The Next Solar Energy Challenge

If you've been following solar energy for the last year you know that costs have been falling fast, putting pressure on manufacturers around the world. But, in theory, there should be a limit to how far the cost of solar energy can fall. Once solar power costs equal to, or less than, the cost of electricity from the grid, known as grid parity, there should be a large increase in demand.

The challenge for solar is how utilities will welcome or handle that demand. This becomes an important question for the solar industry to answer.

Moving to distributed solar
It's becoming apparent that the near-term future of solar power is in distributed generation. This includes small plants, residential, and commercial rooftop solar. The new German feed-in tariff is so low for utility-scale solar that it won't likely be profitable, and companies from SunPower (Nasdaq: SPWR  ) to NRG Energy (NYSE: NRG  ) are focusing on the distributed market.

Just yesterday, NRG Solar and PsomasFMG announced they would jointly develop a portfolio totaling 11 MW of solar in California. These include installations on schools as well as on building carports and ground mounted installations at other facilities. Backed by power purchase agreements, the installation partners were able to get solar power with no money down, showing how inexpensive solar has become.

Solar leasing
SunPower and SolarCity have launched leasing programs for distributed solar that allows customers to lower their electric bill with no money down. These types of programs could be the next major driver of demand for solar manufacturers. Suntech Power (NYSE: STP  ) , Trina Solar (NYSE: TSL  ) , and Yingli Green Energy (NYSE: YGE  ) all have their sights set on expanding their U.S. market shares, and by partnering with companies like SolarCity, they can grow sales.

Net metering
Understanding distributed solar and solar leasing brings me to the next potential explosion in demand, or roadblock to overcome, for the solar industry: net metering.

Net metering is basically just allowing rooftop solar to power your house when the sun is available and allowing the meter to spin backward if there is extra power. This way, consumers only pay for the net amount of electricity they use.

The reason this is becoming a topic today is that solar costs are now competitive with the grid, meaning net metering is a cost effective way to install solar power. In Hawaii, solar power costs less than regular power generation because they get most of their power from oil. In Germany, feed-in tariff rates have fallen below electricity rates, which means that net metering would be more cost effective than going with a feed-in rate. And in California, during peak hours the cost of electricity exceeds the cost of solar power and has reached overall grid parity in some areas.

This could lead to an explosion in demand for solar manufacturers, but it opens a new can of worms for utilities. Distributed solar isn't a problem for the grid on a small scale, but like utility-scale solar, the larger the system gets the harder it is to handle. In California, San Diego Gas & Electric is trying to add a fee to those generating solar power to cover costs associated with operating the electrical grid. This, the company argues, would pay for external costs that come with handling the distributed power, costs the utilities are eating themselves, or spreading to other ratepayers right now.

Solar installers and citizens have been fighting the proposed fee, but as solar grows the cost associated with operating the grid, and eventually installing backup power, will have to be paid somehow. Should it be solar homes, other ratepayers, or spread evenly among everyone? How the industry handles this could be a boon, or an obstacle, in the very near future for solar expansion.

Policy watch
Keep an eye on how states and utilities handle a growing number of solar installations, especially in California and Arizona. If net metering is allowed to remain across the country, then we could see a boom in demand. If utilities in the 43 states that allow net metering fight its usage, it could be a long 2012 for some manufacturers. For now, net metering looks safe, but as distributed power installations rise the pressure also will rise on utilities to find ways to adapt to this new energy source. At that point the net metering equation will change and may redefine the payback for solar power systems.

Solar stocks are still a risky bet right now, but there's one company our analysts think is going to win no matter what energy source we use. Find out what that company is in our free report, "The Only Energy Stock You'll Ever Need".

Fool contributor Travis Hoium owns shares of SunPower in a personal account and an account he manages. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

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