- Californian authorities have suggested to reduce subsidies for rooftop solar.
- Although no final decision has yet been made, battery storage solutions might see an increase in demand as customers would try to circumvent negative consequences of the new rules.
- Sunnova does not see its residential solar and energy storage business at (significant) risk, short-term growth could be hit though.
On December 13, 2021, Californian regulators released a proposed decision. While this bill leaves, at first glance, major California utilities such as Pacific Gas & Electric Company (PCG) and Southern California Edison (SCE) as winners, rooftop solar owners and the solar industry as a whole, represented by publicly traded companies such as Sunnova (NYSE:NOVA) and Sunrun (RUN), do not see their positions adequately addressed. The battle in the media for public opinion is in full swing.
The aim of this analysis is to shift the points of contention to the factual level and, on this basis, to understand what possible implications this could have for the business model of Sunnova in particular.
Let me ask you a simple question: What is the one argument that makes installing solar panels on your roof so attractive to residential customers? Nope, it's not necessarily your contribution to the fight against climate change. And no, it's certainly not the aesthetics of plastering your house roof with panels.
The truth is that it has to be financially worthwhile for the masses to make an investment in solar panels on their own roofs. That is understandable. After all, we are talking about an investment amount of several thousands of dollars. Dependent on the energy demand the price ranges from around $15,000 for a 6 kW system up to $30,000 for a 10 kW system (source: energysage.com).
So you're asking where the financial incentive comes from to go solar. It's simple. The magic word is tax credit.
The best incentive for going solar in the country is the federal solar tax credit, or the investment tax credit (ITC). This incentive allows you to deduct 26 percent of the cost of installing solar panels from your federal taxes, and there’s no cap on its value. For example, a 10 kW system priced at the national average ($2.76/W) comes out to $27,600. However, with the ITC, you’d be able to deduct 26 percent of that cost, or $7,176, from your taxes. This essentially reduces the cost of your system to the $20,424 price tag we highlighted at the beginning of this article (source: energysage.com).
The tax benefit is essentially immediate. Apart from this tax advantage, home owners save on energy costs once they start producing their own electricity.
For most homeowners, solar is a worthwhile investment, and you can “break even” in as few as 7 or 8 years. From that point on, you’re essentially generating free electricity and racking up the savings. During those 7 to 8 years, you’ll be generating your own electricity instead of paying for electricity from the grid, and any extra electricity you produce you might be able to get credit for thanks to net metering policies (depending on where you live; source: energysage.com).
Net metering. What's that?
Net metering is an electric billing tool that uses the electric grid to store excess energy produced by your solar panel system. Under net metering, energy your solar panels produce and you don’t use is credited back to you (source: energysage.com).
How does it work in practice? For instance, imagine a rainy day. Your solar system will not produce (enough) energy. Thus, the utility grid will provide you the energy you need. As the previous days had been very sunny, your panels had generated far more electricity than you and your family actually consumed. The deal is that you will only get billed for your net energy usage. So the over-production on sunny days which most likely is resulting in a positive net energy usage is counted against the under-generation on rainy ones which probably turns into a negative net energy usage.
This concept also helps you to level seasonal differences (winter with less electricity production against excess energy months in summer). And net metering allows homeowners to save lots of money over the lifetime of a solar panel system (20 to 25 years).
Both concepts - tax benefits and net metering - aim to encourage (residential) customers to go green. They are effective and common solar policies around the globe, not just in the US. The map below illustrates those ~40 states/ territories that currently rely on mandatory net metering rules for certain utilities.
Source:Database of State Incentives for Renewables and Efficiency (DSIRE)
According to other data from DSIRE, the method used to calculate customer credits for monthly net excess energy generation (NEG) under net metering varies significantly across states. States such as California, Colorado or New Hampshire have the most customer-friendly approaches in place. First of all, NEG is credited at retail rates, which may reduce utility bills even to zero, and, secondly, earned credits do not expire.
