Commercial solar projects are typically analyzed through a variety of financial metrics including net present value (NPV), internal rate of return (IRR), and payback period. But like all financial metrics, the returns they indicate are only as good as the assumptions that drive them.
Given its consistent growth over the past decade, the solar industry knows with near certainty what a solar solution will produce over its lifetime. Here at Borrego Solar, our projects have historically outperformed our projections to the tune of 102%. However, what we do not know for certain, and what is the key assumption driving most customer returns, is the future price of retail electricity.
A customer’s future cash flows from the solar solution equals the difference in value between what the system provides on a $/kilowatt hour basis and the utility rates they would have otherwise paid.
With this in mind, commercial customers should consider valuing a solar solution not just as an investment but also as a hedge against the risk of rising energy costs and volatility. As a hedge, there is additional value a solar system provides that may not be evident in traditional metrics. And the higher traditional retail electricity prices go in the future, the more valuable that hedge becomes.
This perspective is particularly useful today given the shift away from using a power purchase agreement (PPA) to finance solar systems. Many customers are turning down PPAs because the price is not low enough today relative to what they are currently paying. However, the price today is much less important than how that price will compare to future electricity prices down the road.
There is additional value the system provides that is not necessarily evident in an “apples-to-apples” comparison of electricity rates.
In response to this, some customers are waiting until the price of solar can significantly beat their current rates. They value the system as a hedge but they want to wait until prices drop even further. The problem with this strategy is that time is running out. With the 2017 expiration of the federal investment tax credit (ITC), which provides a tax credit of 30% of total project costs, the economics of solar have never be better.
Future Electricity Prices
So what will future retail electricity prices look like? No one knows for certain.
What we can say is that there will be a high level of volatility. According to data from the U.S. Energy Information Administration, average California commercial retail electricity prices have had annual price swings as high as 18 % since 2000. And for customers with significant demand charges or a larger than normal percentage of their energy usage coming at peak hours, the swings have been even more significant.
There are quite a few reasons to believe that this trend will not only continue but worsen moving forward. The basis of that belief falls on the future price of natural gas. Demand for natural gas is set to explode in the United States as the grid becomes more reliant on it for base load power.
Due to the U.S. Environment Protection Agency’s latest ruling on coal, almost 17% of coal power plants over the next few years will be phased out. In addition, following Japan’s Fukushima nuclear disaster, there is little support to renew and rebuild our aging nuclear infrastructure here in the U.S.. With a smaller portion of our energy mix coming from coal and nuclear, the only place to turn for a major source of base load power will be natural gas.
In addition, states have begun to pursue moratoriums on hydraulic fracking (see New York State) because of health concerns and the recent earthquake link discovered by the USGA in Oklahoma. With a reduction in places to drill for natural gas, coupled with a growing distrust of the industry, there is a strong possibility that supply could be strained in several key areas.
In addition, 70% of our electric transmission and distribution infrastructure will need to be replaced over the next few decades. Transmission and distribution costs account for roughly half of all retail electricity prices. Utilities are poised to invest huge capital resources in the coming years that will surely only be financed through rate increases that regulators will have no choice but to approve.
The beauty of a solar solution is that it allows businesses to protect themselves against future increases in retail electricity prices and provide a value level of certainty around future energy costs. The question for commercial customers: How much do they value that certainty and how much will their competitors or customers?