Spwr Residential Close Up

Image: SunPower.

There's a battle brewing in California that could affect the state's booming solar industry as well as the vision of a cleaner energy future. SolarCity (NASDAQ:SCTY) and other residential solar developers could be disrupted by utilities beginning the fight against solar energy, and unlike previous battles they may have a good argument against solar. 

The way utilities are attacking solar and the reliance the industry has on California could tell us a lot about the future of solar investments in general. Those ready to adapt will thrive and those who who are in for dark days ahead.

Utilities make the argument against solar energy
California's three largest utilities -- Southern California Edison, Pacific Gas & Electric, and San Diego Gas & Electric -- recently filed rate proposals with the California Public Utilities Commission that would end net metering as we know it and could kill the residential solar industry in its tracks. SolarCity is by far the biggest residential solar company in the state, but Vivint Solar (NYSE: VSLR) , Sunrun (NASDAQ:RUN), and SunPower (NASDAQ:SPWR) have been growing there as well, so the whole industry would be affected if the proposals go through.

Solarcity Copper Ridge School

Image: SolarCity.

Before getting to how rates affect solar, we have to understand how utilities are basing their argument. Utilities think that customers with solar energy on their roofs are more costly to the grid than the bills they're currently paying. Net metering allows customers to only pay for the net energy they use, freely consuming or distributing electricity from the grid depending on whether the sun is out or not. In effect, the grid becomes a free battery for these homes, which utilities don't think is right.

There are many good arguments on both sides of this debate, but the utilities typically don't have a good argument when solar energy is a small percentage of the grid, as has been the case in the past. The few homeowners who are sending electricity to the grid periodically just aren't all that taxing on the system.

But when solar becomes so common that it's a larger percentage of the grid it is extremely taxing. When the sun goes down and customers get home from work there's a huge spike in demand (the duck curve), meaning natural gas plants have to spring into action to keep the grid working. Since California is approaching its 5% net metering cap for residential solar, it's time for utilities, regulators, and solar companies to figure out what rate structures are fair in a post-net metering world. 

Why net metering is so important to solar developers
It's important to understand why this debate is so important to SolarCity, Vivint Solar, Sunrun, and SunPower. Their $0 down solar power purchase agreements or leases are predicated on net metering being in place, and if it goes away demand could dry up quickly.

First, let's look at how a bill might work under the current rate structure and what it would look like with an interconnection fee, a demand charge, and a lower rate for electricity. This is an example based on fees utilities across the country are trying to test. You can see below that the bills customers pay would be exactly the same, so the utility would argue that there's not a big change for its customers.

 

Current Structure

Example Rate Structure

Utility Energy Cost

1,000 kWh @ $0.18 per kWh = $180

1,000 kWh @ $0.13 per kWh = $130

Interconnection Fee

 

$30

Demand Charge

 

$20

Total Monthly Bill

$180

$180

Example by author.

The big impact the example structure would have is in how solar economics work. Even if we assume that customers get full credit for the electricity they're sending back to the grid (not always the case in utility proposals) they're getting a lower rate per kWh for that electricity and paying other fees along the way.

The $50 in interconnection and demand fees I've used in this example would remain the same even for solar customers, which actually makes a solar system non-economical.

 

Current Structure-Net Metering

Example Rate Structure w/ Solar

Solar Energy Cost

600 kWh @ $0.15 per kWh = $90

600 kWh @ $0.15 per kWh = $90

Utility Energy Cost

400 kWh @ $0.18 per kWh-$72

400 kWh @ $0.13 per kWh-$52

Interconnection Fee

$0

$30

Demand Charge

$0

$20

Total Monthly Bill

$162

$192

Solar Savings

$28

-$12

Example by author.

This isn't just a hypothetical scenario either. When Arizona's second largest utility changed its rate structure to include demand charges and other fees for solar customers to access the grid the industry fell 96% overnight. The risk from rate structures is very real for every company relying on residential solar to essentially go unchanged. 

Changes are coming
Given California's commitment to solar energy, its large solar workforce, and regulators' willingness to push back against utilities on net metering in the past, I don't think the worst case scenario of the industry collapsing is in play. But rate structures will likely change to more appropriately compensate utilities for services solar customers get from the grid.

This will likely change the economic case for SolarCity, Vivint Solar, Sunrun, and SunPower. The first three are heavily concentrated in residential solar in California so the business disruption from changing rates could be huge. But disruption can bring opportunities as well.

Tesla Powerwall Header

Maybe new rates will make Tesla Motors' Powerwall more economical. Image: Tesla Motors. 

The upside of new rates
What shouldn't go overlooked is that higher demand charges or minimum fees also make things like energy storage more economical. For SolarCity and SunPower, which have been testing energy storage on a small scale, this could open up the option of selling energy storage with solar systems because they could save on some of these fees we see above.

Tesla Motors is no doubt eyeing new rate structures as a potential way into the market because today energy storage makes little sense when the entire grid acts like a free battery for solar systems.

Adapt or die
What's not in question is that the business model for solar companies will change as utilities learn how to fight it and high solar adoption rates put a greater stress on the grid. The companies that can adapt to this new reality will be big winners and those too reliant on a single business model won't survive.

SolarCity has proven to be very nimble in its time as a public company, and while there's likely disruption ahead I think management has built the capabilities to adapt. SunPower can simply rely on its diverse business model and change with the times in residential solar.

The companies to worry about here are Vivint Solar and Sunrun, which have fairly narrow and non-diverse business models. They'll have a harder time adapting if California's regulators make the state less attractive to solar installers.

Knowing where the strengths and weaknesses of solar companies lie is key and that's showing itself in California today.

Travis Hoium owns shares of SunPower. The Motley Fool owns and recommends SolarCity and Tesla Motors. 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.