Honduras, El Salvador, Mexico. These are many projects. I think the main areas is in New Zealand and Indonesia.
We hope that Turkey's economy will come back to its feet, and that's a market that has a very high potential for growth as well.
Is the growth of New Zealand and Indonesia predicated on certain macro developments or, what's really driving that expansion?
No. New Zealand, it's a question of negotiating contracts and winning tenders, and the same in Indonesia. It's not. They have the resource, the land, the willingness to develop and the financing. It's just a question of either negotiating a one-on-one contract or responding to tenders. New Zealand projects have been ready during the COVID and waited for COVID to go away. Now they are back into the market.
Okay, great. Last question, in terms of the IRA impact to your core business, you highlighted more on the development side, but are there any expansions or repowering that may qualify for the ITC or PTC for geothermal?
In the geothermal part, if it's basically expanding an existing power plant like Brawley, that we had one project, and we are increasing it significantly, then the addition, the expansion should be eligible for the PTCs and ITCs, yes.
Okay. Appreciate the time. Thank you.
Thank you.
Operator, do we have more questions?
Hello?
Operator?
Thank you. Our next question.
Operator?
Yes.
Okay. Please bring the next question.
Next question is from the line of Jeff Osborne with Cowen& Company. Please go ahead.
Yeah, great. Good afternoon. A couple questions on my end. Assi, I was wondering if you could just go over the current portfolio storage. Is that 100% merchant, or could you give us a sense of the mix?
Sure. When you look at the current portfolio, we do have only in California. What we call a RA contract. They usually cover up to 40% of the revenue. On the current portfolio, the Pomona 1 asset has a contract, Vallecito has an RA contract, and Tierra Buena has an RA contract. All of the remaining of Ormat contracts are basically on a merchant basis. When you look at the current operation of Ormat, the majority of the revenue is coming from a merchant revenue. With that being said, when you look at what we expect to bring online between now and the end of 2023, we're actually shifting to a more contractual revenue.
The leading part of it is the Bottleneck contract, which is an 80 megawatt, 320 megawatt hour project. The size per megawatt is bigger than anything that we operate, including everything that we're gonna build next year. That one will have a full tolling, which mean it's a fixed revenue for 15 years, which will benefit and allow us to balance between merchant and fixed revenue.
That's great to hear. I see in the footnotes to the Bottleneck slide, which is helpful, that it requires CPUC approval. Do you have a sense of when you would anticipate that, just given you're hoping to have it up and running by the end of next year?
We have started with the construction. We expect the CPUC approval within 60-90 days. That's what we were told. We know that they've asked for an expedited approval. We hope we'll get it within 60-90 days.
Excellent. My last question is just not as part of your 2023 outlook, but more for your mid-decade. M&A was a part of that. I was just curious if you could opine on where M&A valuations are on both geothermal and storage. My sense is that storage had been a bit inflated a year or so ago. I didn't know if that's cooled off at all.
On geothermal, it's easier. We don't see today any assets in the market, but we're constantly discussing with owners whether or not they would like to sell or go into some kind of an M&A transaction. On the storage, you're right. You know, on the last year and before pricing were way inflated. I think the increased interest rates will bring them to reality. It didn't happen yet, but we do expect it to happen. Once they come to reality, we are there in the market, and we are constantly looking to acquire energy storage assets.
Excellent. That's all I had. Thank you so much.
Thank you.
Thank you.
Thank you. The next question comes from the line of Justin Clare with ROTH Capital Partners. Please proceed.
Yeah, hi. Thanks for taking our questions here. So, first off, in Q3, we saw the gross margin for the product segment rebound meaningfully here. I was just wondering if you'd share a little bit more detail on what drove the improvement. Was it largely pricing related, or did you also see improvement on the cost side? Then just looking forward, was wondering how we should think about the product segment margins. You have a much larger backlog here. You know, could we see further improvement on the margin side?
Thank you for the question. In 2021, we have signed two contracts in the product segment that when we bought the raw material, including transportation, we incurred additional costs, mostly related to supply issues and also, I would say, in general, commodity market uplift. As a result, we saw the margins all year prior to this quarter at a lower level. The third quarter, we're actually seeing that these projects from 2021 are basically almost at the end of their cycle. They are basically almost over. The new contract that we sign that will be seen mostly 2023, those are at a higher margin. I know that historically, we would suggest that we think we can get anywhere from 24%-28% margins with the product segment.
I will say that, I think that we're not there yet. Maybe in the low 20s% at this point. We are seeing now a phenomenon of a slight decrease in raw material costs. The hope is as we sign new contract, when we go and buy the raw material, we actually got a benefit similar to the fact that how we lost money on when the cost of the raw material went up. I think we will be in the low 20s%, but not there in where we need to be, but we're making progress.
Okay. That color's really, really helpful there. Just wanted to understand your expectations for the level of the ITC you think you might be able to capture in the storage segment, given there's this range of 30%-50%. I think part of that is a result of if you meet domestic content requirements. Can you meet those requirements, do you think, in either the 2023 or 2024 timeframe? Any context there will be helpful.
Look, I think as you said the going up from 30%- 50% is a bit more challenging and requires some additional definitions. The detailed guidelines by the IRA have not been all of them issued. The question of domestic content, it's a question how it is going to be defined. As we all know most of the battery cells are manufactured outside of the U.S. In other areas and in other countries, this definition, how you define something as manufactured locally and not just quite differently. That's one thing that we still open and we don't know. The other 10% is location-specific. We have some locations that might qualify.
We're not sure. We're looking at other locations that we know are not eligible for the additional 10%. It's really a project-by-project analysis. You know, the Inflation Reduction Act took us immediately from zero to 30% ITC, so it's a big upside.
