Rooftop Solar Going Into 2016 - Silly Season Is Here

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Includes: CWEN, FSLR, NRG, RGSE, RUN, SUNEQ, TERP, TSLA, VSLR
by: Rogier van Vlissingen

Summary

The shadow of 2017 has given way, and serious market distortion of ITC continues.

The ITC is becoming a case study in misdirected incentives.

Reports of home sales falling through over solar leases are on the increase.

Net metering with per-kWh charges to cover distribution cost is an important reason why residential PV generation is more heavily subsidized than utility-scale PV generation. In addition, net metering raises equity issues: it is far from obvious that it is fair for consumers with rooftop PV generators to shift the burden of covering fixed distribution costs to renters and others without such systems.

...we believe that the system of solar support policies should be reformed to increase its efficiency, so that more solar generation is produced per taxpayer and electricity-consumer dollar spent.

from MIT: The Future of Solar Energy, 2015

solarIn other words, how much sense does it make to pour subsidies on rooftop solar at $3/installed watt versus utility scale solar at $0.60/installed watt... The above quotes were perhaps the most common-sense observations to be made about rooftop solar in 2015. In the end, economics will prevail and the bubbles that are created by temporary anomalies will go away eventually. Recently, the Nevada PUC, in a precedent setting move analyzed by EnerTuition here, followed the economics, while the California PUC pandered to politics, keeping retail rates for the overage in NEM2.

Meanwhile, irrational exuberance is the word of the day in rooftop solar, thanks to the likely extension of the ITC. Rooftop solar panels give politicians something tangible they can point to that they are doing about climate change, and consumers seem to be happy to pay for it, and they don't even consider it a tax.

As the dust has settled from underwhelming 3Q15 results in the third party owned rooftop solar sector, and silly season broke out with news of the ITC extension, the bad news on the consumer front is also getting more publicity:

  • July saw the publication of a study from Arizona State University, concluding that leased solar systems were causing a 3-8% discount on home sales, whereas owned systems resulted in a 4-6% premium.
  • More recently, there was extensive coverage in the Washington Post that leased solar panels were complicating home sales, including one horror story of buyers walking away three times from a home with one year old solar panels.
  • There is also a growing string of reports on the increased fire risk from solar panels, in some cases caused by solar panels, and in other cases complicated by the presence of solar panels. There was one famous incident in New Jersey here, a warning by the International Association of Certified Home Inspectors here, and another story from Massachusetts here, as well as a story from San Francisco here, reported by the UL Firefighter Safety Research Institute. Recently I learned of two incidents in Fairfield County, Connecticut. The question is when will this be reflected in the cost of homeowners insurance.
  • There are contradictory regulatory and political developments, with people up in arms in California that rooftop solar is not going to count towards the state's efforts to get utilities to increase the use of clean energy, as per a recent article in the LA Times. As I have pointed out in other articles, the Renewable Energy Credits (RECS) cannot be double-counted for obvious reasons. Meanwhile, a serious revamp of utility rate structures is under way, see a public comment from PG&E here. However, the California PUC seems to be steering a solar-friendly course since then, as reported in the LA Daily News here.

The various risk factors are both physical and financial, and it does not add up to a pretty picture for consumers. None of it should surprise, as the presence of leased panels is a separate liability that needs to be assumed by the buyer when the home is sold, and it places the seller between a rock and a hard place in the sales negotiation. Solar companies report that they are generally successful in reassigning the leases, but they remain silent on the level of discount the sellers take on such sales. The issue was aired on the 3Q investor call for SolarCity, and their answer avoided discussion of the problems of the sellers, and focused on the fact that they were successfully transferring these leases, so for them, there's no problem. As the bad news spreads however, consumers are learning the hard way that a different approach is needed.

When you move, and you cancel your utility account, you do not have to keep on paying for the utility meter, which was rented, not leased to you. You never sign a 20-year lease with the utility. If the savings where large enough, you could rent out solar panels, and you could never get them back, but since the savings are mostly unconvincing, consumers need to be sold a bill of goods, in this case a 20-year take or pay contracts. The rental model is feasible only if the savings are large enough.

