Solar City

Travis Hoium has an interesting summary of the future of solar leases over at The Motley Fool investment site.  Hoium sees an evolution from leases to loans as the costs of PV installations become more predictable and affordable.  New solar loans will be structured to capture more of the tax benefits from PV panels at the homeowner level rather than sold to tax-equity investors.  He expects some leasing to remain, though at a much lower level -- about the same 20% of the market that auto leases comprise. 

Though solar leasing is still quite new and continues to grow quickly, there are some strains starting to emerge.  In my view, how these strains play out will drive the future of financing for PV panels, and for many other commercial and residential distributed technologies as well.  Here are some of the possible scenarios I see:

Scenario 1)  Utilities are successful in dumping as much of their fixed costs as possible onto distributed generators.  They will argue this is simply an equitable cost sharing of grid support service costs, but the actual amounts allocated may be driven more by political power than actual economics. 

At all levels of charges, the returns to DG owners will decline.  At very low levels of surcharge, this is probably tolerable.  On new lease or loan contracts, for example, the reduced returns will likely be shared between the leasing company and the owner, not borne entirely by the owner.  However, if existing leases are inflexible in the face of changing power prices and charges, homeowners could lose a sizable portion of their projected returns. 

At higher levels of non-bypassable charges, the cost shifting will essentially constitute an anti-competitive strategy by utilities to protect utilization of their existing fixed assets, including generation and lines.  They will try to bring returns to DG providers down far enough that new installations decline sharply and providers exit the market.  The impact on leasing per se would not be much different from the impacts on solar loans or direct purchases:  all would be depressed significantly.

Of course, markets and politics are both dynamic, so there are some interesting twists to how this strategy could play out that may end at a very different place than the utilities are predicting:

  • Decoupling DG from the grid.  Some current proposals, such as this one by Ashley Brown of Harvard's Kennedy School, would charge DG owners full retail price for their gross power consumption -- including not only what they take from the grid, but gross self-generated kWh as well.  They would then be credited back a portion of this amount, based on the calculated value of the power to the utility using locational marginal pricing (LMP).  If the utility is also charging customers using LMP, the rebate credit would never exceed the price the DG owner is paying to the utility.  At best one would break even on their own power, even though it is being generated with customer-owned (or leased) capital.  Most often, this structure would seem to result in DG owners paying the utility for their own power, albeit at a lower rate than if they just bought it straight from the grid.  Adjusting for the capital cost, however, the DG owner will probably come out behind.  The spread between the buy and sell prices is ostensibly to cover the grid service fees.  Brown is advocating a similar approach for pricing DG in our town's municipal utility in Belmont, MA.

    The need to equitably recover grids costs is real.  However, the solutions are not easy.  In addition to potential for rates to be set politically to protect utility returns, another concern of deploying Brown's approach widely is that it may create an incentive for decoupling.  If consumers are using most of the power they self-generate onsite, their incentive may be to disconnect their DG from the grid and instead to run two parallel power systems:  their onsite generation and a standard grid connection that has no associated DG, though still uses less power than before the DG installation.  In principle we all do a similar thing when we invest in home energy efficiency:  we pay for systems (which can be as simple and high-efficiency LED bulbs) that reduce our grid demand, but retain our pre-existing connection to the grid. 

    In the case of a larger DG systems, decoupling could result in having to dump some excess energy into the ground.  If the dumping is large enough, it could drive end-users to invest in battery storage for the excess, or to establish small interconnections with neighbors to use periodic surpluses.  Assuming the decoupling is done carefully, the utility would simply see certain customers with reduced demand, but would not be collecting the fixed charges it had hoped to from the DG-associated demand destruction.  In fact, the rate structure could inadvertently accelerate the incentives for customers using DG to decouple; and for solar leasing firms to bundle some battery storage into their product -- as Solar City is already talking about doing.
  • Anti-trust.  A core element of the original push for power deregulation was that the natural monopoly of power generation (economies of scale sufficiently high such that a single regulated provider of power would be far more efficient than multiple competitors each operating at a lower capacity utilization or production scale) no longer applied.  Yet, even in places with merchant production, ties between generation and power transmission and distribution (which is for the time being still a natural monopoly) were not severed. 