Okay. Great. Just one last one. You reiterated the plan here for reaching a run rate for adjusted EBITDA of $500 million toward the end of this year. Was just wondering kinda what is factored into that. Are you including the potential upside from the tax credits for the PTC in that number? Have you factored in the ITC for storage into that number, or could those be upside as we look into 2023?
As we outlined in the investor discussion that we had in March, Ormat always anticipated PTC to be part of our life. Most of the projects that are gonna end in 2022 and 2023, those will be eligible for PTC regardless of the new regulation, because start of construction was a few years ago. The PTC was already included. The ITC, though. There are four Big Four accounting companies, and each one of them have a different thought of how we need to account for the ITC, especially when we are able to sell them in a transfer mode versus the ability to sell them as part of an ITC tax equity transaction.
We are not sure yet if it's gonna go through the EBITDA line or potentially through the tax line item. Therefore, we did not include any significant dollars related to ITC in our $500 million.
Okay. I appreciate it. Thank you.
Thank you. The next question comes from the line of Julien Dumoulin-Smith with Bank of America. Please go ahead.
Hi. Good morning, team. Thank you. I appreciate it. If I can go back to this, and I don't mean to rehash too much, but I wanna ask it more directly here. You have this $650 million EBITDA target by 2026, right? You outlined that at the Analyst Day prior to IRA. You've articulated numerous upsides on both development as well as seemingly upside on projects that are already in flight and contracted. How do you think about upside to the $650 million, or said differently, additional balance sheet latitude, once you hit the $650 million created as a function of this?
If you can clarify, for those projects that are already contracted here, specifically or more likely biased towards the geothermal side, to what extent is that additional value from IRA held on by you guys at this point?
Hi, Julien. I'll start with then. Regarding the IRA and who actually gets at the end of the day the full value, obviously supplier, developer utility, everybody is aware of this upside. As you might expect, it would be somehow split among all the parties in the transaction. It differs between projects that are already in development and are going to be in construction. Obviously, all contracts and CapEx has been signed already. The IRA will move more toward the developer compared to future projects that we believe the market over time will get to a new stability on a different number of merchant pricing, CapEx pricing, and development.
Regarding the target that we've set in the Analyst Day, five years or today, it's not something that we constantly look and update. Obviously, in March, when we did the Analyst Day, nobody knew about the Inflation Reduction Act. However, everybody was expecting the PTC for the geothermal to continue. This is something obviously that was all the time part of our modeling. The PTC is obviously in the geothermal part. While ITC for storage is something new that came after that, so that was not included there.
Can you clarify just in terms of the $650 though, I mean, how do you think about when you come back and provide a more comprehensive update? Again, I get that you don't have full line of sight as exists with the current projects necessarily to get out to there, but you know, how do you think about just the accelerating nature of opportunities? Even more to the point, forget the $650, how do you think about the timeline for coming back and providing a medium-term update on opportunities arising from this? I get that a lot of the storage is merchant in nature and therefore is driven by you from a timing perspective, but a lot of the geothermal is driven by the pace of RFPs and procurement.
Shouldn't we be seeing an accelerating effort on that front, both because California and the West are broadly short, and need resources on a timely basis, as well as these elevated IRA opportunities for the time being?
Julien Dumoulin-Smith, we have been even before the CPUC targets were set, pushing exploration and pushing development of geothermal projects, and we are continuously doing it. We see extensive demand in California for geothermal assets. Whatever we can develop and move forward, and we've invested this year more in exploration than we've done in previous years. Next year we'll probably invest even more in exploration and development than in this year and previous years. We are pushing it. The storage, the main barrier to develop storage projects in the U.S. is the interconnection queue. Cluster 14 in California came out. I think the queue had 90 gigawatts of potential projects.
I think the entire usage in California is 50 GW, but the queue for new projects was 90 GW. This is something that is becoming the biggest barrier, even more than supply chain issues. We have put on the table. The IRA didn't change our plan to develop as many energy storage as we can. If during next year or any other time in the future we would like to update specifically we'll do a detailed analysis and give some updates.
Julien, this is Assi. I think there are two parts of the plan that we are looking at as we speak. First, it looks like the capital needs that we had in mind of $2 billion to put all of this to work will be reduced because the ITC will provide on the storage anywhere from 30% to 50% in tax benefits to us. The cost to rebuild the five-year plan that we put together will be lower, and that will enable us to have a lower interest cost, lower leverage, which in our mind is very beneficial for the plan. Second, as I mentioned earlier in the prior question, if we will have a significant ITC that will impact EBITDA, we will have to look into it.
We are not sure yet that the ITC will flow to the EBITDA level. It may go directly to the bottom line, so the earnings per share, which we are not guiding at this point. Once everybody agree on how to account for the ITC, we'll be able to look into our 650. As I said, bottom line, we will see that the additional part of the funding to grow Ormat will be covered by ITC benefit. In the Analyst Day, we expected to spend roughly $ half a billion on storage segment over the next four years from now. If that will be the case, then 30%-40% of it will be financed by the IRA. It basically will reduce our cost of debt and our debt significantly.
Yep. I hear you on all points. Thank you. Good luck. We'll speak to you soon.
Thank you.
Thank you. Again, to ask a question, please press star one. There are no additional questions at this time. I will pass it back to the management team for closing remarks.
Thank you. Thank you all for joining us. This was another good quarter for Ormat, and we are now focusing on developing and pushing forward as we ended the call on our growth and exploration targets. Thank you all.
That concludes today's conference call. Thank you. You may now disconnect your line.