What is the regulatory change about?
On December 13, 2021, the California Public Utilities Commission (CPUC), which is regulating privately owned public utilities, proposed changing the way net energy metering (NEM) is done. Essentially, the regulators want people - 1.2 million California homes use rooftop solar panels - to pay more for grid usage. CPUC's publicly available statement says:
Our review of the current net energy metering tariff, referred to as NEM 2.0, found that the tariff negatively impacts non-participating customers; is not cost-effective; and disproportionately harms low-income ratepayers (source: CPUC).
The proposed decision would bear the following cost increases for owners of rooftop solar panel solutions (source: California Solar & Storage Association):
- A monthly $57 solar penalty fee for the average residential solar system which is only partly set off by a monthly $15 credit for the first 10 years. Low-income ratepayers and commercial customers are exempt from the fee.
- NEG rates for residentials would be cut back to 5 cents per kWh, while being currently in a range from 20 to 30 cents per kWh. Recall that the current NEG rates are equal to retail rates making it a zero-sum game from a solar panel system owner's perspective.
- Existing solar customer would see their grandfathering be reduced from 20 to 15 years.
The line of dispute is between the big utility companies and the solar stakeholders.
Utilities like Pacific Gas & Electric, California’s largest, have argued that this credit system, known as net metering, is not fair to people without solar panels who are left to bear the cost of operating the grid. Solar installers argue that the system fairly compensates homeowners and encourages greater use of renewable energy (source: New York Times).
To give you some additional, historical context: Net metering rules have been introduced for the first time in 1995 (NEM 1.0). Currently, NEM 2.0 is in place. Thus, the revised version would become NEM 3.0. Note that this law covers all customers of California's three largest utilities. These are Pacific Gas & Electric Company, Southern California Edison and San Diego Gas & Electric (SDG&E).
Source: S&P Global
|Parent company||N/A||Edison International (NYSE:EIX)||Sempra Energy (NYSE:SRE)|
|Customer accounts||5.5 million||5.1 million||1.4 million|
|People served||16 million||15 million||3.6 million|
Source: own illustration
Right now, the regulator's proposal is subject to public comments. In addition, the CPUC must conduct a final vote, which can take place the earliest during CPUC's business meeting on January 27, 2022. Without approval, the proposed decision has no legal effect (source: CPUC).
Over the upcoming weeks, intense lobbying by all sides will take place to shape public opinion. For instance, Tesla (NASDAQ:TSLA), through its subsidiary Tesla Energy which was formerly known as SolarCity, "asks employees to fight policy proposal" (source: CNBC).
Important side fact: The vote will not be an ordinary one as two commissioners (out of a total of five) who strongly pushed for the proposed decision left the CPUC in the meantime. Both the now former president, Marybel Batjer, and one commissioner, Martha Guzman Aceves, left the board. While the former retired, the latter was appointed by the Biden administration to serve in another governmental body (source: insideclimatenews.org). Governor Newsom already picked two replacements (see CPUC).
It remains to be seen what stance the two new commissioners will take on the matter. Another exciting question is if any of the five commissioners will put an alternative proposal on the table for the panel to consider.
What else might be important to fully understand the issue?
Over the last few years, in California and few other states, so-called Community Choice Aggregation (CCA) or also known as Community Choice Energy have gained ground.
CCAs are local, not-for-profit, public agencies that provide electricity service – and much more – to residents and businesses (source: theclimatecenter.org).
Therefore, CCAs are offering a decentralized approach to the energy supply issue. The very same issue was historically addressed by a handful of big utilities - either investor-owned or municipal.
Below you will find an illustration and a short video. Both pretty much explain the twist of CCAs. Essentially, they break down the traditional energy value chain and pursue a hybrid model. Unlike private or municipal utilities, CCAs handle the power purchase on their own, but rely on existing transmission infrastructure that continues to be provided by incumbent players.
