Solar Shows Investors the Money

 | Sep 29, 2013 | 5:00 PM EDT
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Solar power is a surprising asset for most electric utilities. It does not matter who owns the solar energy source -- the utility or a third party. Either way, the local distribution utility is not threatened. In fact, for most utilities, solar power installations provide an opportunity to deliver greater returns to shareholders.

The reason has to do with government regulation, to which every utility wire in the U.S. is subjected. Big wires are regulated by the Federal Energy Regulatory Commission (FERC). Little wires are regulated by individual state public utility commissions (PUCs).

Utility prices are set by regulators on a cost-plus basis. At the federal level and state levels, transmission and distribution utilities ask these agencies to establish rates based on their cost plus a modest profit. They add up their expenses for operations, maintenance and capital to arrive at their base cost. Then they add a modest return to reward shareholders for their investments.

Of course, this process can be complicated. As PG&E (PCG), Duke Energy (DUK) and Pepco Holdings (POM) will attest, politics typically enter into the equation. State commissions frequently adjust returns and determine if capital investments have been prudent. They will also punish unreliable operations after poor responses to storms and other natural disasters. Nevertheless, in the end, transmission and distribution utilities operate cost-plus businesses.

With most cost-plus businesses, investors cannot lose. The company will make more money as its costs increase, giving shareholders more operating income. Utilities' costs are increased by any capital investment, such as new wires or poles, smart meters or distributed solar power.

Very few solar panel owners go rogue and operate off the grid. Most customers who add solar to their properties still need their native utility company to provide backup and net metering services. To connect to the utility's distribution system, they will pay a fee for the service. That fee will be based on cost plus economics, as mandated by the government, and will guarantee utility shareholders a prudent return.

Deregulated utilities and many decoupled utilities do not profit from the sale of electricity but from renting their wires. Accordingly, if a new energy source, such as solar power, connects to their distribution system, the electricity from that source has little impact on these utilities' energy profits.

Having a large volume of distributed solar-generated power could cause utilities to increase their investments in more sophisticated distribution, metering and billing systems. A good example can be seen in New Jersey, where local distribution companies' systems were reaching their limits, compelling them to invest in upgrading substations and wires -- until the state passed a law curbing utility-grade solar projects. Today, these companies are installing net meters for every home that builds a rooftop solar generating system.

Nor are traditional utilities in the U.S. threatened by distributed solar. While they would rather build, own and operate multibillion-dollar steam power plants, they can also earn a return on utility-grade solar power farms. As with other investments, they are entitled to put solar farms into their state-regulated rate base and pass the operating and capital costs on to customers.

When it comes to passing on costs, critics may argue that solar power is far too expensive compared with the alternatives. But they would not be entirely correct.

The new integrated gasification combined-cycle clean coal technology at Kemper County cost Southern (SO) and its partners more than $7 million per megawatt. Southern's new nuclear power plant in Georgia cost more than $6 million per megawatt, as did a nuclear plant built by. SCANA (SCG). While these plants are the first of a kind, they may be the only ones built for a long time.

General Electric's (GE) and Siemens (SI) combined-cycle gas turbines cost slightly more than $1 million per megawatt, but their fuel costs can skyrocket. The levelized costs of these new turbines depend greatly on the price of natural gas.

By comparison, the capital cost of a utility-grade solar power facility is approximately $3.5 million per megawatt, depending on the technology selected. Unlike most other alternatives, solar's fuel costs are zero.

Pure distribution companies, such as FirstEnergy (FE), Consolidated Edison (ED) and Northeast Utilities (NU), should be agnostic on solar power at worst. At best, they should be enthusiastic.

Investors, too, should be enthusiastic when utilities encourage distributed solar power. Solar increases the capacity factor on existing distribution systems, requiring additional capital investments and providing shareholders with new sources of earnings.

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