Distributed Solar is the Real Threat - The Difficult Position of Utilities

This is part 6 of a series on disruption of electric utilities.

Disruption of Electric Utilities
1.  Background on Utilities
2.  Why Utilities have Avoided Disruption Thus Far – Reliability
3.  Why Utilities have Avoided Disruption Thus Far – Financial Metrics
4.  Community Choice Aggregation is a Red Herring Disruptor
5.  Distributed Solar is the Real Threat - Trends
6.  Distributed Solar is the Real Threat - The Difficult Position of Utilities
7.  A Survival Strategy for Utilities

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Solar represents a dangerous disruption for electric utilities, particularly because as more consumers install solar, the price of power for utility customers will increase.  When consumers use less utility power in favor of distributed solar power, utilities have to distribute their fixed costs over fewer customers.  Utility electricity prices then increase, and more customers are driven to install solar.  Jim Rogers, CEO of Duke Energy, a utility serving Ohio, Kentucky, Indiana, Florida and the Carolinas, described solar as a threat to utility survival in the long term.  Moreover, the risk of distributed generation including solar is noted in nearly all utility annual reports.

A logical next question, however, is why utilities cannot enter the residential solar business themselves.  After all, solar leasing companies are financing the installation of energy assets, a business model very similar to that of utilities.  The good money, bad money theory explains why this endeavor is challenging to a utility.  In early 2010, PG&E saw the opportunity of residential solar ownership and invested $160 million in funds raised by SunRun and SolarCity, the two leading solar leasing companies.  Unfortunately, in late 2010, PG&E faced a crisis when a gas line it owned exploded in San Bruno, CA, killing 8 people and destroying 38 homes.  The disaster forced PG&E to pay large expenses not recoverable from rate payers and to devote significant resources to ensure the safety of its existing infrastructure.  As a direct result, in 2011 PG&E shutdown its residential solar investing group to focus on its core business.  PG&E offered bad money for solar investment, and leasing companies have found more patient capital from financial institutions.

As descried earlier, utilities should have the correct financial incentives to defend against the solar threat.  In fact, though solar only represents about 1% of California electricity generation currently, utilities have been aggressive in lobbying for changes in rate design of marginal costs that would reduce the incentives to install residential solar.  However, the solar industry and political supporters now have the ability to lobby back.  In addition, as solar continues to decrease in price, it will undercut even the average cost of power provided by utilities, making it more challenging for utilities to stymie solar via rate design reform.  In the short-run, utilities will likely be able to stay in business so long solar customers still need the grid for backup service.  In the long run, though, fully modularized solar power may kill the utility industry.  NRG, a large S&P 500 power generation company, has announced plans to sell micro gas generators as a backup to distributed solar.  Micro generation allows customers to completely disconnect from the electricity grid while staying on the gas grid.  While micro generation or other backup power sources like batteries are unlikely to be cheaper than wholesale utility power, the combination of cheap distributed solar plus backup power may be able to provide reliable electricity at a cost below retail rates offered by utilities.  As customers start to leave utilities, the remaining customers will see higher rates due to utility stranded assets, accelerating the transition to distributed generation.  Even though the utility industry is set up with factors that have encouraged it to fight new entrants, distributed solar power has the potential to be the long-term threat that finally disrupts the electric utility industry.