Source:National Renewable Energy Laboratory (NREL)
According to the California Community Choice Association (CalCCA), the state's 23 CCA programs are serving more than 11 million people. This number is huge put into context with the table shown above containing customer count information of the big utilities. Apparently, CCAs are increasingly chasing customers away from the top dogs.
Note that CCAs are considered to support the green energy transformation as they opt for sourcing from renewables - as requested by the community. This is due to the competitive pricing of renewables compared to traditional energy sources (even though this might only be due to subsidies). Obviously, legacy businesses on the other hand do not have huge incentives to abandon their significant investments in fossil-fueled plants or nuclear.
Without doubt, Sunnova and other players in the renewable energy universe benefitted from the trend towards CCAs. The traditional utilities, on the other hand, see their business models more and more under pressure.
There is another effect coming with the emergence of CCAs. The erosion in their customer base might motivate the incumbents to become pure infrastructure plays, thus, stop signing contracts for electricity supply. This seems to be sort of reasonable as "the utilities don’t profit from energy sales, anyway — they’re allowed to charge customers only what they paid for electricity on the market" (source: Los Angeles Times).
Regulators - such as the CPUC - take a critical view of the trend toward decentralization. They fear that the shift from few large providers to many small ones will push the already outdated grid infrastructure completely to its limits.
According to a 2019 article in the Los Angeles Times, the CPUC raises two main concerns on CCAs but also on rooftop solar and home battery systems:
- Provider of last resort: In case of a failure of a CCA, customer automatically would be routed back to one of the three big dogs (dependent on the customer's location). Yet, the question remains what happens to stranded customers if the big utilities decide to get out of the electricity sales business?
- Climate goal of 100% renewables by 2045 (in California): As essentially every household can produce and supply electricity to the grid, the physically required balance between supply and demand on the grid is increasingly challenged. This comes on top of seasonal, daily or even hourly swings of solar and wind power generation.
What are potential implications for Sunnova's business?
I reached out to Sunnova's IR department and came back with the following (as of January 03, 2022):
- Given the personnel changes in the commission, the result of the final vote is unclear. A compromise resulting in modifications of the proposed decision would not be a surprise at all as this is a highly political issue.
- Compared to peer companies, Sunnova's California exposure is small. Yet, ~25% of the company's installed basis is located in The Golden State.
- No significant effect on P&L nor cashflows expected. Obviously, this is contingent to the final version of the decision. Most likely, Sunnova (and others) will try to keep end-user prices and their own profit margins constant while cutting into juicy installer profits. Remember that Sunnova relies on a network of independent dealers which provides great flexibility in this situation.
- Customers' demand for battery storage solutions might see a substantial uptick. The rational customer will try to circumvent the lower feed-in tariff by simply no longer feeding surplus energy into the grid, but by temporarily storing it with the help of battery storage solutions.
In my initial write-up on Sunnova, I stated the below which obviously does refer to the whole US (not California exclusively), but gives you a good indication:
To me it seems obvious/ compulsory to pursue a more aggressive upselling strategy as customers are locked in for up to multiple decades. According to Sunnova's company presentation on 3Q21 the weighted average contract life remaining is 22.4 years. This is a sticky business model. Leveraging on this stickiness means developing existing customers within the ecosystem. The ongoing electrification and energetic transformation of our society offers multiple opportunities to do so. According to the company's 3Q21 earnings call, Sunnova sees significant potential in penetrating its existing customer base with storage systems. CEO Berger mentioned a growth factor of six by 2025 based on today's penetration rate of roughly 10%.
Things are never as bad as they seem at first glance. Sure, investors should closely monitor what's happening next in the matter. As this is a highly political issue and given Governor Newsom's aspirations to run for presidency in 2024, we potentially see (significant) modifications to the proposal.
Apart from this political perspective, we should note that a redesign of the regulations, no matter how far-reaching it ends up being, should provide an unprecedented boost to the battery storage solutions business. Based on recent communication, Sunnova seems to be set to embrace this opportunity.
This article was written by
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