    This linkage always creates potential conflicts of interest.  The optimal power supply for customers may not be from the generators owned by the utility; however, the utility would nonetheless have a financial incentive to buy from itself.  This same dynamic plays out in other line-based natural monopolies -- oil and gas pipelines for example, where complex ownership agreements aim to manage this risk through co-ownership of fields and lines; or broadband providers providing net-neutral services for data packets of self-generated content versus competitor-generated content (look for big battles on this in coming years given the recent Supreme Court ruling on net neutrality).  The rise of leasing models, combined with falling costs and the availability of smaller scale DG, mean that the competitive threat from non-utility models is very real. 

    And if there is price discrimination, one solution would be to force the utilities to finally divest all generation assets, and for them instead to focus soley on building optimal supply via contracts and delivering that power to customers.  I think this is eventually where we'll end up, though the shift may still be quite a few years off.

Scenario 2)  Utility surcharges remain small and DG markets remain viable.  In this scenario, I don't see leasing arrangements disappearing, but hope that they will continue to evolve.  More competitive leasing markets should allow property owners to capture a larger share of system gains.  Equally important is for the risk of market changes to be borne at the lease level rather than by homeowners.  Just as bundling solar leases has important economies of scale in financing and administration, so too does managing the risks of regulatory changes or price changes for the power produced. 

Hoium points to examples from Solar City where marketing hype seems to be overstating the benefits of solar by assuming continued escalation of power prices beyond what is reasonable. But having solar leases get grouped into the same category as car leases -- that extreme diligence is required in order to avoid being screwed -- would not be an optimal development path for the industry.  Just as mutual funds were required to provide standardized descriptions of performance and expenses over time, it is probably time for similar disclosure to be implemented on solar leases as well. Such disclosure might include return projections should key assumptions change (i.e., the power cost to the consumer escalates each year but the utility power cost remains stable or falls).

Whether leases shift to loans or not I think depends on how much value homeowners continue to obtain from not having to vet installers, installation locations, PV panels suppliers, or repair people.  If prices fall and installation and repairs become no more complicated than for other home appliances, I do think more customers will chose loans or buying the panels outright.  This trend will make even more sense as subsidies drop; if subsidies remain high, there are some that are available for corporations, but not necessarily to homeowners.

Under any of these trends, I do hope that the leasing approach continued to be deployed, but in a more transparent and competitive form.  There are many other untapped markets to which they could be expanded (see below).

Scenario 3)  Utility integration develops such that it can more effectively use DG and share associated value creation.  A solar lease solves a number of problems for consumer and commercial customers.  These include technology and vendor selection, financing efficiency and pricing,  repairs and management over time, utilizing avaialable subsidies, and establishing a return floor. 

Other energy markets to which such solutions would also be attractive include solar hot water, geothermal installations, small scale co-gen systems, even window replacements or other efficiency upgrades.  The measurement challenges may be a bit diferent, but all involve an upfront capital investment for energy-saving capital equipment that may be unfamiliar to small property owners or challenging for them to manage over time.  In all of these areas, third party leasing agents could add tremendous value. 

Because each incremental expansion of the leasing model will shift an additional block of demand away from the conventional customer/utility relationship, some tension between DG funders, owners, and utilities will likely remain.  As this pressure builds, my hope is that regulators narrow the role of the utility to that of a power intermediary and delivery agent, rather than acquiesing to market structures that slow or block the development of non-utility resources.

Image of traffic jams linked to NJ Gov Chris Christie
Image of traffic jams linked to NJ Gov Chris Christie

Ahh, how the petty world of politics doth make fools of us all.  It is not enough that Elon Musk is trying to start a new car company in a market segment ruled by massive multinationals.  He is ratcheting up the risk level by taking on a  great deal of technology risk as well.  And in the process, he is doing tremendous legwork for future producers to get an electric drive train working well, and also to create an electric vehicle that onlookers envy rather than mock. 

Trouble with the batteries?  No problem.  Just build a massive, multi-billion dollar factory (though maybe they can still change the name from "Giga Factory" to something a bit catchier...) to make lithium batteries at a scale that can bring costs down both through high volume production and through incremental learning and technical improvement.  And if you happen to have large volume production of these batteries while also being Chairman of a large solar panel leasing firm (Musk started Solar City), why not use some of those batteries to help the PV sites store power?  It's at least a twofer:  the storage helps better match onsite production with onsite consumption, and can also enable PV producers to sell stored power back to the grid during periods of higher value.  The expensive panels are being leased anyway; adding a few battery packs won't make it markedly more complex.  And if you upend the utility industry by boosting the ability of self-generated power to substitute for grid-supplied juice, all the better.

