SolarCity: Bolted Onto Your Roof for 30 Years

 | Mar 24, 2014 | 7:00 PM EDT
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Solar power is here to stay in the U.S. For the next decade, solar power production will likely grow at astounding rates. In fact, it is easy to see how solar and wind will provide more energy than the nation's fleet of nuclear power plants.

The primary driver behind the growth is cost leadership and risk. In North America's 10 wholesale power markets, energy from photovoltaic sources have production costs nearing zero. With zero production costs, solar assets are dispatched first and they earn the greatest margins.

In retail power markets, where levelized costs influence investment decisions, utility-scale solar power reached parity with nuclear and coal. Solar's levelized costs blew pass 14 cents a kilowatt-hour. According to the Department of Energy, the average levelized cost reached 11.2 cents a kilowatt-hour. 

 Courtesy of the U.S. Department of Energy

Graph Courtesy of the U.S. Department of Energy

The risk profile for solar is small compared to new nuclear and new coal. From beginning to end, a new megawatt of solar power can be planned, constructed and operating within 24 months. In addition, the cost and schedule estimates are real. Usually, there is no big surprise at the end.

A megawatt from a new nuclear or coal plant is a different story. The planning process alone can take more than 36 months. Design, procurement, construction and startup can take more than 60 months. The cost and schedule for new nuclear and new coal have high degrees of uncertainty.

From investors' perspective, the internal rate of return (IRR) on a dollar invested in a project completing in two years is much healthier than the same dollar invested in a project completing in five years. When uncertainty is added to the five years, the IRR drifts towards zero.

This might explain why companies like NextEra Energy (NEE), Consolidated Edison (ED), Sempra Energy (SRE), Berkshire Hathaway (BRK.A), Public Service Enterprise Group (PEG), Exelon (EXC) and other large utilities jump at the opportunity to own utility-grade solar farms. Particularly when power purchase agreements are offered, returns are simple, healthy and safe.

Some may argue that solar returns are distorted by federal giveaway programs. Those arguments are wrong. New solar investments have no advantage over new coal or new nuclear power investments. It is the opposite. The list of federal incentives for a new nuclear power plant, like the one currently under construction for the Southern Company (SO), amount to billions of dollars. In comparison, net federal incentives for utilities wanting to build a new solar farm are approximately zero.

Notwithstanding, investors should not automatically assume that the same results for an aftermarket company like SolarCity (SCTY). Small, distributed systems can never achieve economic efficiencies associated with centralized utility-grade solar farms.

One reason is SolarCity backfits equipment onto properties that were never intended to host solar panels. To achieve reasonable performance, panels must face a specific direction at a specific angle. Most homes face the wrong direction. Those that face the right direction, have roofs with the wrong pitch. Combining these two essentials suggests many SolarCity's residential consumers can expect poor performance and an ugly house.

As second reason is SolarCity's sharing arrangements. No party in SolarCity's value chain is allowed to bank the full economic value offered by solar power. SolarCity and its bankers insert themselves between property owners and the panels on their roofs. For decades, third parties are extracting large percentages of the solar system's benefits. To make matters worse, since backfit systems produce meager results, SolarCity and their stakeholders earn only slivers of the potential value. 

A third reason is customer awareness. If a homeowner wants solar power, they are better off owning their systems outright with little involvement from intermediaries like SolarCity. Local utilities provide metering services, so there is no need to complicate a passive system with superfluous management and monitoring services.

A third reason was mentioned in last week's article. It is a big one. It is customer acquisition and retention costs. SolarCity is spending almost $100 million a year to attract new customers. It appears half of those customers are one-time sales. The other half will need a lot of hand holding, particularly as SolarCity's panels and inverters age. It will become more costly when homeowners try to maintain, upgrade or sell their properties with 30-year contracts bolted onto their roofs.

Solar power makes a lot of sense. Utility-grade solar is competitive. It makes money for investors. It helps the environment.

SolarCity's systems are less effective and relatively uneconomic. It is difficult to see how they can overcome the arithmetic, at least in the short term.

Investors wanting in on renewable energy and solar power might consider safer plays. NextEra is one example. SunPower (SPWR) is another.



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