More in general, the party has run its course for numerous reasons. Companies were growing like mad, in hopes of achieving scale before 2017 arrived, thinking the momentum would carry them over the step down in incentives. In spite of an all out effort ahead of the original 2017 ITC step down, now there is the anti-climactic feeling that there's no hurry, and that is not likely to bode well for the rooftop solar companies, as Gordon James at Axiom pointed out recently. Reality began to set in as push back from the utilities as solar penetration began to exceed useful levels. The market leader, SolarCity (NASDAQ:SCTY), and copy-cat-in-chief Vivint Solar (NYSE:VSLR) had so-so 3Q15 results, with Vivint noticeably falling behind, and also-rans like NRG Home - division of NRG Energy (NYSE:NRG), Real Goods Solar (NASDAQ:RGSE), did no better. Late entrant SunRun(NASDAQ:RUN) was the exception that confirmed the rule at least in growth terms, even if not in profitability.

And now, the market is having a party over the likely FTC-extension, which is allowing investors to ignore the budding problems.

Apples and oranges

There are two ways to look at the rooftop solar decision from the standpoint of the property owner (see also the recent exploration by Paulo Santos, on why a Solar Lease is like subprime credit):

  1. Assume you are always going to be paying an energy bill to the power company, i.e. treat your electrical bill as a permanent liability that is inherent to ownership of the property, and all you can to is try to make it cheaper, you can't eliminate it. This is false financially because a monthly power bill is not unavoidable, specifically not if you are in a location where going off-grid is at least theoretically feasible. More in general, you can't compare a month-to-month bill with a 20-year take or pay contract. This is not even apples to oranges, this is a choice between a grape and an investment in a vineyard.
  2. From a standpoint of classic economics, the decision is a make-or-buy decision between generating your own energy in whole or in part, or buying it month to month from outside providers. The decision is a capital project, not an operating decision, and should be evaluated as such, and the decision should be made on the basis of the NPV of the project - how much value it adds to the property.

As I have demonstrated extensively in my articles here and elsewhere about the rooftop solar decision, the reality is that for most home owners rooftop solar is a negative NPV decision today, if nothing else because there are usually a long list of more valuable projects that do directly add value to the property, which rooftop solar, properly analyzed generally does not. Simply put, a rooftop solar contract is a liability that adds no value to the property, and may in fact detract from the value: whatever savings it produces are often wiped out if the house is sold. The exceptions that confirm the rule may be places like Hawaii (and a few other places), where the savings may be material. Even then, if rooftop SPV is economically sensible, ownership is likely to be the better deal, and there are plenty of even zero-downpayment financing options around.

The only downside in the ownership scenario is that the homeowner does have a disposal problem at the end, and every ten years when the inverters need replacing. Electronic waste is becoming tougher to deal with.

The example set by the Nevada PUC, is likely to result in a portfolio of orphaned solar leases and PPAs in that state, where the conditions on which they were sold are being invalidated by the phase out of unsustainable netmetering incentives of retail rates for the overage, towards a wholesale level. And this is happening very early in the 20 year running time of those contracts, raising a significant specter of challenges, defaults, or lawsuits. The story is simply one where the incentives outran their usefulness, and must be scaled back.

Rooftop solar, myth versus reality

Apparently, in the rooftop solar sector, borrowed capital is not viewed as capital at risk, and the consumer marketing concept is based on that kind of financial naiveté. According to the solar companies, who don't seem to follow even the guidance of their own industry association on marketing, there is no problem because the consumer purportedly saves money. The fact that a solar lease or a PPA is a 20 year liability, a take-or-pay contract, is omitted from the conversation and purposely obfuscated as much as possible. SolarCity advertises (banner ads) that the average New York customer saves $227 in their first year - evidently that is just the nominal savings against the alternative power bill - not real economic savings, which are nonexistent. If you bought your system outright, for say $15,000, that means a 1.5% return on investment, and at that, it comes with a lot of risk. But, if you got your panels from SolarCity with expensive financing and paid a lot more for it, it is obviously far worse than that. The only way it makes any sense is by assuming the panels are 'free,' even though the industry association (SEIA), says companies cannot advertise 'free' solar panels. Even if they don't use the word 'free' in their advertising, their sales practices imply that the panels are free. One way or another, in most cases the whole thing is not worth doing, if analyzed properly.

