Navigant Research Blog

Solar Subsidies Attract Financial Schemes

— October 20, 2014

Arizona Public Service (APS) and Tuscon Power have recently come under a lot of scrutiny for their proposed rate-based solar programs.   The complaint from private sector companies is that rate-basing (i.e., the utility practice of raising funds for capital investments by increasing electricity rates) would create an uneven playing field in the solar industry, because rate-basing a capital expenditure gives utilities a guaranteed rate of return.  As SolarCity’s VP Jonathan Bass put it, “If there were ever a reason for a regulatory body to exist, it would be to stop a state-sponsored monopoly from unfairly competing against the free market in an entirely new industry.”

That’s hard to argue with.  However, I would add that another reason for a regulatory body to exist is to stop the free market from abusing the subsidies that are so crucial to an entirely new industry.  In the spirit of fair-minded analysis, let’s take a closer look at the solar industry and at how level the playing field actually is.

Pump and Dump

First, let’s examine the solar developers (SolarCity, Vivint, SunRun, Clean Power Finance, etc.) whose solar lease and solar loan programs are responsible for catapulting the industry into the period of rapid growth we’re seeing today.  Critics argue that solar developers base their business models around building solar arrays on the cheap and claiming an inflated fair market value (FMV) of the systems.  The FMV is supposed to reflect the fair price of a system, and it’s ultimately used by the government to determine the monetary value of the 30% income tax credit (ITC) that goes back to the owner of the system.  Ironically, the FMV is becoming increasingly difficult to determine as more solar companies are vertically integrating, which has made the true system costs less transparent.

For systems that are being leased (which are most systems), the owners and thus recipients of the ITC are actually third parties.  These third-party owners tend to be financial institutions, such as Morgan Stanley, Goldman Sachs, Credit Suisse, Google, and Blackstone, that are constantly looking for tax credits, and they have found a slam dunk as financiers of residential and commercial solar arrays.  Typically, the developers bundle a group of solar customers together into a tranche (essentially a bucket of leases), which is then backed by the third-party ownership groups.  The financial firms own the leased systems for 5 years and then dump them, but not before taking advantage of the Modified Accelerated Cost Recovery System (MACRS), which is a method of depreciation that allows third-party owners to recoup part of their investment in the solar equipment over a specified time period (5 years) through annual deductions.  Basically, MACRS represents an additional subsidy, with a net present value of 25% of the initial investment.

The Treasury Steps In

So between the 30% ITC and the 25% MACRS, the owners should be getting a 55% subsidized investment; but with the inflation of the FMV, it turns into a much larger subsidy, on the order of 80%.  Then consider the high rate of return (up to 15%) that investing in solar offers on top of all these subsidies, and it starts to sound pretty good to be a solar financier.  Solar developers readily admit that their business models are dependent on government subsidies, but this sounds like manipulation of those subsidies.  Indeed, this practice is currently under investigation by the Department of the Treasury.  While the developers claim they haven’t done anything wrong, if the government tightens the rules around the ITC or tries to recoup the inflated subsidies, it could be a major blow to the solar industry.

What’s more, the developers themselves don’t seem to be reaping the rewards of their innovative business models that have brought solar to the masses.  If anything, they seem to be bearing all the risk while the third-party owners reap most of the profits.  Is there some merit to rate basing solar?  In my next blog, I’ll examine this question.

 

From NRG, a Solar Storm

— June 12, 2014

According to David Crane, NRG Energy’s outspoken CEO, residential solar power will be cost-competitive with retail electricity in about 25 states next year.  As a result, NRG is making some big moves in residential solar installation and financing.

In March, NRG announced that it is acquiring Roof Diagnostics Solar (RDS), which is the eighth-largest residential solar installer in the United States, employing 475 people.  NRG already has a small but growing residential solar installation and financing business called NRG Residential Solar Solutions (RSS), which mainly consists of licensed dealers and operates in Arizona, California, Connecticut, Hawaii, Maryland, Massachusetts, New Jersey, New York, Texas, and Vermont.  RSS has a fleet of several thousand residential systems installed, but it hit a sales plateau in 2013.  The company showed that it’s serious about becoming one of the largest solar installers and financiers in the United States by acquiring RDS, which will be rolled into RSS.  NRG hopes to maintain its existing installer network despite some channel conflicts with RDS, which operates in New Jersey, New York, Massachusetts, and Connecticut and has expansion plans for California.

