Why Solar's Economics Are Different

 | May 06, 2013 | 6:00 PM EDT  | Comments
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Stock quotes in this article:

fslr

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spwr

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wfr

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scty

Solar power can be far more profitable than many analysts understand. The issue that most of them miss is geography. Instead, they argue about grid parity. They look at competing resources such as nuclear, coal and natural gas. They benchmark solar against those resources and then reach the wrong conclusion.

When was the last time anyone built a nuclear power plant in the backyard? How about a coal-fired plant or a combined cycle gas turbine?

Nobody.

But a growing number of customers are installing solar panels on their rooftops and backyards. Included are the big-box stores, which have acres of empty roofs and parking lots that can easily accommodate hundreds of solar panels.

Here is the kicker missed by many analysts: Most rooftop and backyard installations are wired "behind" the utility's meter -- the home remains connected to the utility but uses the solar panels first and supplements this use with power from the utility.

Why is this important?

Because the economics are different. For these installations, the benchmark is not nuclear, coal and natural gas generators. The benchmark is not even the market price of wholesale power. For these installations, the benchmark is the utility's retail price of power.

The differences between retail and wholesale power prices can be 200% to 300%. Independent power producers such as Exelon (EXC), Entergy (ETR) and Atlantic Power (AT) struggle to find buyers for their production at $45 per megawatt-hour, but Energy Information Administration (EIA) data show that average retail consumers pay nearly $100 for the same power.

 

Average Price Paid for Retail Power
EIA/Williams

 

On a state-by-state basis, the picture is more graphic. Ignoring Hawaii's special case, some lower 48 states' retail rates are more than two times greater than Louisiana's:

 

Retail Prices Paid for Power, by State
EIA/Williams

 

Local distribution companies and state and local taxing authorities have doubled and tripled wholesale power prices when they deliver retail electricity to consumers. Keep in mind that retail consumers include large industrial, commercial, government, transportation and residential consumers (and the graphs represent a blend of all customer classes).

By installing and operating solar panels on the customer side of the meter ("behind the meter"), the consumer avoids the utility's retail price of power. Of course, the customers must consume their own power.

Many states and utilities offer their consumers a net metering package. This provides panel owners the best of both worlds. They can over-produce some hours, under-produce other hours, and the utility will invoice the net amount of power delivered. If customers design solar systems correctly, they will produce slightly less than they consume and avoid additional fees for net metering.

In addition to pro forma returns, solar panels offer an interesting hedge against inflation. They are also a hedge against state regulators. Each year, utilities seek rate increases and local governments' attempts to add taxes. Rarely do utility commissions lower tariffs.

Businesses that install behind-the-meter solar panels are offered additional incentives. Some can write off depreciation expenses. Some can bank investment tax credits. In some states, some can even cash in on renewable energy credits.

Critics might argue that not all states are suitable for solar panels. They are not entirely correct. The Department of Energy's (DOE) National Renewable Energy Laboratory (NREL) collected solar insolation values for all 48 states. It turns out, insolation varies, but not as much as many might expect. The highest and lowest states differ by only 50%. (See NREL's solar map.)

When it comes to distributed generation using a behind-the-meter strategy, solar power is the cost leader by a mile. As businesses and other consumers become aware of the long-term value of solar power assets, installations should accelerate. Further, as utility rates soar, solar power becomes increasingly attractive.

The beneficiaries will be First Solar (FSLR), SunPower (SPWR), MEMC Electronic Materials (WFR), SolarCity (SCTY) and others. All four companies are project developers. As project developers, these companies are not locked into one technology over another.

But when it comes to technology, SunPower has a technical advantage in behind-the-meter installations. Their new panels surpass the 20%-efficiency milestone. Developers who use SunPower panels will need less space to produce the same amount of power.

First Solar's panels have a technical advantage in areas where land is plentiful and less costly. Their cost per watt is among the lowest, but they require more space.

The industry is on the precipice of a new era. As the point of view shifts from national energy policies and politics to investor returns, solar power is one of several new opportunities. It is also a threat to the incumbents that own nuclear, coal, and natural gas assets.

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