More American homeowners are investing in residential solar power systems, thanks in part to regulations that enable such installations to sell surplus electricity back to utility companies at retail rates.
But that regulation, called net energy metering, is a victim of its own success. Electric utilities are required to buy this rooftop-generated electricity at rates far higher than the wholesale rates that they would have otherwise paid for the same energy. These additional costs, in turn, are passed down to all ratepayers, effectively acting as a cross-subsidy.
Now regulators and lawmakers in dozens of states are reevaluating their policies — and their decisions will have a major impact. “There’s a lot of fighting in state capitols,” says Stanford Graduate School of Business professor Stefan Reichelstein, “and it’s going to shape how quickly the whole residential and commercial segment of the industry will grow.”
New research from Reichelstein and coauthor Stephen Comello, director of the Energy Business Innovations, examines three states that have already enacted changes and calculates the threshold to keep the solar industry humming without undue economic support.
Beware the Death Spiral
When net metering policies were first introduced in the 1980s, they were an important mechanism to help jumpstart the solar industry. While the details vary by state, these policies typically call for owners of solar systems to be compensated for the surplus electricity they feed back into the grid at the going retail rate. Utilities are required to buy this power, even though they could procure the electricity at a much lower rate on the wholesale market. In California, for example, rooftop solar customers can sell back electricity at around 17 cents per kilowatt hour, whereas the utility could buy it on the wholesale market for around 4 cents per kWh.
The utilities opposed the agreement initially, Reichelstein says, but “at the time the solar industry was so tiny that the utilities shrugged it off.”
Now, solar costs are dropping and demand is spiking, changing the economics of residential solar installations and the need for net metering. Some even speculate solar incentives will lead utility companies into a “death spiral.”
This threat unfolds like this: As more customers install solar panels, a utility will sell less electricity in total. Since the utility also incurs fixed costs in order to maintain the overall grid infrastructure, the rate it charges for electricity goes up even as it sells less of it. This makes installing solar panels even more attractive to more people, which means the utility sells even less and charges even more. And so on down the spiral.
Even if encouraging more solar deployment is desirable, this is not a happy scenario for the overall health of the industry. For one thing, while solar customers add to the overall infrastructure burden by requiring two-way flow of electricity, those costs tend to get shifted onto the remaining non-solar customers while solar developers reap tidy profits.
“With retail rates going up and the cost of solar going down,” Reichelstein says, “the margins are getting fatter for the solar companies. But those margins are based on the support mechanism of net metering.”
For customers, Comello says, net metering can amount to a subsidy for the rich. “Those who own their home and are more traditionally well off are the ones who have the advantage. Whereas if you live in an apartment or don’t have the means to install solar panels, you’re cut off from all the benefit while paying more for your electricity.”
The Happy Middle
As regulators and lawmakers across the country look to revise net energy metering policies, the open question is what they will look like in their next incarnation.
Reichelstein and Comello hope that their recent study will provide a perspective that’s acceptable to both sides. “In terms of public policy support, we wondered what’s an inexpensive way to encourage further investment in rooftop solar without giving lavish profits to developers,” says Reichelstein. “There are lots of benefits in terms of the overall energy mix to keep the growth in solar going, but it shouldn’t be more than what’s necessary.”
The researchers looked at recent policy changes in California, Hawaii, and Nevada to calculate how net metering could be ideally calibrated. California preserved its retail rate net metering policy through 2019, while Hawaii replaced net metering with two new tariffs still somewhat favorable to solar, with plans to revisit the matter again in two years. Nevada, however, eliminated its net metering policy completely and replaced it with a system that values excess electricity from solar systems at a much lower rate. This move, the researchers argue, was the death knell for residential solar development in the state. Shortly after the new rate took effect, SolarCity, Sunrun, and others announced they would cease such operations in Nevada.
“It shook the industry,” Reichelstein says. “If other states were to follow that example, it would bring the residential solar market to a standstill.”
Reichelstein and Comello in their paper suggest tying the rate at which customers sell back surplus electricity to a metric called the levelized cost of electricity (LCOE).This metric accounts for the expected lifetime costs of generating electricity — including construction, financing, taxes, maintenance, and more — and varies depending on the location because of differences in the abundance of sunshine. In the case of California, where retail rates are 17-18 cents per kWh and wholesale rates more like 4 cents per kWh, the LCOE sits comfortably in the middle at around 12 cents per kWh.
Most critically, the researchers’ calculations show that the LCOE represents a tipping point. While it’s not overly generous to solar companies, it’s good enough to incentivize homeowners and developers to invest in rooftop solar while easing price pain for utilities and working toward protecting customers from cost shifts. Anything set distinctly below the LCOE, they warn, could erase the incentive to install residential solar systems and likely decimate the industry.
The researchers say that the LCOE is a sweet spot for another reason: It’s a moving target. That means as solar gets cheaper, the LCOE will decrease, and essentially phase out net metering without putting undue stress on the industry. The authors suggest a “margin of safety” ought to be built into the process, such as setting the compensation rate at LCOE plus 10%.
“A perfectly suitable policy would have the rates calibrated this way,” Reichelstein says. “That would reduce the margins of the solar developers, but it would still keep the incentives to build more rooftop solar and sustain growth in the industry.”