The Dark Side of Energy Costs

 | Jun 01, 2012 | 6:00 PM EDT  | Comments
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If investors ignore the fundamentals, their technical analysis may inexplicably fall apart. This is particularly important with solar power and companies using photovoltaics.

Some analysts may claim otherwise but state, not federal, policies drive solar power in the U.S. Each state has a different incentive program and some states have no programs.

To understand the fundamentals, let's take a look at the top lines of a solar power facility. Its largest source of revenue is from the production of renewable energy credits, or RECs. REC programs are unique to each state but some states don't even have one. For example, Massachusetts recently paid $540 per megawatt-hour. Washington, D.C. recently paid $300. Ohio recently paid $270. Maryland recently paid $215. New Jersey recently paid $145. Pennsylvania recently paid $20.

Other states bundle rates for solar panels and allow their owners full recovery plus a margin. Most of those states prefer to have their native utilities participate and discourage independent power producers. However, most of these states are regulated and are not experiencing significant investments in solar. But policies may be changing: Virginia recently announced it is considering a solar farm under a pilot program suggested by Dominion Resources (D).

The next largest source of revenue comes from the sale of energy. Since solar is a very efficient peaking facility, it will always be producing during periods of high demand, but not necessarily at the peak. As such, solar production should be in the power markets when prices are high. Most producers can expect an average annual price of $50 per megawatt-hour or more.

The last source of revenue is capacity payments. Some grids will pay to have independent power producers available to assure system reliability. Consider it a rent payment. But the markets don't consider solar capacity to be as valuable as a gas turbine, which can be dispatched 24 hours a day.

NextEra Energy (NEE), for example operates a 5-megawatt solar farm in southern New Jersey. PJM Interconnection will be paying NextEra and most other commercial solar producers in the area, approximately 38% of the capacity auction, or about $63 per megawatt-day.

The only program the federal government has been offering is to temporarily lower federal income taxes on solar profits. It does not offer any top-line revenue sources. In fact, after a solar facility has been operating profitably for six years, the solar farm is fully exposed to the highest possible income tax bracket possible and is left with no deductions. For the next 20 years, the solar farm is required to pour money into federal and state coffers.

If a company such as Duke Energy (DUK) or Exelon (EXC) invests in a new solar farm, the federal government will only offer them two tax reduction incentives: accelerated depreciation and an investment tax credit. To claim them requires the facility to be operating and profitable; the federal government won't be writing any checks for solar operators.

Like all businesses, the federal government allows the solar industry to depreciate equipment. But in solar's case, the federal government allows owners to compress depreciation schedules according to the Modified Accelerated Cost-Recovery System (MACRS). This allows owners to finish expensing depreciation by year six, instead of say, year 25. MACRS doesn't cost the government a dime; business owners were going to depreciate their assets anyway.

The federal government offers solar facilities an investment tax credit (ITC), which amounts to 30% of the equipment's cost. It does not include the cost of land or land improvements. The ITC can only be claimed after the solar facility begins to produce power. Like MACRS, the ITC doesn't cost the government a dime. It's all recovered in subsequent years.

For a short period during the 2008 recession, the federal government did allow owners to convert their ITC into cash via Section 1603 of the American Recovery and Reinvestment Act. It expired last year and there is no serious movement to resurrect it. (So analysts who claim the Solyndra scandal is hurting the solar industry do not understand the landscape.)

Few single solar farms have been built in states that do not have incentive programs. Federal tax incentives are necessary, but they are not sufficient. And, contrary to political opinion, federal incentives have a net cost to taxpayers of zero.

When analyzing companies such as  First Solar (FSLR) and SunPower (SPWR), research them from the bottom up. That is, look at their markets on a state-by-state basis, not from a congressional perspective.

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