When people have to sell their property before the solar lease runs out, they may end up giving up as much or more as what they 'saved' each month in the form of a discount on their property. As the number and frequency of these reports increases, consumer attitudes will begin to change, and the class-action lawyers won't be far behind. Presently, the reversal of the PUC in Nevada includes a phasing out of the net metering subsidy regime in four years for existing customers, which again merely adds up to a discount on the property if it is sold. These become very demonstrable and verifiable damages, and great material for a class-action lawsuit some day.

The deeper problem remains that just as you can't build a house from the chimney down, you can't do an energy retrofit, starting from one of the least important components. Successful energy retrofits depend on the fungibility of energy, and the ability to switch energy sources, and, bearing in mind that roughly 70% of residential energy demand is thermal, and only 25-30% actually is electrical, the economic rank order of solutions remains roughly as follows:

  1. Passive thermal (insulation, window treatments, heat recovery).
  2. Active thermal (solar thermal at 70-90+% efficiency, and heat pumps (ground source with 500% efficiency, and air source at 250% efficiency). With or without subsidy.
  3. Gas
  4. Oil
  5. Solar PV electricity (with subsidy)
  6. Electricity from the grid
  7. Solar PV electricity (without subsidy)

To redesign an energy system in light of current technology, you have to look at it holistically, and create a viable retrofit program which could be a multi-year endeavor, and should be prioritized on an NPV basis: adding value to the property. With low oil and gas prices, careful planning is in order. The current sales model for rooftop solar flies in the face of proper decisions that can have a major impact on property values. They amount to a combination of deceptive consumer marketing, enabled by unintended consequences of an awkward subsidy regime, and resulting in a dubious investment proposition that is built on a house of cards, and now is on life-support with the new ITC-extension. And evidently the investors are fooled by it, for solar shares went up. The only good thing

3Q15: Quiet before the storm

The following summary leading up to the ITC "bounce" might clarify the picture:

  • SolarCity was seeing some headwinds, manifesting in some significant declines in its stock price amid the yieldco meltdown. EPS was ($0.20) for the quarter, and ($0.69) on a trailing twelve month basis. EBITDA has gone from ($70 mln) to ($234 mln) YOY. Their sister company Space-X parked some significant money in their solar bonds earlier this year, in a curious related company transaction. In 3Q15, management called time for profitability over growth at all costs, but with the continued staffing up for the giga-factory, and increasing headwinds, there seems to be no real plan, only motherhood and apple-pie about financial prudence. It seems to be more about rationalizing what is happening anyway, more than any specific plan. The indications so far are that the panels from the giga-factory will not improve the company's competitive position, but management has put off providing a detailed forecast until 4Q15. Elon Musk recently made some token stock buys, and the CFO is leaving. Net net, these are not positive indications.
  • Vivint Solar really surprised, falling significantly behind SolarCity with a significant slow down in YOY growth to about one third the rate of SolarCity. In an earlier article, I had made note of the fact that Vivint Solar had an amazingly rapid start, probably due to their inventory of leads in the form of home security customers, but that they seemed to be standing still lately, compared to SolarCity. Presently they are falling behind, and SolarCity is leaving them in the dust. It seems unlikely the SUNE acquisition would come unraveled completely, but nothing can be ruled out either.
  • At NRG Energy the green/consumer subsidiaries including residential solar, are being put on a leash (NRG reset, here) and set up for a potential spinoff, with a clear limitation on the credit backing the parent company provides ($125 million). In light of recent questions about how well these consumer contracts mix with utility scale projects, it should be noted that NRG Yield (NYSE:NYLD), assumes NRG's consumer solar exposure. EPS on a TTM basis is ($0.04), explaining why there are limits on the willingness to absorb the ongoing cash burn from the residential solar business.
  • At SunRun, net income is also still negative, but the growth rate was significant, at 47% revenue growth year over year, and operating income jumping 69% on a YOY basis. Given the relative slow down at Vivint, SunRun is fast closing in on the #2 spot.
  • At RGSE, growth was negative YOY, and the company is still losing money.

