Edison Electric Institute (EEI), the association of U.S. shareholder-owned electric power utilities, recently published a startling report calling out distributed energy resources as disruptive technologies threatening the existence of today’s U.S. electric utility industry. While the EEI report and the commentary that followed view solar primarily as a threat to their business model, Sol Systems has seen some utilities find opportunity in the potential of small-scale solar by making real investments in portfolios of distributed assets. By leveraging “disruptive” solar into their portfolios, utilities can position themselves to benefit from the continued growth of solar and the tax benefits therein. And by streamlining the investment process, challenges like high transaction costs and low velocity of capital can be overcome.
At the most basic level, utilities make money by selling power to consumers – and distributed solar cuts away the demand for their product. The EEI report identified several factors that have made distributed solar a viable alternative to purchasing power from the grid:
- Declining prices of installed solar, specifically modules and equipment
- Increasing utility prices for electricity that make solar competitive in a large parts of the country
- Federal incentives including the ITC and accelerated depreciation (MACRS)
- Increased adoption of Renewable Portfolio Standards (RPS) at the state level
- Increased adoption of net metering policies at the state level
- Time of use (TOU) rates that charge higher prices for electricity consumed during peak hours, which coincide with the peak production hours for solar and reduce sales of the utility’s most expensive electricity
- The emergence of financing structures, including PPAs and leases, that allow for third-party-owned solar requiring no upfront investment by ratepayers.
These factors combined endanger the standard utility business model, in which profits are directly linked to a greater volume of energy sales. In the past, the volume of energy sales has increased while the cost of energy has decreased. This factor alone has made investments in utilities attractive. Utilities, however, will not be able to capture value from new, non-conventional sources of distributed energy through their traditional business model – a model that has remained unchanged for literally hundreds of years.
The EEI report states that as customers switch to solar and other distributed energy resources (DER) and the volume of energy sales decrease, the remaining customer base suffers. Specifically, DER customers shoulder fewer of the fixed costs for the grid system they still require in times when their DER is not producing energy. The presumed result is higher rates for non-DER customers. In response, more customers may then choose to install DERs, further eroding a utility’s profits. Some utilities fear this would catalyze a cycle in which greater DER deployment results in fewer full customers and increasing electricity rates. The EEI report contends that non-DER customers bear the burden of lost revenue and higher fixed costs in the form of increased rates, an assumption which may or may not be true. The ultimate concern for utilities is decreased investor confidence, leading to an industry-wide lowered credit rating leading and reduced access to capital.
It’s worth considering whether these fears are accurately communicated. The report is produced by an industry group likely interested in protecting its members’ current business model. Admittedly, the EEI report ignores many of the cost-saving benefits from solar, including avoided costs from new energy generation, reduced transmission costs and line losses, and help in meeting state renewable energy mandates. Because distributed solar produces both costs and savings, only detailed analyses within a specific territory can determine the effect of distributed solar and other energy sources on local rates. While utilities will very likely see their revenue diminish, it’s still unclear what the eventual impact on rates for consumers will be.
Amid the debate, Sol Systems is partnering with several utility clients, both IOUs and POUs, investing in portfolios of distributed solar assets. Specifically, Sol Systems is working with the branches of utilities that generate energy or are operating as independent power producers (IPPs). The generation branches are generally separate and distinct from the transmission and distribution branches of utility companies, which are regulated by public utility commissions (PUCs). Though it varies state by state, typically a regulated utility involved in the transmission and distribution of energy is not involved in the ownership of solar projects. Thus, even within a single holding company, different subsidiaries can have entirely approaches to distributed solar investment. While others see only unified opposition to solar from utilities, Sol Systems sees utility investment in distributed solar as a key element in the future growth of the industry.
Some utilities are already heavily investing in the solar asset class, though admittedly with larger, centralized projects. The Solar Electric Power Association’s (SEPA) Utility Solar Rankings for 2012shows that utilities own 12 percent of the 1,106 MW of solar projects above 5MW added in 2012. Utilities can also take advantage of the 30% investment tax credit (ITC) for solar including accelerated depreciation through 2016 as a strategy to reduce their tax liability. Until new financing structures like MLPs, REITs and PACE financing free up new sources of capital, utility investments provide a natural source of tax equity for the industry.
What’s new about the activity Sol Systems has been seeing is the scale of the investments – increasingly smaller DG projects, often well under 1MW. And though solar energy still makes up less than one percent of the U.S. energy mix, utilities are increasingly aware of the impact even low levels of penetration could have on their business model. Utility ownership of small and distributed solar projects can realign the interests of both industries as our current model shifts to adapt to the increasing adoption of solar and other DG energy sources. Sol Systems sees the aggregation of portfolios of DG solar assets as an encouraging point of collaboration between both groups.
Sol Systems is continually originating and providing due diligence on DG assets in order to creatively place capital on behalf of utility and other investor clients.
This blog has been cross-posted at The Daily Energy Report.
About Sol Systems
Sol Systems is a boutique financial services firm that offers investor clients direct access to the renewable energy asset class and provides developers with sophisticated project financing solutions. Founded in 2008, Sol Systems focuses on meeting the most critical needs of the industry, including SREC monetization, capital placement, tax equity, and New Market Tax Credits. To date, the company has arranged financing for thousands of projects and facilitated hundreds of millions in investment on behalf of Fortune 100 companies, private equity, family offices and individuals. For more information, please visit www.solsystemscompany.com.