Ormat Technologies, Inc. (NYSE:ORA) Q3 2022 Earnings Conference Call November 3, 2022 9:00 AM ET
Company Participants
Sam Cohen – IR, Alpha IR Group
Doron Blachar – CEO
Assi Ginzburg – CFO
Smadar Lavi – VP, IR & ESG Planning & Reporting
Conference Call Participants
Noah Kaye – Oppenheimer
Mark Strouse – J.P. Morgan
Ryan Levine – Citi
Jeff Osborne – Cowen and Company
Justin Clare – ROTH Capital Partners
Julien Dumoulin-Smith – Bank of America
Operator
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. [Operator Instructions]. 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.
Sam Cohen
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 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.
Doron Blachar
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 initiatives, 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 credit for storage projects. We continue to see strong global tailwinds from renewables, specifically in the U.S. and Indonesia. The elevated global price environment for fossil fuels and increased focus on energy security, supports 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 2022.
Now before I provide further update on our operations and future plans, I will turn the call over to Assi, to review the financial results. Assi?
Assi Ginzburg
Thank you, Doron.
Let me start the review of our financial highlights on Slide 5. 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 $0.32 per diluted share in the second quarter — in the quarter. This compares favorably to the results of $14.9 million or $0.26 per diluted share in the same quarter last year. On an adjusted basis, net income attributable to the company’s stockholders was $18.8 million or $0.33 per diluted share, with net income attributed to the stockholders up 5.3% and diluted adjusted EPS 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% in operating income, driven the good performance of our three segments as well as a reduction in the G&A expected 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 6. Breaking the revenue 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 of 2022. Revenues in this segment were partially offset by the ongoing shutdown 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-megawatt/20-megawatt hour 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 margin.
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 slide.
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 $263 million compared to $387 million as of the 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 dividend and shares buyback. We note the decrease of cash have 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 financial cost. 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 position Ormat competitively in the 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 spend 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, has expected to improve economics in both segments, reduced capital needs in the U.S. even further than anticipated.
First, the IRA extended the tax credit for geothermal by three 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 five years to six 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 benefit.
Moving to Slide 11. Year-to-date in 2022, we have invested nearly $408 million in CapEx to advance our growth. 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 of 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 2, 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 16, 2022, payable on November 30, 2022.
That concludes my financial overlook. I would like now to turn the call over to Doron to discuss some of our recent developments.
Doron Blachar
Thank you, Assi.
Turning to Slide 14 for a look at our operating portfolio. Generation growth was positively supported by the inclusion of Tungsten and CD4 and the generation of the Dixie Valley power plants 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 megawatts 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-megawatt 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 contracts.
Turning to Slide 17. First, in our Olkaria power plant in Kenya, we are 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 this profit.
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 secured 100% of revenue of the 80-megawatt, 320 megawatt hour 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 builder year for Ormat. The foundation we laid this year will support our robust growth plan 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 lower availability of local contractors, among other items. These have caused some delays in projected commercial operation date, 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 displayed the six geothermal and five hybrid solar PV projects currently underway. We are on track with COD of North Valley and Heber 2, both of which we expect to bring online by the first quarter of 2023. Heber 1 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. And in our solar PV portfolio, we completed the Tungsten Solar project and released the Steamboat Hills solar unit for construction.
Moving to Slide 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 date, 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 revenues, 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 revenues to range between $720 million and $735 million, increasing our mid-point of the range. In turn, we are slightly narrowing adjusted EBITDA guidance within the previously articulated range, anticipating results to be between $430 million to $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 exit our integrated business model.
I will end our prepared remarks on Slide 28. This was a solid quarter demonstrated by continued financial and operating momentum with strong progress against our long-term goal. 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 toward 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 customers 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 plan 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.
Question-and-Answer Session
Operator
We’ll now begin the Q&A session. [Operator Instructions].
The first question is from the line of Noah Kaye with Oppenheimer. Please proceed.
Noah Kaye
Good morning, and thanks for taking the questions. Could we start with just some clarification around the statement on Slide 10? The new geothermal project receiving up to $0.3375 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 you think would actually qualify for that level of subsidy?
Assi Ginzburg
Hey, 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 5x the minimum rate that was established by the regulator. And the reason why we are able to get the 5x minimum rate is because we do plan, and we will use contractors that need for 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.