Undercutting the Customer

NRG is also planning to eventually use the growing underground network of pipes that delivers gas to about half the homes in the United States to complement its residential solar business.  According to Crane, the company wants to provide customers with fuel cells and microturbines, which produce electricity from gas, to fill in the gaps of solar generation.  Plus, NRG is dabbling in energy storage and microgrids on Richard Branson’s Necker Island.

In some cases, NRG is making bets against its traditional customers (and its own traditional business).  It has become the largest power provider to U.S. utilities, with 25 GW of natural gas power plants, 13 GW of coal generation, 448 MW of wind farms, and 1.2 GW of utility-scale solar systems.  Some of this power goes to NRG’s own service territory, but more than half of the company’s revenue comes from power sales to other utilities on the wholesale market.  With its 47 MW of distributed solar panels on rooftops, NRG is actually undercutting the business of the utilities it serves.

A Lot to Lose

Why is NRG pursuing such an aggressive strategy?  As the largest power generator in the United States, NRG has a lot more to lose than transmission and distribution (T&D) oriented utilities with the proliferation of distributed generation (DG).  DG directly affects NRG’s bottom line, since every kilowatt-hour not provided by the company is a kilowatt-hour that’s costing NRG revenue.  This doesn’t affect utilities that are focused on T&D as much, since they’re still providing the same interconnection services (at least for the time being).  As a power provider, it’s in NRG’s interest to own as much of the utilized generation capacity as possible – and that now includes DG capacity, especially when you consider that DG output is always utilized due to policies like net metering.

Having an aggressive strategy also seems to be part of having David Crane as a CEO.  According to Crane, future power customers will be able to disconnect from the grid as they use residential solar coupled with energy storage and a gas-powered fuel cell or microturbine to provide for their own power needs.  This was the subject of Navigant Research’s recent webinar, The Energy Cloud.  Crane is positioning NRG to be the supplier of solar arrays, fuel cells, and microturbines to power customers in this age of grid obsolescence.  It’s remarkable to see a utility betting on the grid’s eventual obsolescence, but it’s important to note that within that framework, NRG is still maintaining its core business as a power provider.

 

Enabling Remote Microgrids in the Developing World

— April 4, 2014

In my last blog, I wrote about the success mobile network operators (MNOs) are having with electrifying rural communities in developing regions, such as Latin America and Africa, by partnering with companies that sell solar home systems.  Much credit must go to the pico systems themselves, which are a cheap and reliable way to provide for the customer’s basic energy needs (cell phone charging and lighting).  However, there are two greater forces at play that reach far beyond the business of rural electrification: MNOs have found an effective business model in pay-as-you-go (PAYG) and they have employed an effective money transfer technology, known as mobile money.

These two forces answer the question: What has enabled the exponential growth of cell phone usage in the developing world?

Phone Bank

PAYG is a prepaid mobile phone plan.  You pay for a phone with a certain amount of airtime on it and you refill the time in your account as needed.  There’s no contract or monthly rate.  If you run out of time, your service is cut off, plain and simple.  This model works well for the off-grid rural poor who live on an inconsistent daily budget and who typically don’t have bank accounts.  It should be noted that some utilities in developed parts of the world are also experimenting with PAYG meters and they are finding that it is the only model that has successfully led to a change in consumer behavior (in the form of energy conservation).  As my colleague Peter Asmus details in his recent blog, this isn’t the only example of how the developed world can learn about energy solutions from the developing world.