This 3rd quarter the overwhelming story was slowing down growth rates, amidst what should have been an all out sprint for the maximum number of installs ahead of 2017. Now, that story changes into an expectation of continued expansion, but without the sprint. Meanwhile all eyes are on the SunEdison/Vivint Solar story, and its portends:

The SUNE, TERP, VSLR circus

As if the warning signals from the yieldco meltdown were not enough, SunEdison (NYSE:SUNE) further aggravated the innate problem of conflicts of interest between sponsors and yieldcos with moves that reduce and don't improve the independence of Terraform Power (NASDAQ:TERP) from SUNE, just ahead of the planned execution of the VSLR acquisition, and this now came to a head with some shareholder lawsuits and an open letter from David Tepper of Appaloosa Management LP, here, followed up by a demand to see the books, here. The choice observations include the following gems:

Notwithstanding your explanation in the release, we find that "aligning the company's strategic focus around acquiring projects from its Sponsor" offers little apparent benefit for TERP stakeholders and raises concern for obvious conflicts between the interests of TERP and its "Sponsor", SunEdison .

and:

The July announcement of the acquisition of the Vivint Solar portfolio of residential rooftop assets marks an unfortunate departure from this business model and appears to serve the sole purpose of promoting SUNE's desire to acquire VSLR's development and operating assets, rather than enhancing the quality and value of TERP's holdings. Indeed, the shift to weaker counterparties (homeowners) and the higher risk profile inherent in these assets (small rooftop panels) also appears to disproportionately benefit the "Sponsor's" incentive distribution right ("lOR") at the expense of significant downside financial risk to TERP. Worse yet, is SUNE's stated intention (revealed through the release of an Interim Agreement between SUNE and TERP) to place 500MW per year of these inferior assets in TERP for the next 5 years.

In short, the news is now out that these consumer debt portfolios, which I labeled 'solar subprime' even a few years ago when they were just starting, are of a somewhat parlous quality. The 'subprime' descriptor has now entered the main stream ever since Jim Chanos's discussion of his SolarCity short on CNBC recently. As a corollary to that issue, the whole issue of the potential conflicts of interest between yieldcos and their sponsors is now squarely on the table, exactly because these consumer contracts may be inferior.

The actions of Appaloosa so far have caused the deal to be dialed back from an original value at the time of the announcement of $2.2bn, which was already drifting down to approximately $1.4bn now, leading fellow analyst EnerTuition to observe that now SUNE would be overpaying only $1.4 bn, and in light of the developments in Nevada, this is not a joking matter. Furthermore all of these developments will also ricochet back to the ratings agencies, and it would seem that SolarCity is unlikely to ever repeat the (relatively) low interest rates they have obtained for the earlier deals. The two most attractive forms of long term financing of the consumer debt in rooftop solar, syndications of the ABS notes, or sales into the yieldcos may both be becoming increasingly doubtful.

The back story: It's all about electricity versus oil

In residential energy 70% is thermal and 80% of the load can be solved with passive measures, the remainder can be solved with heat pumps which are up to 500% efficient for ground source and water source and about 250% efficient for air source, all of these shift the competitiveness of "fuel," from fossil fuels to electricity. Instead of arguing over 10 or 20% "savings" on the residential electric bill (i.e. 3-6% of the total energy bill, unless you are in an all electric home), heat pumps are top of the list in retrofits. After that wind and solar PV are the prime candidates for local renewable generation, and they are complimentary, because the wind can blow when the sun does not shine.

