Utility Investments in Solar

I saw this slide, available here, from the 2013 U.S. Solar Market Insight Conference produced by GTM Research and the Solar Energy Industries Association.  The slide categorizes various utility investments in solar projects.  Previously, I have recommended approaches utilities should take to succeed in an era of distributed solar power, and these utilities are likely to be those at the forefront of new solar business models.

I apologize for the poor image resolution of some of the logos.

A Survival Strategy for Utilities

This is part 7 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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To recap, the situation facing utilities is that the price of distributed solar power on customer rooftops has dropped significantly.  Many customers now save money by leasing solar panels and reducing their electricity bills, and this would be true even without government subsidies for solar (the investment tax credit).  Utilities do not like this because their traditional business model is to be the energy asset owner, and this role is being usurped by third party solar investors.  Solar is taking away utility market share.

Furthermore, utilities really dislike net metering, where customers sell excess solar back to the grid.  Utilities justifiably argue that under net metering, utilities are obligated to purchase solar at a higher prices than what it is worth to other grid customers, thereby raising average rates.

Unfortunately, the utility response thus far has been no more effective than the music industry’s early response to file sharing:

The Current Utilities Response to Solar

1. Fight net metering
• Utilities have lobbied for limits to net metering and to reduce the payouts for net metering.
2. Fight community solar
• Community solar, also known as virtual net metering, enables a customer to buy a stake of a nearby solar installation to reduce their electricity bill rather than place panels on their own roof. Therefore, larger, cheaper solar can be built in more advantageous locations, and customers without sunny roofs can benefit from solar.  Utilities dislike community solar because the solar panels are not behind a customer meter, and so power flows across utility distribution wires, but the utility does not get paid.  Utilities do need to get paid for the use of their wires, but rather than naming a price, they have thus far refused to support such programs.
3. Limit investment in distributed solar
• The utility business model is to finance energy investment assets, so utilities could be expected to invest in residential solar.  However, other than two defunct programs between PG&E and SunRun and SolarCity, utilities have left the financing of distributed solar to banks and Google.

The current utility response is effective in delaying the adoption of solar power, but shows no coherent long-term strategy.  By fighting solar adoption, utilities lose a significant opportunity to integrate distributed solar into their own business model.  Moreover, utilities foot-dragging will eventually lead frustrated solar advocates to pay for expensive battery backup systems in order to remove themselves from the grid.  While batteries are not close to being cheap enough for residential homeowners, we are could see larger commercial and industrial customers turning to battery backups or microgrid systems featuring solar and other distributed fossil fuel generation in order to reduce electricity bill and increase reliability.  In the long-term, solar-enabled customer flight is a real threat to utility survival.

That said, the percentage of utility customers with solar remains tiny in the United States.  It is not too late for utility companies to formulate a reasonable solar strategy.  Here is my recommended approach for utilities:

Utility “Survival Strategy” Response to Solar

1. Pioneer community solar
• Realistically, utilities cannot suddenly go after the current residential distributed solar market. They have lost too much ground to distributed solar companies SolarCity, SunRun, SunPower, CPF, etc.  However, utilities are uniquely positioned to lead in community solar because utilities can site and interconnect community projects better than anyone, plus utilities alone can come up with fair distribution wheeling charges.  The community solar model would allow utilities to invest in solar while favorably competing with the leaders in distributed solar.  Also, the potential customer set is much bigger, and includes housing renters.
2. Create a distribution-level energy auction with the utility as the market maker
• While ownership of community solar is an easier short-term advance for utilities, a customer-to-customer market for solar power has much great long-term potential.  The analogy is that at the transmission level, independent system operators serve as non-profit market markers between generators and utilities.  At the distribution level, however, utilities have the opportunity to play the role of market maker between solar customers.  They would profit from distribution wheeling charges, increased utilization of utility assets, and a bid-ask spread between solar buyers and seller.  As the price of solar is reduced, more and more people would want to participate, as sellers if they have a big sunny roof, or as buyers if they do not.  When all customers can participate in solar, the utility has more ability to charge all customers for distribution system investments necessary to upgrade the distribution grid for more solar generation.

