Electric Utility Distribution: Solar, Home Batteries And The Risk Of 'Bad Ratemaking'

by: Wayne Olson, CFA


Solar, home batteries (e.g., Tesla Powerwall) and other forms of distributed energy resources may profoundly affect the future of the electric utility industries.

What I will call "bad ratemaking" can lead to subsidies from the general body of utility ratepayers and utility shareholders to the owners of distributed energy resources.

This begs the question: What is good utility ratemaking? And what changes to traditional utility ratemaking are needed to accommodate DER?

Nevada recently changed its net metering policies. Hawaii has made similar changes. A key difference is that Hawaii grandfathered in existing net metering customers, and Nevada didn't.

This is the second in a series of articles on the future of the electric utility industries.

Q1. What is the purpose of this article?

A1. In a recent Seeking Alpha article, I examined the competitive threat to electric utilities from the combination of solar, home batteries and what I chose to call "bad ratemaking." This begs the questions of what is "good ratemaking" and what are good public policies toward solar, home batteries and other types of distributed energy resources (DER).

In my previous article, I defined "bad ratemaking" as: (1) "bad" net metering policies and prices, and (2) "bad" retail rate design policies and prices. I emphasized that ratemaking policies should be economically rational, properly reflecting cost causation, i.e., cost causers should be responsible for the costs that they cause. However, these topics are merely the tip of the iceberg vis-a-vis the regulatory and public policy issues that DER presents. Moreover, DER raises a number of interrelated issues - the goal must be to establish the best mix of ratemaking and regulatory policies toward DER, while modifying these policies over time as economic conditions and policy goals change.

I recommend that readers do their own due diligence on the investment prospects of the companies discussed in this article. Please note, however, that I believe that a solid understanding of the economic and public policy issues related to net metering is crucial to evaluating the financial prospects of the companies discussed in this article.

I will focus on SolarCity (NASDAQ:SCTY) as well as Sunrun (NASDAQ: RUN) and Vivint Solar (NYSE:VSLR), all of which use a similar power purchase agreement (PPA) business model, with customers signing a long-term agreement to buy power from the solar developer. SolarCity, Sunrun and Vivint Solar operate in a number of states, including Hawaii and Nevada (I will sometimes refer to these companies as third-party solar companies).

I also will focus on Tesla (NASDAQ:TSLA) and its business activities in the home battery market. Note that Tesla doesn't lack competition in this market.

NextEra Energy (NYSE:NEE) and Hawaiian Electric Industries (NYSE:HEI) announced plans in December 2014 to merge in a transaction valued at $4.3 billion, subject to approval by the Hawaii Public Utilities Commission (HPUC) and HEI shareholders. HECO is a subsidiary of HEI. I haven't analyzed the prospects of this merger being approved.

The largest U.S. electric utility parent companies include (1) American Electric Power (NYSE:AEP), (2) Avangrid (NYSE:AGR), (3) Consolidated Edison (NYSE:ED), (4) Dominion Resources (NYSE:D), (5) Duke Energy (NYSE:DUK), (6) Edison International (NYSE:EIX), (7) Exelon Corporation (NYSE:EXC), (8) NextEra Energy, (9) PG&E Corporation (NYSE:PCG), (10) PPL Corporation (NYSE:PPL), (11) Public Service Enterprise Group (NYSE:PEG), (12) Sempra Energy (NYSE:SRE), (13) Southern Company (NYSE:SO), (14) Wisconsin Energy (NYSE:WEC) and (15) Xcel Energy (NYSE:XEL).

Q2. Please discuss recent developments in Nevada and Hawaii.

A2. SolarCity, Sunrun and Vivint Solar have recently announced plans to exit Nevada, although it is unclear how this will affect their existing customers in this state. Sunrun, for example, had promoted its offer to provide "lifetime support" to its solar customers. In Nevada, the Public Utilities Commission of Nevada recently took a number of steps to revise NV Energy's net metering rates in order to reduce the shift of fixed costs from net meter customers to the general body of utility customers. Going forward, Nevada will price the net metering credit based on the avoided cost rate (the cost of NV Energy producing the electricity itself or the cost of acquiring the electricity in the wholesale market). NV Energy's parent company is Berkshire Hathaway Energy, a privately held company.