To paint some idea of how far we have come, watch to this presentation by Bob Wyman at the October convention of the Ground Source Heat pump industry, which is all about the fact that ground source heat pumps are simply our most economical heating and cooling (and hot water) solution going forward. As recently as 2011 was then Mayor Bloomberg pursuing solar PV on city buildings, while I was advocating to the city that geothermal was the single most strategic retrofit option for NYC buildings, and that solar PV advocates should be offered a one way ticket to Siberia. The last act of the Bloomberg administration was commissioning a study of geothermal for NYC, and we now have a requirement in NYC for new buildings from 2017 forward, to prioritize geothermal.

In other words, it took New York City only six years to realize the obvious, namely that geothermal, sourced under ground, and 500% efficient, must be the first choice for energy in the city, and by implication that solar PV, at 15-20% efficiency must be an after-thought in a high-rise city where roof space is at a premium, and moreover that there is also an option of solar thermal that is up to 95% efficient, and should be prioritized over solar PV wherever possible. As I've argued in earlier articles, the large integrators who do performance contracts among others for the federal government, long since understand the hierarchy of energy solutions for buildings very well, and you can see in the two net-zero schools in NYC, PS 62 in SI here, and the Trevor Day School here, as well as in Walgreen's net-zero store in Chicago, how geothermal is the key to making the solution work - it is the strategic technology in all of these projects.

In short, by starting from the least effective technology and selling property owners on it first, frequently will impair the opportunity to design a truly functional energy solution, it amounts to majoring in a minor, of building a house from the chimney down. This is one reason for my analysis that rooftop SPV is often a negative NPV decision for home owners. Meanwhile, as a corollary to all this, mortgage finance needs to become the primary vehicle for energy retrofits, and the Third Party Ownership model is an inferior second choice for financing them. In the end it is all about building equity in a home, but if people cannot carry the finance, the TPO model may be the only way to go, as long as it is still constructive financially, and offered with full disclosure - meaning the savings should be very substantial since the TPO model cannot and does not add value to the property. The problem in rooftop solar that in many cases the savings are too small to be worthwhile.

In other words, if the savings are large enough, the TPO models may work if the homeowner can't get any other financing, but to sell them anything just because you can stretch the payments, and make them seem small enough, is outright consumer deception. There is no point to finding more ways to finance home owners who can't afford the house they live in, except if such financing overwhelmingly improves the cash flow position of that home owner, and with rooftop solar that is mostly not the case.

ITC extension and net metering grows up (a little bit)

Currently, the important news is the Califonia Public Utilities Commission action on Net Metering 2.0 ((NEM2)), where the end of subsidization of solar customers by non-solar customers is clearly on the table, but was avoided for now - by the PUC preserving retail rates for rooftop solar overproduction. Nevada chose the better part of wisdom and eliminated retail rates for rooftop solar. The eventual outcome will likely be increasingly towards a more balanced arrangement in other states besides Nevada. This will likely slow down the uptake of rooftop solar where it is economically marginal. The economic realities can not be avoided or talked away, though the rooftop solar camp is trying hard to do so, the analysis of the Nevada decision cited above likewise sees the developments in Nevada as realistic, and the rest as short term policies that will inevitably give way to economic realities and issues of social justice eventually.

Clearly, the future of energy retrofits, especially for the residential market will involve consumers becoming more educated about their choices, and about the issue of how to add value to their homes with energy retrofits, and the more that analysis is properly understood, the more solar PV will become the last choice not the first. The current marketing methods, in spite of the new solar industry marketing ethic, remain thoroughly deceptive, and therefore open to challenge.

Conclusion

The overall outlook across rooftop solar providers is now one of slowing growth, eroded by a battery of problems on numerous levels, but all attributable to a shoddy business concept, and unsustainable business assumptions. Optimism over the ITC extension is providing some short term bounce, but is likely to add to the underlying deterioration. The change will come from providers that focus on truly solving the energy problem on a whole property basis, and adding to property value, not the tokenism and showmanship of solar panels.

The ITC extension is likely to be value additive in utility scale solar, and that reflects on players like First Solar (NASDAQ:FSLR), and SunEdison if they can right the ship from the misstep with Vivint Solar.

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.

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