For Traditional Utilities, Solar Is Far From a Threat

 | May 13, 2013 | 5:00 PM EDT
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It may sound counterintuitive to some, but solar is not a threat to traditional utilities. In fact, for most shareholders of investor-owned utilities, solar power can represent a growth opportunity.

The confusion originates from deregulation over the past few years, with several states having deregulated their utilities to separate power generation from the utilities-distribution businesses. Here is the puzzling part: After states deregulated their utilities, what remained were -- well, regulated utilities. To put it another way, every utility that had been regulated before the deregulation is still regulated.

That's because the power­-plant assets were the only part of the business that became deregulated, as some states decided power generation was not a natural monopoly. In those states, power plants were barred from operating within the state's rate base, and regulated utilities were required to sell off ownership in regulated generating assets. Everything else remained unchanged.

For most electric utilities, the core business is in delivering electric power from producers to consumers. These firms use transmission lines for long-distance transportation, with distribution systems used for local transport -- and the nation's interstate transmission lines (electric and gas) are regulated by the federal government via the Federal Energy Regulatory Commission.

FERC is an independent commission that allows transmission owners to charge rates that provide them full recovery of their costs for operations, maintenance and capital. Under this scheme, most transmission lines are a cost-plus business.

The nation's distribution lines (electric and gas), meanwhile, are regulated by state governments. While non-profit utilities experience light regulation, the state allows investor-owned utilities to capture all their costs for operations, maintenance and capital. They also allow those utilities a modest profit. Most distribution systems are a cost-plus businesses under this scheme, as well.

Enter solar. Most solar power, with the exception of massive utility-grade solar, sits inside the utility's distribution system. Solar power is distributed power, and it is collocated near consumers.

When it comes to distributed solar equipment, most production needs support from utility-distribution systems. In order to maximize economic performance, owners of solar equipment may request new meters that can measure power flowing in two directions, or net metering. They may also request beefed-up distribution lines and power systems that can manage bidirectional distributed energy.

The meters, the beefed-up distribution systems and the energy-management systems are, in turn, owned by the regulated utility -- and remember that this is a cost-plus business. More demand for high-level services means more investments and more returns to shareholders.

These requests are consistent and compatible with the long-term trends associated with smart-grid technologies. Upgraded infrastructure is needed with or without solar power, so solar simply accelerates the inevitable.

Solar offers an opportunity for regulated utilities such as Consolidated Edison (ED), Northeast Utilities (NU), National Grid (NGG), FirstEnergy (FE) and PPL (PPL): They get to use other people's money to increase assets and returns on those assets. For these utilities, in the right places, solar is not a threat.

Yet in the world of energy supply, the road to solar gets a little muddy. For some, solar power is just another energy supplier, while for others it's part of the distribution system.

From the perspective of deregulated energy suppliers, solar is a clear threat. Independent producers rely on the power markets for their revenue and their earnings. The introduction of modest amounts of solar, no matter where it's positioned, lowers market-clearing prices -- and that means lower gross margins, which interfere with incumbent producers such as Exelon (EXC), Entergy (ETC) and Dynegy (DYN).

As a result, investors should expect to see marketing campaigns develop against solar, wind and energy efficiency. Already Exelon has been campaigning against extending federal tax credits for wind power. As investment tax credits expire for solar in 2016, investors should expect louder voices against that industry.

The challenge is not just in Washington. It is primarily at the state and local levels. Some deregulated states are already finding themselves caught in the middle.

If states push solar too far, they'll alienate independent power producers, which could attract litigation. If they ignore solar and other renewable resources, however, they may find their state short capacity, which would mean higher prices for constituents.

States may also find themselves short air and water permits in non-attainment areas. Without the ability to issue new permits, the state limits their potential for economic growth (a discussion for another column).  

For the next few years, we'll see some back-and-forth as equity issues are sorted out. However, because solar is a cost leader, it's bound to emerge as a winner. In the interim, traditional transmission and distribution utilities will triumph if they can successfully deploy new assets in existing networks.

If investor-owned utilities win, shareholders will win.

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