The future of solar leases
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 return
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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.