Image source: Solar City.

California regulators are pondering how the state's net metering policy for residential solar energy should change under a new plan known as Net Energy Metering 2.0.

The first iteration of net metering allows customers with rooftop solar to supply electricity to the grid, or draw it from the grid when ever they need, only paying for their net usage every month. This is how residential solar companies promise customers savings and justify their system economics. Critics argue that net metering doesn't compensate utilities for the services they provide to solar customers, so new rules are being discussed. 

As part of the discussion, the state's three biggest utilities, Southern California Edison (SCE), Pacific Gas & Electric (PG&E), and San Diego Gas & Electric, are proposing changes to net metering that could stop the residential solar industry in its tracks.  

For SolarCity (NASDAQ:SCTY.DL), Vivint Solar (NYSE:VSLR), and Sunrun (NASDAQ:RUN), who all rely on California for most of their residential solar demand and growth, the changes could be "catastrophic," as SolarCity CEO Lyndon Rive said. Another player, SunPower (NASDAQ:SPWR), would also see a hit to earnings, but it is less reliant on California residential solar than the others, so the impact would be muted.

Understanding what utilities are proposing and how it would affect solar companies is important for investors, so let's go through what we know so far. 

Image source: SolarCity. 

Changes are coming for residential solar
In 2013, California's utility regulators made a compromise with utilities and the solar industry on net energy metering. Under the plan, net metering would remain in place until mid-2017, or when net metering was 5% of a utility's nameplate capacity, whichever came first. But regulators also needed to come up with a plan for what they called Net Metering 2.0 by the end of 2015. It's now crunch time for those plans.

Solar companies, of course, don't want any changes to the status quo. After all, business has been great for them since 2013, especially in California. But utilities are proposing changes that would make solar on rooftops less affordable. Here are some examples of the strategies they're using:

  • Charges for solar customers based on the size of a home's solar system. In the case of SCE, the company is proposing a charge of $3 per kW, or $18 per month for an average 6-kW system.  
  • Lower feed-in tariff rates. SCE has proposed a feed-in tariff rate of 8 cents per kWh, about half the cost of electricity in California today. PG&E has proposed a complex system that it suggests will pay about 9.7 cents per kWh for electricity fed to the grid. This is for the energy exported from a solar system, so customers would still be able to offset the higher electricity rate by using energy on site.
  • Minimum bills have also been used around the country to make solar energy less economical. In California, utilities can start charging minimum bills of up to $10 per month, whether customers have solar or not. 
  • Demand charges, which change based on the peak consumption customers draw in a month, have also been proposed. These charges are common in commercial buildings but are rare for residential customers.

These plans could be used by themselves or in combination to make residential commercial less economical for homeowners and solar companies. As we recently saw in Nevada, regulatory changes can kill the residential solar industry almost overnight. But that's very unlikely to happen in California.

California won't kill solar, but residential solar will change
Regulators in California have been some of the most accommodating to the solar industry for years, and for their efforts, the state is now a solar leader worldwide. The state also recently passed a 50% renewable energy mandate by 2030, so it can't afford to kill residential solar today.

Instead, I think California will allow utilities to put minimum bills in place for customers, and maybe even lower payments for electricity that customers send to the grid. If done correctly, this would make solar incrementally less economical for SolarCity, Sunrun, Vivint Solar, and SunPower, but it wouldn't kill the industry altogether.

Changes to the regulatory structure could also open up markets like demand response and energy storage. Under net metering as it is today, there's no incentive to save solar energy for nighttime use or to worry about what peak demand is from the grid. Demand charges, lower feed-in rates for solar electricity, and a demand response program could change that.

That's why it's important that companies like SolarCity and SunPower are working on energy management, not just putting solar systems on rooftops. Adding even a small energy storage system and some smart electronics could create an opportunity for solar companies to make more money, not less, under a new rate structure.

The fight for the future of residential solar
California accounts for nearly half of the residential solar industry, so rate changes are a big deal for the solar companies who operate there. SolarCity has been the most vocal against changes, but all residential solar companies will be negatively affected if the changes work against the industry.

It's worth keeping an eye on for all solar investors, because this is the biggest fight the residential solar industry has faced yet.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.