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Any Increase in Regulations Could Be SolarCity's Achilles Heel in 2014

SolarCity (NASDAQ: SCTY  ) installs solar-power systems on rooftops. Business has been brisk because of government mandates that electric companies buy excess power created by customers that install such systems. Arizona, however, is the first state to allow utilities to charge customers for that privilege -- which could materially alter the dynamics of SolarCity's business.

Two markets
One of SolarCity's big customers is Wal-Mart Stores  (NYSE: WMT  ) . The duo has worked together on more than 170 of the giant retailer's 200-plus rooftop solar installs. And there are plans for more. This effort has made Wal-Mart one of the largest players in the rooftop-solar space -- and it has plenty of room to grow its footprint since it has thousands of stores in the United States alone.

However, Wal-Mart's goal is to replace just 30% of the power it uses in a typical store. A local homeowner installing solar power has a different profile. Unlike a Wal-Mart, which is open while the sun is shining, a personal home may be fully or partially vacant during the day. With the family out of the house, all of the power being generated isn't likely being used. It would, thus, be "sold," by government mandate, back to the power grid.

A nice add on
Being able to make money off of a rooftop-solar installation, or at least offsetting a notable portion of an electric bill, is a big selling point. It also helps explain why SolarCity has partnered with retailers like Home Depot and high-end homebuilder Toll Brothers (NYSE: TOL  ) . Both companies clearly see the environmental trend of solar as a way to boost both their sales and images.

Home Depot, for example, has brought SolarCity into around 450 stores. Toll, meanwhile, is benefiting from SolarCity's program that allows homebuilders to "offer solar in their new residential communities without incurring any upfront costs." And Toll's high-end customers are the perfect target market to install such systems.

An unhappy alliance
Power companies, however, aren't pleased by the government mandate to buy power from would-be customers. Companies like California's Edison International (NYSE: EIX  ) contend that rooftop-solar owners are getting a free ride on their distribution networks. That essentially makes other customers pay for the benefit residential SolarCity customers receive.

And that differential isn't small. Edison International estimates that it costs around $0.08 per kilowatt hour for the company to make electricity, but it has to pay rooftop-solar owners about $0.28. That's a big difference, and it helps explain why utilities are working hard to get paid a monthly fee for hooking rooftop-solar systems to the grid.

Arizona has heard the utilities' concerns and done something about it. Arizona Public Services Group, a division of Pinnacle West Capital (NYSE: PNW  ) , asked regulators in that state to allow a $50 per month charge for net-metering customers. Although it didn't get what it wanted, the utility was allowed to charge such customers around $5 a month.

Pinnacle West's $5 a month charge clearly isn't a death blow to SolarCity. However, it suggests an important change on the regulatory front. Where once the idea was to foster such renewable-energy systems with little regard to the impact on supporting systems, Arizona marks a switch to looking at the bigger picture. If other states follow this lead, it will be harder for SolarCity, Home Depot, and Toll Brothers to get customers to sign up for new solar systems.

Watch, but don't fear
Arizona allowing Pinnacle West to charge customers a fee for net metering is an important trend for you to monitor. It's a potential lifeline for utilities that were watching customers essentially turn into competitors. For SolarCity, however, it could make selling residential solar much harder. However, it's important to remember that residential solar systems are only one part of SolarCity's business. Any setback here could simply result in a shift toward serving more business customers like Wal-Mart. You should keep a close eye on how SolarCity adjusts if the Arizona ruling is the start of a trend. 

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Reuben Brewer

Reuben Gregg Brewer believes dividends are a window into a company's soul. He tries to invest in good souls.

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