Let's give the guy credit.  Elon Musk is taking on the economies of scale for both electric vehicle and battery production -- high risk endeavors that, against huge odds, he may actually succeed at.  And Solar City isn't exactly low risk either. 

So Governor Christie ought to be out there thanking the guy for the work he's doing, knowing that the road to success remains long and hard, but nonetheless admiring Musk's role as an outsider taking on the power structure to build a better society.  That is, after all, what Christie himself did back in 2009.

If you add enough fixed costs, maybe even Elon will drown

Alas, Christie took the vested path instead.

His appointees issued a regulatory ruling to block direct Tesla sales in NJ without at least letting the issue be argued in court.  The effect is to lump on another layer of large fixed costs to roll out the vehicle -- adding the sales network to the already high risk areas of vehicle and battery manufacture. 

Selling too few cars to support a dealer network like GM can? Too bad:  Governor Chris says you need an independent network anyway.  Who cares if your product directly competes with the vehicles they are making most of their money on and might generate a conflict of interest.  Selling an idea as well as a car, and need a specially trained staff?  No problem: the existing dealers can do it.  People will flock to them to chat and learn:  after all, bartering for a vehicle is one of most people's favorite activities and car salepeople among their favorite teachers.  High level of training needed to explain the new technology and the complex financing approach?  Again, somebody in that independent dealer network could learn to be that trusted communicator.  They may have to:  the independent dealer networks receive regulatory protection from direct sales of automobiles in at least 48 states and dealerships with protected franchises that date back 99 years in some cases.   (Dan Crane did a nice write-up on the history of these market protections last year.)

Does it all tie back to the bridge?

Let's give Christie a break.  Maybe the decision to restrict direct sales in NJ really isn't about politics.  Maybe Chris Christie is just worried about the well-being of New Jersey residents, and felt that the charging station issue --  you know, range anxiety -- required him to act.  Christie knows that sometimes drivers in his state get tied up in massive traffic jams on the George Washington Bridge near Fort Lee.  Who knows when this will happen again? Or where?  It's not as though the GW Bridge is the only possible site: other places yet-to-be named could also experience one of Chris' trade mark "FLASH JAMS". 

So he is worried.  He is worried that people driving Tesla's on that bridge (or location to-be-named later) could suddenly find themselves not moving for hours.  And they would run out of power.  And be stranded, maybe forever (who knows -- Governors need to think about worst case scenarios).  To ensure this doesn't happen, maybe Christie is looking out for the little guy here to make sure Granny isn't left toothless on the bridge, and with no food or water or place to plug in. 

Well, this could be what is happening, couldn't it?  Quick:  somebody check the e-mails.  They keep finding new information.  Has anybody searched "Tesla" yet?

Gecko power

Hey, if it does turn out to be just routine political pandering, what is Tesla to do?  After all, vehicle sales aren't the only industry to be hamstrung by old regulations that protect incumbents against new ways to provide the same good or service cheaper, faster, or better.  Taxi-cabs are another great example.  They are often licensed at the town, city, or county level, rather than the State.  Those licenses (medallions) can be worth hundreds of thousands of dollars each (and more than $1 million in NYC) -- a good proxy for the value of the operating monopoly.  And as a result we have the rather bizarre outcome in which many suburban cabs drop customers off at the airports and leave empty while city cabs leave the airports full and come back from surrounding towns empty.  Both practices burn a ton of extra gas (and a ton of driver time).  Yet at the same time, we see growing regulations forcing cab companies to buy energy-efficient and more expensive "clean" cab fleets to reduce their climate and air pollution impact.

Market changes that affect entrenched industries or marketing arrangements often trigger fierce political battles.  Following the NJ ruling, Tesla's initial strategy is one of bypass, directing customers to check out showrooms in NY and PA.  But longer-term, Tesla should be looking for allies to help overturn restrictions on direct sales of automobiles.  The ideal candidate would be somebody in a related industry that has also faced challenges in being able to direct sell; who has enough clout and power to just perhaps get the rules rewritten; and who might see profits rise if the luxury Tesla vehicle starts to sell in larger numbers.  Any suggestions?