In October 2015, the HPUC closed the Hawaiian Electric Company (HECO) net metering program to new customers and established new self-supply and grid-supply tariffs to replace it. Under the new "grid-supply" tariff, the credit is reduced from the full retail rate for net metering customers to the cost of wholesale power in Hawaii. Wholesale prices on the Hawaiian Islands are said to be in the 15-28 cent per kWh range, which is said to be about one-half Hawaii's average retail electricity rates. Moreover, solar customers will pay a monthly minimum flat rate of $25 to pay their share of the fixed costs of the electric utility system, reflecting their option to rely on the grid. (Apartment renters have to pay their rent even when they are away from home. Similarly, electric utility customers should pay their share of the fixed costs of the electric utility even if they rely mostly on self-generation so long as they retain the option to rely on the grid when they need to do so.)

Q3. Are the new net metering policies in Hawaii and Nevada similar?

A3. Yes, the HPUC in Hawaii and the PUCN in Nevada recently initiated similar policies. The economic effects for SolarCity, Sunrun and Vivint Solar are quite different, however. Given high retail electricity rates in Hawaii (about 28 cents per kWh for residential customers in October 2015, compared to about 36 cents per kWh in October 2014), the PUCN's actions do not appear to be especially problematic for SolarCity and its peers. Thus, it appears that Hawaii's new grid-supply tariff is "economic" for the "third-party solar" companies, meaning these companies may foresee that they will have a reasonable opportunity to recover costs, and thus, will continue to market to potential new customers. This is apparently not the case in Nevada, where the third-party solar companies are exiting the market.

Note also that Hawaii's "self-supply" tariff, which doesn't pay solar customers for sending power back to grid, may actually help to promote the combination of solar and energy storage in the home. It is my understanding that solar customers with energy storage receive an expedited review and approval in areas where there is high solar penetration. In this case, solar customers would have an incentive to store electricity during the day and use it at night rather than send electricity to the grid for free. In effect, they could avoid the full retail rate by using less electricity at night, which might end up being a better deal for them than selling electricity to the grid under the grid-supply tariff. Thus, it might be a positive development for Tesla.

Q4. Please compare the "net metering" decisions in Nevada and Hawaii.

A4. The two decisions are comparable in many respects. Going forward, both Hawaii and Nevada will set the rate that utility customers receive for electricity sent to the grid based on the cost that the utility avoids occurring because it buys solar instead - this avoided cost is basically the wholesale cost of electricity (to nitpick, the utility might also avoid some transmission and distribution costs, but those cost savings would be difficult to quantify). Both states also have increased the flat rate paid by net metering customers to pay their share of the fixed costs of the utility system. As a general matter, I would characterize these changes as being consistent with what I would call "good ratemaking" with respect to net metering.

There are two key differences between the Hawaii and Nevada changes to net metering policies. First, in Hawaii, the HPUC decision "grandfathers in" current net metering customers. One can say that this amounts to a windfall to early adopters of solar technology in Hawaii, but given the nature of the collaborative decision-making process used in Hawaii, it is not surprising that existing users were grandfathered in. This grandfathering includes solar systems installed by the third-party solar companies.

In Nevada, the PUCN phases in the new net metering rates over a period ending on January 1, 2020, but did not "grandfather in" existing systems. It is unclear whether third-party suppliers would have departed if their existing customers in Nevada had been grandfathered in.

Grandfather clauses can be a form of "transition relief" when new regulatory policies are adopted. Given Hawaii's relatively large number of existing net metering customers, this will continue the existing subsidy that flows to them for many years. But given the state's target of 100 percent renewable generation by 2050, it may have seemed reasonable to agree to this grandfathering in order to expedite changing to net metering credits based on wholesale power costs as soon as possible.

Nevada did not choose to do this. The apparent result was that the third-party providers exited the state. It appears that the PUCN may prefer to focus on utility-scale renewables rather than DER. This may make sense from a cost standpoint (there may be economies of scale associated with very large solar installations), but may not be consistent with some utility customers' desire to reduce their carbon footprint by self-generating. On the other hand, third-party solar in Nevada may have been overly dependent on the subsidy to net metering customers that flowed from using the full retail price of electricity as the basis of the net metering credit. It should surprise no one that business models that are based on an artificial subsidy persisting have a high degree of business risk.

The other difference between Hawaii and Nevada is that switching to net metering based on wholesale power costs may be less "painful" for third-party solar companies in Hawaii given that wholesale power prices are relatively high in the state (where oil is the incremental fuel) compared to Nevada. Wholesale electricity costs in Nevada (around two to four cents per kWh) are relatively low compared to the average utility rate of about 13 cents per kWh in October 2015 in Hawaii.

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.

Additional disclosure: Author of The A to Z of Public Utility Regulation (Vienna, VA: Fortnightly, 2015). See: http://www.fortnightly.com/ATOZ.

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