Returning to the unbanked poor of the developing world, MNOs spotted an opportunity to capitalize on the lack of banking infrastructure in remote communities, and they have leveraged vendor networks and mobile technology to offer basic banking services to their customers.  To purchase airtime in the developing world, customers visit their local mobile airtime vendor and pay cash upfront for a scratch card of a certain value.  They enter the code from the scratch card into their phone to redeem the value of the card as mobile money, which goes directly into the mobile money wallet in their phone.  The mobile money wallet is protected by a PIN and acts essentially like a debit account, which can be used to purchase more airtime, along with other goods and services, to send and receive money, and to pay bills.  The MNO charges the customer for transactions made, so it is a lucrative new revenue stream for them.  More significantly for nanogrids, mobile money has opened the door to provide financing to unbanked customers.

Nanogrid Frontiers

Historically, one of the greatest barriers to off-grid households purchasing solar arrays has been the high upfront cost.  Investors, whether they’re vendors, microlenders, or nongovernmental organizations (NGOs), have had a hard time offering PAYG lending schemes to consumers due to the difficulty of collecting a long stream of small payments from a remote village, as well as the inability to monitor the systems.  Mobile money can provide a platform that enables lenders to conveniently offer PAYG schemes to off-grid consumers for the purchase of nanogrids, among other things.  More importantly, mobile money could turn remote parts of the world into profitable frontiers for the nanogrid market.  Many residential solar vendors (such as Simpa Networks in India) already see them that way, and these vendors are finding investors to finance PAYG systems as well as partners to handle the mobile money transactions.

While there is some variability in what these PAYG schemes look like, the keys to success seems to be the ability to track payments and usage easily and the ability to cut off service if a customer falls behind.  To view a list of nanogrid PAYG case studies, check out Navigant Research’s report, Nanogrids, and to learn about other business models that are being used to electrify remote parts of the world, view the replay of our Remote Microgrid Business Models webinar.

 

Village Nanogrids Fuel Mobile Networks

— April 1, 2014

There have been numerous efforts to electrify remote parts of the developing world.  Typically, these have come in the form of philanthropic ventures, with little to no expectation of a return on investment, using distributed energy systems that were often out of touch with the consumers’ energy needs, as well as their capacity to maintain the systems.  As a result, these efforts have been largely ineffective.  More recently, some for-profit companies (mostly mobile network operators) have found that a business case exists for investing in distributed energy for rural off-grid communities – by implementing systems that are much more in tune with customer needs and capabilities.  These systems usually take the form of nanogrids, which are described in the recent Navigant Research report, Nanogrids, and in my colleague Peter Asmus’ recent blog.

For mobile network operators (MNOs) in emerging markets, such as MTN, Vodacom, and Safaricom in Africa and Digicel in Latin America, the challenge is that there are millions of mobile customers without access to the electricity grid; approximately 259 million, according to a recent GSMA report.  For these customers, the cost of charging their phones can represent up to 50% of their total mobile expenditures (airtime plus charging costs), so their phones are only turned on when absolutely necessary, in order to conserve battery life.  Since MNOs make money when the phones are in use, it’s in their interest to make charging convenient and inexpensive enough that conserving battery life becomes an afterthought.  MNOs are quickly finding that distributed nanogrids, such as 10 watt solar home systems (SHS), are the cheapest, most effective way to maximize cell phone usage by existing customers, as well as to bring more customers online.  To stimulate the spread of these systems, MNOs are starting to form commercial partnerships with local vendors of portable solar products.

Friendly Local Utilities

In Uganda, MTN has partnered with Fenix International to provide MTN airtime vendors with a Fenix ReadySet solar-powered battery kit that charges phones and provides LED lighting for the vendor station, allowing them to stay open longer.  The ReadySet has turned MTN vendors into micro-utilities in their communities, creating additional revenue from phone charging and increased mobile money transactions, as well as savings for the vendor from using the LED light.  MTN is also repackaging the ReadySet as the ReadyPay Power System, which is now available to all its customers on a pay-as-you-go basis.  Similarly, Digicel Haiti partnered with Solengy in 2011 to install over 400 solar-powered street lamps and phone charging stations across Haiti.  Each station is operated by an airtime vendor that sets up shop below the LED street light and manages the phone charging service.  Other examples include Vodacom and Mobisol in Tanzania and Safaricom and M-KOPA in Kenya.

Forming the backbone of this transition are pay-as-you-go business models and mobile money, which I’ll explore in my next blog.

 

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