So the 27.5% is already a higher number versus where we are today. And there are two other ways to get to a higher rate. One can take you to around $30 per megawatt and one can get to 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 you have local content, as part of our construction. We now 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. So 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 projects that will start in the next few years, and we will finish probably in the next five years to six 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.
Noah Kaye
That’s incredibly helpful, Assi. So yes, $33 per megawatt, that actually, I think, sounds like $0.033 per kilowatt hour, if I’m dividing it correctly, but there just maybe a typo there. But that certainly, I understand the higher benefit potential capture there and the impact. If we talk a little bit about project timing, 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 the geothermal side and what you’re seeing in terms of 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?
Doron Blachar
Hi Noah thanks for the question. It’s Doron. We don’t see 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. So we do see some small delays in — maybe in North Valley. But in general, what we have on the plan is a thing that we expect that will meet and should not be impacted by supply chain issue.
Noah Kaye
Okay. That’s — that’s very helpful. And then last, congratulations on, I think, $100 million in products. Can you talk to us a little about a) kind of the timeline for converting that backlog into revenue? Is that really more of a 2023 story in terms of the inflection? It seems like that may be. And then just the potential depth of demand behind that, what the pipeline looks like in products for additional contracts?
Doron Blachar
So in general, I would say EPC projects that we signed, and that’s what the projects in New Zealand are. EPC projects usually are between 18 months to 24 months, tended more beginning to the first 12 months compared to the second 12 months. Supply contracts are usually within one year, but the big projects we had in New Zealand is an EPC, so it will spread a bit over 18 up to 24 months.
In the pipeline, we have a few potential projects that we are discussing with — with 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 a supply built actually quite a few pockets there and we’ll see some more opportunities there. I’d say the next large players as 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. And we see — and we expect to see quite a few tenders coming out over there in the next few months and quarters. Let’s say, these are the two and Noah, and there are obviously also other places, but I think these are the two large.
Noah Kaye
Okay. I mean, it’s good to see that turning from a really kind of a revenue headwind that has 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.
Doron Blachar
Thank you.
Operator
Thank you. The next question comes from the line of Mark Strouse with J.P. Morgan. Please proceed.
Mark Strouse
Yes. Thanks 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 4Q are now in early 2023, you’re not surprising, as Noah said, just given the industry headwinds. But 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 constraint to last year?
Doron Blachar
Well, I think the lower range is mainly because of what you and Noah said. We see some issues with the supply — supply chain. So we have the project that should come online and we also discussed Bottlenecks that we have secured through a contract in all the batteries, so it should be online by the end of 2023. Apart from that, we are continuing with our plans. 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.
Mark Strouse
Okay. And then more of a modeling question for my follow-up. Just going back to your comments around the profitability of your 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?
Assi Ginzburg
So I’ll take. Good morning. It’s Assi. I will say that the third quarter really enjoyed the higher prices due to natural gas prices increase in the East Coast. PGA market was our leading market. And month-by-month, we see that. When you look year-over-year, our revenue is up over 50% with almost no increase in assets.
We only added the 5 megawatts of Tierra Buena. Q4, we already gave you guidance of $30 million for the year. So as you can see, it’s not going to be as good as the Q3 because prices are not as high as of at least the first month of the fourth quarter. And so 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 overall increase as we increase our capacity in our gross profit and EBITDA margin. And you can look, for example, on the Bottleneck project, which we just signed, we gave an example in our Investor Day of an 80-megawatt, 320-megawatt hour project. And the one in the Analyst Day is roughly $16 million of revenue and almost $13 million of EBITDA. So when we look forward, I will tell you that the EBITDA margins for this segment should continue and go high every year as we move forward. But Q4, I don’t expect it to be as good as Q3, but things can change. Commodities are moving really fast, but at least October, we have seen better market than last year but not as good as Q3.
Operator
Thank you. The next question comes from the line of Ryan Levine with Citi. Please proceed.
Ryan Levine
Good morning. Thanks for taking my questions. 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 timing — time shifts? And how does that impact your financing plan and other capital plans?
Doron Blachar
Hi, Ryan. Thank you for joining us. And what we see at least today are relatively small delays of a few weeks, so 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. And on the contracting side, it is — it’s many times a challenge.
And 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 it to work.
Regarding LDs, this is something that is not a material impact. It’s a — sometimes, we have some LDs with our suppliers. However, in most cases, we have long-term relationship with our suppliers, and it’s a dialogue that we have. So this is not a major part.
