Arizona is the stage for a very important debate at the heart of the solar industry right now, and it could have a big effect on some of the industry's largest players. Arizona Public Service (APS), the regulated monopoly utility for Arizona, is proposing major changes to the way solar customers are paid for the energy they provide, essentially hoping to upend the net metering that's led to a residential solar boom.
Net metering is the process of selling extra electricity that solar panels create back to the utility and getting "paid" the same rate you pay for electricity. A customer only pays for the net energy used so, if a customer uses 1,000 kW-hours per month and generates 700 kW-hours of solar power her net bill will be for 300 kW-hours of electricity, no matter when the power is produced or generated.
Utilities, particularly in the southwestern U.S., have started to fight this system, arguing that it doesn't properly compensate them for grid services supplied to customers and will eventually push grid costs onto those customers without solar. But is that true, and how will this impact investors? Let's take a look at what we know right now.
Monopoly vs. non-monopolies
Solar power is coming to the grid, no matter what utilities want, and that creates a conflict for monopoly utilities. The cushy business of supplying power at a set return on equity doesn't require much innovation or adaptation and it's highly profitable, especially if you can constantly grow your assets. That's why solar power is so scary. Instead of relying on utility investment in grid and power generation assets, solar allows a customer to own the power-generating assets at home, taking away a potential revenue source.
That's part of the prism people need to understand when looking at net metering and how utilities around the world view solar. It's different in regulated markets, where utilities have more incentive to innovate.
But not everyone in the utility business is fighting solar. NRG Energy (NYSE:NRG) owns utility-scale solar projects and is investing in residential projects as well. Edison International (NYSE:EIX), which owns Southern California Electric, not only owns commercial and utility-scale assets, it recently invested equity into Clean Power Finance,a residential solar financier, and bought its own project developer SoCore Energy. Some utilities will embrace solar and some will fight it, which makes the debate so intriguing.
Does solar really cost everyone else?
In the abstract, the concept of pushing costs from solar owners to non-solar owners makes sense. Think of an example of a grid with two customers, both using 1,000 kW-hours of electricity per month and regulated rates requiring $200 in revenue for the utility ($0.10 per kW-hr). Without solar the bill for both customers would be $100.
If one of these customers installed solar power that generates 700 kW-hours per month, then the $200 in revenue would be split among the additional 1,300 kW-hours, resulting in a 15.4 cent per kW-hour rate and a $153.85 bill for the non-solar owner. This is the argument APS and other utilities are making against net metering.
Reality, however, is far more complex than this simple example. The biggest reason is that solar panels generate the most power when wholesale power rates are the highest, so solar actually lowers the average cost per kW-hour the utility pays for power by reducing peak demand, at least until solar adoption is too high.
Some will also point to evidence that solar can have an adverse impact on grid prices based on Germany, where solar adoption is the highest in the world and at times can generate 40% of the country's electricity. Germany's electricity costs have risen about 4% annually since 2000 and 4.8% over the past two years, largely because of the adoption of solar. This compares to about a 2% increase in electricity costs annually in the U.S.
That figure will scare some but it also needs some context. What we need to keep in mind with that comparison is that Germany had a feed-in tariff that paid solar installers a solar premium for over a decade. This was nothing close to net metering. As recently as 2010 the feed-in tariff rate was 39.14 euro cents per kW-hour versus 24.4 euro cents for power from the grid. That's not exactly net metering and still the cost increase hasn't been wildly faster than the U.S. Plus, even Arizona is years away from the level of solar adoption Germany has, and Germany's installed base gets a rate far more attractive than net metering.
Should solar owners have to pay something for use of the grid? Maybe, because the grid does offer a service, but there are auxiliary benefits that serve the public's best interest, such as lower fuel consumption, reduced stress on existing transmission and distribution lines, new jobs, and more. Some would argue that these factors should be weighed heavily, especially in an area where a company like APS is given a government approved monopoly. It also doesn't help that APS is currently asking for the world instead of reasonable fees for solar owners.
What APS wants
Instead of net metering, which effectively pays solar owners $0.15-$0.16 per kW-hour for their power, APS has made two alternative proposals. The first is to pay customers $0.06-$0.10 per kW-hour for the power they generate, about in line with wholesale rates. The second proposal is to charge a fee that would reduce the average solar owner's savings from 70% of their bill to 30%-40%. That's no small impact for solar owners and could bring returns to such a low level that it kills residential and commercial solar immediately.
As APS's proposal has made the rounds it has turned into a political battle. There have been commercials in Arizona about both sides of the battle. What's changing for the solar industry is that it looks like the political winds are in solar's favor. Consumers favor solar, and both sides of the political aisle are seeing the value of this growing industry.
What it means for investors
For investors, this is a valuable debate to watch. SolarCity (NASDAQ:SCTY.DL) and SunPower (NASDAQ:SPWR) rely on net metering to fund their residential and commercial solar installations, and a lower rate changes the returns dramatically. On the private business side, Sunrun and Clean Power Finance could be devastated by a change in net metering rules, especially if it spreads around the country. Sunrun, in particular, relies on net metering for all of its projects.
For now, net metering is under attack, but it's still in place in most key states for solar companies. But the debate will rage on, particularly where adoption rates are the highest.
Fool contributor Travis Hoium manages an account that owns shares of SunPower and personally owns shares and has the following options: long January 2015 $5 calls on SunPower, long January 2015 $7 calls on SunPower, long January 2015 $15 calls on SunPower, long January 2015 $25 calls on SunPower, and long January 2015 $40 calls on SunPower. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.