What future Value of Solar policies could mean for the solar industry: 3 key things to know

There has been a wave of contentious net metering policy battles waged across the U.S. in 2016. Some net metering policies have remained largely intact, as in California, though much to the chagrin of the utilities. Other net metering policies, such as those in Nevada, have been fundamentally restructured, to put it kindly - though many would say they were just plain gutted. As with the ITC, a significant part of the solar industry formed around the net metering policy structure, and like many industries is reluctant to let go of such a foundational policy. But the aforementioned battles beg the question - is net metering the appropriate policy for solar looking to the future? Many believe that it has been a necessary stopgap policy measure, but not one that needs to live in perpetuity. One alternative that has been floated is the idea of a Value of Solar (VOS) policy that seeks to compensate solar based on a more nuanced understanding of the value that it provides to the grid. That is an easy enough idea to get behind, in theory, but just what could VOS mean for the industry?

(Source: Institute for Local Self-Reliance)

Utilities and solar investors both come out on top with a VOS policy

• The conventional thinking is that net metering is simple and the VOS approach would be inherently more complex. Yes, the calculation of VOS is more complex than just remunerating solar owners at the retail rate of electricity. As shown in the graph above, VOS is comprised of a number of factors, some which require relatively novel computations (though not necessarily very complex). However, when the VOS rate is established, it functions much like a wholesale or retail rate.  

 

• Preliminary analysis done for a Minnesota VOS policy revealed a $0.145/kWh VOS, rate which was $0.01-$0.02/kWh more than the prevailing retail rate at the time. The quick conclusion was that VOS would be more expensive, but this only accounted for a snapshot at the current year. The reality was that, over time, the VOS compensation scheme would actually be cheaper than the incumbent net metering policy for utilities. In the near-term, solar power producers could receive slightly more favorable compensation, while in the long-term the cost of solar would likely fall well below the market-based value. So, IPPs and solar owners win with better compensation schemes while the cost of developing solar continues to decrease in the near-term, while utilities accrue the long-term benefits of cheaper solar over the lifetime of the asset. Let’s dig into what is really included in this VOS calculation to get a sense of the source of this value.  

Avoided costs hold the key to understanding how the “Value of Solar” is framed

• I have touched on the topic of how natural gas prices can impact the value of solar from a project finance perspective in a previous post. Avoided fuel costs, as shown in the graph above, internalize the risk of exposure to fuel variability in short-term fuel purchases for natural gas power plants compared to long-term, fixed price (or at least contracted price) contracts with solar. This is essentially an attempt to capture the value of the hedge against natural gas prices that solar provides. Thus far, utilities that purchase power from IPPs have benefited from their ability to purchase this hedge without really paying the full price for it. VOS would change that. 

 

• Avoided generation capacity cost is another large and important component of the VOS calculation that is designed to capture the value of not building additional power plants if future capacity needs can be met with solar. This calculation is commonly done from an accounting perspective, but the real question is would solar actually supplant future conventional generation capacity. And the answer seems to be that, yes, it’s starting to happen (see EIA). And VOS provides a way in which to account for this cost transfer, which will be especially important over long time horizons as we transition the grid. 

Playing up the environmental costs angle could be the greatest strength of VOS
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• The conventional wisdom is that solar is becoming mainstream precisely because the economic fundamentals are solidly in its favor. While early adopters were quick to buy into solar despite the financial penalty of doing so, the trailing majority waited until solar costs were too low and financing structures too attractive to ignore. If VOS were to replace (or just complement) net metering, it would add a twist to this bottom-line oriented story, as proposed VOS calculations often include an avoided environmental cost, usually synonymous with the social cost of carbon. Now there has been a lengthy and vociferous debate about what constitutes a legitimate social cost of carbon, but for the purposes of this discussion, the most important thing is that it would be included at all. While this move might fall on the right side of history (especially from the perspective of future generations living in a climate-impacted world), it opens to door to criticism from opponents who claim that this is an unnecessary subsidy to the solar industry that distorts “free market” principles (free markets are a myth, anyway, as eloquently articulated by former Secretary of Labor Robert Reich).

 

• The holy grail of sustainable business is when the generation of financial returns and the production of environmental (and social) goods are in alignment. Shying away from the fact that solar can achieve this only undermines the ethical thrust underpinning  the transition to renewable energy. And considering the rampant climate illiteracy and misinformation obscuring the debate about our energy future, why not have this solar policy be another mechanism through which the current generation can start accounting for the environmental costs of our legacy energy system?   

The City of Austin, TX and the State of Minnesota have led the charge on the initial VOS studies, and have proposed different cost structures and calculation methodologies. It would have been easy to anticipate that VOS would have taken off, especially as a substitute for the much-maligned net metering policies, but so far it has not. But if the recent solar policy battles are any indication, the days of the old net metering policies may be numbered. VOS may open the door for a more nuanced treatment of solar in our energy policy.