Will The Solar Industry Ultimately Cause Electricity Deregulation?

| About: SolarCity Corp. (SCTY)

Around 15 years ago, there were many pushes in several states to allow competition into the electric utility industry. States like Texas (1999), Pennsylvania (1997), Ohio (1999) and Maryland (1999), among others, choose the path of competition to allow customers the right to choose their energy provider. The year provided reflects the year of passage of the bill that ultimately drove deregulation, not necessarily the year in which deregulation was fully implemented. It should also be noted that the distribution utility remained the same and customers had choice of who provided the energy transmitted over the wires. However, California's subsequent energy crisis dampened enthusiasm for deregulation.

Today, a new challenge is rising against the regulated electric utilities. Companies like SolarCity Corporation (NASDAQ:SCTY) are providing customers access to electricity through solar photovoltaics (PV) and reducing their dependence on the electric grid and utilities. Initially, solar integrators would provide companies with power purchase agreements in which the customer would pay per kWh of solar electricity delivered. Some utilities opposed this under their franchise right which allow them to essentially have a monopoly within their service territory.

Utility franchise rights are being eroded

One example involved South Carolina Gas & Electric, a subsidiary of SCANA Corporation (NYSE:SCG). DCS Energy Inc., a Connecticut based company, sought to provide solar systems in South Carolina to a range of non-profits. DCS would provide the solar systems in exchange for payment based on the electricity provided. However, SCG&E filed a complaint to the state utilities commission seeking that DCS be regulated as a utility. Ultimately, DCS backed off. SCG&E has worked with other organizations to install and connect solar photovoltaic systems, including the Charleston-area Boeing plant.

However, the cracks in this defense are starting to appear as state legislatures begin changing the laws around electricity to favor a range of solar companies. For example, California passed legislation that recognized third party owned solar PV systems are not utilities or electrical corporations and non-traditional power generators are not utilities. This designation exempts them from regulatory oversight.

(E) "Electrical corporation" does not include an independent solar
energy producer, as defined in Article 3 (commencing with Section
2868) of Chapter 9 of Part 2. - California Public Utilities Code 218

It also creates allowances to enable net metering in which that solar electricity is sold back to the local utility:

The use of or sale to not more than two other corporations or
persons solely for use on the real property on which the electricity
is generated or on real property immediately adjacent thereto - California Public Utilities Code 218

The state of Colorado created some initial clarity when Xcel Energy Inc. (NYSE:XEL) in Colorado waived its monopoly rights for systems under 10 kW. However, this was then followed with Colorado Senate Bill 51:

The supply of electricity or heat to a consumer of the electricity or heat from solar generating equipment located on the site of the consumer's property, which equipment is owned or operated by an entity other than consumer, shall not subject the owner or operator of the on-site solar generating equipment to regulation as a public utility by the commission if the solar generating equipment is sized to supply no more than one hundred twenty percent of the average annual consumption of electricity by the consumer at that site. - Colorado Senate Bill 51 - Section 10 - Public Utility defined.

Alternative business models are even avoiding the issue of franchise rights

Other approaches to ensuring the legal standing of solar systems include addressing the equipment used. Nevada and Oregon have excluded solar systems from utility commission oversight with these tactics. All of these efforts facilitate the growth and adoption of distributed solar PV. Furthermore, a shift in business models to allow customers to simply lease solar PV systems represents another approach to increasing access to solar.

Under a solar lease, the customer does not purchase power from a third party but simply leases equipment and receives the power generated by that equipment. This solution has been used in Florida, which does not allow the third-party PPA model. Although it avoids the retail sale of electricity, the solar lease model creates challenges for the use of the federal tax credit and accelerated depreciation - NREL - Solar PV Project Financing: Regulatory and Legislative Challenges for Third-Party PPA System Owners

Regulatory support for net metering continues

Regulatory commissions and legislative bodies continue to show support for solar PV, but they are starting to recognize some challenges with widespread adoption of solar PV. Net metering is very widespread in the U.S. with over 40 states having officially adopted policies. Other states have left those policies to utilities. Net metering is critical for the adoption of solar PV. Storage technology is not yet cost effective and so when utility customers with solar PV systems produce more electricity than they need, that excess power flows back into the grid and is used by someone else. Net metering creates a framework within which the customer is compensated for that excess production.

Idaho Power, a subsidiary of IdaCorp Inc. (NYSE:IDA), had recently filed for revisions to its net metering program to change the approach and billing structure. While it was ultimately unsuccessful in this effort, the Idaho Public Utilities Commission noted:

Even though the Idaho Public Utilities Commission denied most of Idaho Power's application, the commission said the company raises valid issues that are more appropriately addressed in a general rate case. - Idaho PUC Press Release on Order 32846

Furthermore, the decision noted that net metering customers "do escape a portion of the fixed costs and shift the cost burden to other customers in their class." Idaho PUC Press Release on Order 32846.

Implications for SolarCity

There is continued support for solar PV that represents the growth engine for SCTY. In combination with federal, state and local incentives, SCTY will continue to grow its core business. Furthermore, SCTY has recently announced a partnership with Direct Energy, a subsidiary of Centrica plc (FTSE: CNA). Direct Energy is a leading provider of retail electricity in the U.S. serving customers in many of the deregulated states. SCTY operates in 13 states, including several like Colorado and Washington that do not have customer choice (i.e., deregulation).

SCTY's business model and these changes suggest that it will be able to effectively sell electricity in many parts of the country. As customers demand more options and legislatures comply, SCTY and similar companies are poised to challenge regulated utilities all across the country.

Today, SCTY is a $3 billion market capitalization company, but its challenge is targeted at an industry with a collective market capitalization of at least $480 billion (based on 47 publicly traded electric utilities in the U.S.). The potential upside is obvious.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.