Grandfathering Proposal May Only Be A Short-Term Reprieve For SolarCity

| About: SolarCity Corp. (SCTY)

Summary

Grandfathering in Nevada gets an unexpected ally in the form of NV Energy.

This could be a calculated move on NV Energy's part to reduce the political pressure.

Assuming the systems are grandfathered, it would be a short-term reprieve for SolarCity, Sunrun, and their peers.

solar city In a recent press release based on a blog entry, SolarCity (NASDAQ:SCTY) CEO Lyndon Rive stated that, "I have promised SolarCity's Nevada employees and customers that I will continue to fight for them. I believe when they hear and understand the facts, all Nevadans will join the fight against this unfair decision. This Governor and his commissioners will hear more from all of us in the coming days. Stay tuned."

A few days later, we now know what part of the "hear more" is. Among other things, SolarCity, with other likeminded entities, has formed "No Solar Tax PAC". Through this organization and other means, solar installers are lobbying Nevada politicians to reverse the rulemaking at Nevada PUC.

It also turns out that SolarCity and cohorts have succeeded in getting Nevada Public Commission to conduct yet another hearing on the subject of net metering. However, this time the scope has been narrowed down to address grandfathering. The hearing for this subject will take place on February the 8th.

The lobbying on this matter has been intense, because the ruling as it stands today shows the unsustainability of the business models of SolarCity, Sunrun (NASDAQ:RUN), and their residential lease/PPA industry cohorts. Since the initial Nevada decision, there is already a palpable chill in the capital markets towards residential solar assets, which means access to capital for these companies is going to be increasingly difficult.

It is now becoming a matter of survival for these companies, and, consequently, the Nevada PUC and politicians have been subjected to intense pressure and abuse to come up with a decision that saves the lease/PPA business model.

The indications are that these installers will likely gain some respite in the form of support from NV Energy for grandfathering the existing customers.

In what appears to be a calculated move on Monday, NV Energy announced that it is going to strongly recommend to the PUC that existing rooftop solar assets be grandfathered for 20 years. This is far beyond the 8-10 year grandfathering that the Nevada Bureau Of Consumer Protection requested, and is a huge unexpected surprise. The 8-10 year NBCP proposal has now been replaced by NV Energy's 20-year proposal at the hearing on February 8th.

This development adds an unexpected option to the decision making, and could significantly change our thesis for the approximately 17000 Nevada rooftop solar assets. If the 20-year grandfathering proposal is approved, it can also materially help change the sentiment for residential solar stocks.

Here are some possible scenarios for how these companies will fare:

  1. PUC does not make any changes: In this scenario, which is increasingly looking unlikely given NV Energy involvement and the massive political pressure that is being put on the PUC, just about the only option for the lease/PPA companies is to continue exerting political pressure and/or sue the PUC hoping for a positive outcome down the road. But this could be a long grind and take months or years to get any type of resolution.
  2. PUC extends the grandfathering period by a few years: We can see the PUC taking this route to reduce political pressure. Let's say it agrees with the Bureau of Consumer Protection's now withdrawn request and extends grandfathering and gives existing users a transition period of 8-10 years. In such a scenario, the asset life of leases/PPA would be meaningfully extended, but would still remain far shorter than the 20-year initial terms and 30-year total terms being used by the lease/PPA companies.
  3. PUC extends the grandfathering period by 20 years: In this best-case scenario, the lease/PPA companies are somewhat protected in the initial 20-year term, and will have the market to monetize these assets. However, note that the renewal component of retained value should be dropped down to "0" in this scenario. Note, also, that this only covers the first 20 years of SolarCity's 30-year MyPower product.

Even in the most positive scenario highlighted in 3, readers should realize that this is a very transient win, and a future PUCs and government, with all their rulemaking powers, can change the rules substantially to the detriment of the net metered customers. Legacy customers will still be subject to revised tariffs, increased fixed charges, and other charges that can make the systems uneconomical well before even the 20-year grandfathered term.

At the end of the day, there is no amount of lobbying SolarCity and Sunrun can do fix the fundamental regulatory dependence of residential solar:

  1. Residential solar, for at least the next decade or two, will have to rely on the utility grid. Batteries will neither have the capability nor the cost structure to meaningfully change this dynamic. As long as solar users need the grid, they will have to pay for the use. Governments, PUCs, and utilities will not let solar users ride on the backs of non-solar users.
  2. Excessive growth in uneconomic rooftop solar deployment will lead to stranding of other cost-effective utility-scale assets. This, again, increases the cost of power to non-solar ratepayers, and is a dynamic that will not be tolerated by utilities and PUCs in the long term.
  3. Given the high fixed cost nature of the grid, allowing net metering means the high fixed costs to serve the solar users will have to be allocated to apartment dwellers and others who do not have an opportunity or resources to tap into rooftop solar. Once the realization sets in, fiscally conservative organizations as well as consumer advocates will be working against net metering and grandfathering, instead of arguing for them.

These factors mean that the death of net metering and grandfathering will occur sooner than later, regardless of the current decision.

In other words, in spite of the specifics of what is likely to be approved on February 8th, the business model of the lease/PPA companies remains broken. Any reprieve the lease/PPA companies are likely to get from this ruling is ephemeral and will be overwhelmed with other negative developments in future.

By lobbying hard to maintain their broken business models, SolarCity, Sunrun, and their peers are only burning a significant amount of shareholder wealth on ephemeral fixes that will have no long-term bearing on their value generation. In the short term, investors can expect increasing lobbying and other costs as these companies desperately aim to win a few short-term battles.

From the perspective on NV Energy and other utilities who are on the other side of this debate, the lesson here is that it is dangerous to let customers and installers get used to subsidies like net metering. Once this or any other subsidy is given, it becomes highly politically contentious to take it back.

A stark choice for regulators and utilities would be to cut off the subsidies early or suffer the long-term consequences of bad regulations. In this context, it would be interesting to see how, and if, California regulators will deliver their final net metering decision on Thursday.

While California decision will have significant short-term consequences to all involved, there should be no doubt that the business models of SolarCity, Sunrun, and similar residential lease/PPA vendors have negative value generation, have done considerable harm to customers and the society, and will do significant harm to investors who choose to believe the flawed narrative of the managements.

Our view of value of SolarCity and Sunrun: 0

Disclosure: I/we 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.