Under this plan, utilities keep their role as asset owner of distribution assets, add a new source of revenue, and benefit from decreasing costs of solar rather than suffering.  Finally, with a customer-to-customer solar auction, the utility customers benefit from economies of scale.  Thus, the utility would face less threat from municipalization or community choice aggregation.

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.

Capacity Markets – Renewable Generation

This post is part of a multi-part series on capacity markets.

Capacity Markets – Definition

Capacity Markets – Background

Capacity Markets – A look across the United States

Capacity Markets – Renewable Generation

In a previous post, I described how electricity markets in the US provide incentives for independent power generators to build and maintain generating capacity.  Capacity ensures that the grid has sufficient ability to generate the necessary electricity during peak hours.  These markets function well for traditional natural gas power plants which can be turned on and off fairly easily.  The post looks at the current methodology for valuing the capacity of renewable intermittent resources, such as wind or solar.

In general, wind blows stronger at night, but this chart of the power output 

every day for a month of a California wind farm shows that there can be 

quite a lot of variability

Peak hours for the grid in most of the United States are during the summer afternoons when buildings have their air conditioner turned on (the exceptions are winter-peaking areas in the northern United States where customers have a lot of baseboard electric heating).  Often, the wind is not blowing its strongest on hot afternoons.  In addition, while these hours tend to be sunny, there could be significant cloud cover during an important hour, or the air conditioning load could remain high at dusk when the sun sets.  Wind and solar cannot be counted on to be available the same as a natural gas combustion turbine.

This one day chart of the power output from a photovoltaic solar
installation shows the impact that cloud cover can have on solar power.
Geographic diversity of solar power throughout the state should mute
many of these variations for the purpose of system-wide capacity. 

On the other hand, conventional power plants such as a natural gas power plan is not available all the time either, and it still receives capacity value.  Conventional resources have scheduled maintenance, and unplanned outages.  Moreover, even if wind and solar do not always perform at their maximum rated output during peak hours, surely they are providing some benefit which could be estimated statistically.

California has attempted to address this issue by creating a net qualifying capacity (NQC) methodology to determine the amount of resource adequacy a power plant of a given technology provides.  Resource adequacy, as I mentioned previously, is the closest thing California has to a forward capacity payment.

The NQC for renewables is determined by an “exceedance methodology”, calculate by California state regulators: the public utilities commission (CPUC), the energy commission (CEC), and the ISO (CAISO).  The exceedance approach measures the minimum amount of generation produced by the resource in a certain percentage of peak hours.  The exceedance level used to calculate the QC of wind and solar resources is 70%.  Another way to describe the exceedance level is that the 70% exceedance level of a resource’s production profile is the maximum generation amount that it produces at least 70% of the time (during peak hours).  The peak hours, for the purpose of the exceedance methodology calculation, are 5 hours a day, 4-9 p.m. November to March and 1-6 p.m. April to October.**  These hours vary regionally, and would not make sense for a grid at a different latitude than California. 

To determine the minimum production level of solar and wind resources for 70% of the peak hours, California looks at historical values for load data and power output from solar and wind resources.  Typically, an average of the past 3 years is used.

NQC values for renewable power resources are dependent on seasonality, geographic diversity of the resource, and site specific factors. Anecdotally, I would expect the NQC value of a solar facility to be approximately 25-35% of its installed capacity (measured in MWs), and the NQC value for wind to be approximately 10-20%.

**5 hours a day year round is a relatively conservative metric because the industry standard for determining capacity among distributed resources is the top 250 load hours of the year.  250 hours is an “eyeballed” number for the peak hours in which the grid is most likely to have an outage.  A more rigorous loss of load probability (LOLP) analysis is done for reliability planning, but for economic estimates of resource planning, 250 hours will usually suffice.  5 hours a day is roughly 20% of the hours in the year, whereas 250 hours is less than 3% of the hours in the year.