And on the financing part that you asked, we haven’t yet financed the standard — only once we finance a stand-alone storage project. So we don’t see that as an issue, yes.
Ryan Levine
Okay. And then, in terms of the product backlog, I think you highlighted the 150% increase over last quarter. Can you tell any as to what, what region you’re seeing the growth in or what types of customers you’re seeing the biggest increase in your backlog?
Doron Blachar
I think the main two areas as 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 and in the longer-term or the medium-term it would be Indonesia. So 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. So these are many projects. The main areas is in New Zealand and Indonesia. And we hope the Turkey economy will come back to its fit and that’s a market that has a very high potential for growth.
Ryan Levine
Is the growth of New Zealand and Indonesia predicated on certain macro developments? Or what’s really driving that expansion?
Doron Blachar
No, New Zealand, it’s a question of negotiating the 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 is just a question of either negotiating a one-on-one contract, we’re all answering and responding to tenders. New Zealand projects have been well ready for — during the COVID, they waited for COVID to go away. And now they are back into the market.
Ryan Levine
Okay. Great. And then 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?
Doron Blachar
In the geothermal part, if it’s basically expanding an existing power plant like Beowawe, that we had one project and we are increasing it significantly, then the addition, the expansion should be eligible for the PTC and ITC, yes.
Operator
Thank you. Our next question is from the line of Jeff Osborne with Cowen and Company. Please go ahead.
Jeff Osborne
Yes, great, and good afternoon. A couple of questions on my end, Assi, I was wondering if you could just go over the current portfolio of Storage. Is that a 100% merchant or could you give us a sense of the mix?
Assi Ginzburg
Sure. So when you look at the current portfolio, we do have only in California, what we call RA contract. They usually cover up to 40% of the revenue. So on the current portfolio, the Pomona 1 asset has a contract, Vallecito has an RA contract and a Tierra Buena has an RA contract. All of the remaining of Ormat contracts are basically on a merchant base. So 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 are actually shifting to more contractual revenue. And the leading part of it is the Bottleneck contract, which is an 80-megawatt, 320-megawatt hour project. So the size per megawatt is bigger than anything that we operate, including everything that we’re going to build next year. And that one will have a full tolling, which means it’s a fixed revenue for 15 years, which will benefit and allow us to balance between merchant and fixed revenue.
Jeff Osborne
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?
Doron Blachar
We have started the construction. We expect the CPUC approval within 60 to 90 days; I think that’s what we were told. We know that they have for an expedited approval. So we hope we’ll get it in 60 to 90 days.
Jeff Osborne
Excellent. And 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?
Doron Blachar
On Geothermal, we don’t see today any assets in the market, but we are constantly discussing with owners, whether or not they would like to sell or to go into some kind of an M&A transaction.
On the Storage, you’re right. Over 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. And once they come to reality, we are there in the market, and we are constantly looking to acquire Energy Storage assets.
Operator
Thank you. The next question comes from the line of Justin Clare with ROTH Capital Partners. Please proceed.
Justin Clare
Yes. 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 could 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? And then, just looking forward, I was wondering how we should think about the product segment margins. You have a much larger backlog here. Could we see further improvement on the margin side?
Assi Ginzburg
Thank you for the question. In 2021, we have signed two contracts in this Product segment that when we bought the raw material, including transportation, we encourage additional cost mostly related to supplying issues. And also, I would say, in general commodity market uplift. And as a result, we saw the margins all the year prior to this quarter at a lower level.
The third quarter, we’re actually seeing that this project from 2021 are basically almost at the end of the cycle. They are basically almost over. And the new contract that we signed, it will oversee mostly 2023; those are at a higher margin. I know that historically, we would suggest that we think we can get anywhere from 24% to 27%, 28% margins in the Product segment. I will say that I think that we’re not there yet. Maybe in the low 20s at this point. But we are seeing now a phenomenon of a slight decrease in raw material costs. So the hope is as we sign new contracts, when we go and buy the raw material, we actually got a benefit similar to the fact that how we lost money when the margin –when the cost of the raw material went up. So I think we will be in the low 20s, but not there where we need to be, but we’re making progress.
Justin Clare
Okay. Color is really helpful there. And then 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% to 50%, I think part of that is a result of if you meet domestic content requirements. So can you meet those requirements, do you think in either the 2023 or 2024 timeframe? So any context there will be helpful.
