SolarCity Short Thesis On Tax Change

| About: SolarCity Corp. (SCTY)

(Author's Note, December 21, 2013: As originally written, I had misread the Baucus proposal - I focused on the removal of incentives for specific technologies, which is positive, and would be bearish to SolarCity. Only later on did I realize that it is limited to electrical generation, in which case it is bullish for SolarCity in the short term. One could only hope that the insight that incentivizing specific technologies is detrimental would be expanded to all energy generation, not just electricity, since it is the only logical way to go, so this will be an interesting process to watch. If the proposal survives in its current form it will be bullish for solar PV as a retrofit technology, but very precarious, because the insight has to dawn that focusing on results is the way to go all the way around.)

The winds of change are blowing with a proposal to change energy taxation, though it is limited for now to electrical generation, and short term will continue to favor Solar PV, but once this thinking carries over to all energy generation including retrofits, it will be a complete game changer. The shift is from technology components to whole project outcomes in terms of GHG-emissions reductions, and it is clearly to the benefit of the country, the environment, and investors in the long-term. It is the only way to create a rational regime, instead of the inherently unstable regime that favored certain technologies over others, in which solar PV was the belle of the ball. SolarCity (NASDAQ:SCTY) was perhaps the signature stock and major beneficiary of that situation, because of their efficient mass distribution, riding a wave of "no money down," "self-liquidating" financing to uneducated buyers, who mostly did not comprehend that solar PV might not even be their best choice.

Clouds Before The Sun

One of the most obvious problems with the solar PV juggernaut was the technology risk, which can be most easily demonstrated with a thought experiment:

You and your neighbor have similar properties. You order up a SolarCity PPA, and save 10% over your 2013 electric bill. Your oil bill is unaffected. The panel is 17% efficient in converting solar energy to electricity.

Your neighbor spends more money, but still benefits from the 30% ITC, and he installs a geothermal heat pump which provides whole-house HVAC, and Domestic Hot Water (DHW), he eliminates his oil bill but he settles for temporarily higher electric bills. Five years later he orders up a solar panel, and by that time it is 45% efficient. He now wipes out his new higher electric bill entirely, and his property is near zero if not net zero. You, on the other hand, still have 15 more years to pay on your PPA, which saved you 10% over your 2013 electric bills, but your oil bills continue, and you have no roof space left to do anything else. What will this do for your property's value?

These issues also affect the difficulty with valuing commercial paper backed by solar leases. The seemingly cut and dried "savings" on utility bills, may not have much long-term value, and in fact deprive the property owner of asset appreciation if they are clearly suboptimal. That may not affect the first five years, but it may become significant later on in the life of those leases, and could possibly affect the quality of that paper in the secondary markets.

Here Comes the Sun

The technologies that will emerge from behind the clouds are geothermal, wind and solar thermal, but generally any competing solutions that fell behind, generally because they were more expensive and more involved to install, and often had fewer incentives (with state by state variations).

One example here: solar thermal offers up to 98% conversion efficiency today, versus 15-20% conversion efficiencies for today's solar PV panels.

Counterpoint: Batteries

SolarCity has powerful friends bringing batteries to the party, in the form of Tesla Motors (NASDAQ:TSLA), and a recent announcement of a new solution for commercial buildings with Tesla-developed batteries for energy storage could be the catalyst for more sales. However with a leveling of the playing field in terms of tax incentives, we must note that solar thermal offers an even cheaper and more environmentally friendly storage solution: Hot Water tanks. So, if solar thermal is 500% more efficient in itself, taking the storage capabilities into account, it may be 700% more efficient. This will overcome the installation challenges if the incentives are the same, or in fact now favor solar thermal, because it will produce a far greater reduction in GHG-emissions.

The Fed Chimes In

Meanwhile the fed came calling, and any sign of higher interest rates may start to knock the wind out of the leasing-driven business model of Tesla.

Closet Corpses or Dead Horses?

Meanwhile there is another shadow moving before the SolarCity-sun, a pending investigation into the financing practices of the company. If nothing else, the whole issue highlights again that the company really is just the solar equivalent of a mortgage broker, it's a boiler room leasing operation. It is hard to see how they can make it up on volume, unless they had some technology edge. The Tesla connection helps, but one doubts that it will be enough.

The Winds of Change

Clearly, the minuses strongly outweigh the plusses at this moment. Perhaps the single most damning issue is that selling an obviously inferior solution such as the immature technology of solar PV to an unsuspecting end consumer, relies on the lack of education of that consumer, which is a wasting asset. With a leveling of the playing field in the offing, vendors of the competing technologies are being dealt a strong hand, and consumers will soon begin to learn the vast range of options they really have, and those shiny new solar panels may not look so bright for long.

As far as the tax change is concerned, should it be expanded to cover all energy generation, not just electrical, it would be so obviously sound because it focuses on results, not on building blocks, and the accountants won't be trying to design energy systems any more and leave it to the engineers. And I can always hope that Senator Max Baucus read my Open Letter to President Obama, which recommended just this type of a simplification of the incentive structures, but for all energy retrofits.

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.