Doron Blachar
Look, I think as you said the going up from 30% to 50% is a bit more challenging and required some additional definitions. The detailed guidelines by the IRA have not been all of them issue. 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., but in other areas and in other countries, the definition how you define something is manufactured it locally and not just acquire differently. So that’s one thing that we still open, we don’t know.
And 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%. So it’s really a project-by-project analysis. But the Inflation Reduction Act took us immediately from 0% to 30% ITC. So it’s a big upside.
Justin Clare
Okay. Great. And then just one last one. You reiterated the plan here for reaching a run rate for adjusted EBITDA of $500 million towards the end of this year. I was just wondering kind of what is factored into that? Are you including the potential upside from the tax credits for the PTC in that number? And then, also, is there any — have you factored in the ITC for Storage into that number or could those be upside as we look into 2023?
Assi Ginzburg
As we outlined in the investor discussion that we had in March, Ormat always anticipated PTC to be part of our life, and most of the projects that are going to 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. So the PTC was already included. The ITC, there is still — there are four — big four accounting companies and each one of them have a different sort 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. And we are not sure yet if it’s going to go through the EBITDA line or potentially to the tax line item. And therefore, we did not include any significant dollars related to ITC in our $500 million.
Operator
Thank you. The next question comes from the line of Julien Dumoulin-Smith with Bank of America. Please go ahead.
Julien Dumoulin-Smith
Hi, good morning, team. Thank you. I appreciate it. So if I can go back to this — and I don’t mean to rehash too much, but I want to ask you more directly here. You have the $650 million EBITDA target by 2026, right? And 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? And if you can clarify for those projects that are already contracted here, specifically are more likely biased towards the Geothermal side, to what extent is that additional value from IRA held on by you guys at this point?
Doron Blachar
Hi, Julien, I’ll start with that. Regarding the IRA and who actually gets at the end of the day, the full value, obviously, suppliers, developer, utility, everybody is aware of this upside. And as you might expect, it would be somehow split along the — all the parties in the transaction. It differs between projects that are already in development that are going to be in construction and obviously, all contracts and CapEx has been signed already. So the IRA will move more toward the developer compared to future projects that we believe the market over time will get to a new — stabilize on a different number of merchant pricing, CapEx pricing and development.
Regarding the target that we’ve set in the Analyst Day five years from 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. And this is something, obviously, that was all the time part of our modeling. So the PTC is obviously in the geothermal part what ITC for Storage will be something new that came after that. So that was not included.
Julien Dumoulin-Smith
Can you clarify just in terms of the $650 million, 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 how do you think about just the accelerating nature of opportunities, even more to the point, forget the $650 million, 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?
Doron Blachar
Julien, we have been even before once the CPUC targets were set, we have been pushing exploration and pushing development of geothermal projects. And we are continuously doing it. We see extensive demand in California for geothermal assets. So whatever we can develop and move forward and we’ve invested this year more in exploration than we’ve done in previous years. And next year, we’ll probably invest even more in exploration and development than in this year and previous years. So we are pushing it.
The Storage, the main barrier to develop Storage project in the U.S. is the interconnection queue and Cluster 14 in California came up. I think the queue had 90 gigawatts of potential projects. I think the entire usage in California is 50, but the queue for new project was 90 gigawatts. So this is something that is becoming the biggest barrier, even more than supply chain issues. But we have put on the table. The IRA didn’t change our plan to develop as many Energy Storage as we can. And 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.
Assi Ginzburg
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. So the cost to rebuild the five years 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 we had that the ITC will flow through the EBITDA level. It may go directly to the bottom line to the earnings per share, which we are not guiding at this point. So once everybody agree on how to better account for the ITC, we’ll be able to look into our $650 million. But as I said, bottom line, we will see that the additional part of the funding to grow, Ormat will be covered by ITC benefit.
And in the Analyst Day, we expected to spend roughly $0.5 billion on Storage segment over the next four years from now. And if that will be the case, and 30% to 40% of it will be financed by the IRA, it basically will reduce our cost of debt and our debt significantly.
Julien Dumoulin-Smith
Yes. I hear all my points. Thank you. Good luck. We’ll speak to you soon.
Doron Blachar
Thank you.
Operator
Thank you. [Operator Instructions].
There are no additional questions at this time. I will pass it back to the management team for closing remarks.
Doron Blachar
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.
Operator
That concludes today’s conference call. Thank you. You may now disconnect your lines.
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