Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

The house usually wins in  Nevada. Yet SolarCity's setback there on Tuesday could actually serve a useful purpose for its investors.

Nevada has become the latest battleground in net metering, whereby people with solar panels on their roofs can sell excess power back to the grid, usually at retail rates. The resulting savings are a big selling point for the solar leasing plans offered by SolarCity and its competitors.

Incumbent utilities aren't fans because those panels take business away from them. They have mounted an increasingly effective campaign to persuade regulators that net metering unfairly shifts the cost of maintaining the grid to rate-payers who lack solar power systems.

Nevada on Tuesday effectively sided with the utilities, adopting a proposal from the state's regulator to slash the amount paid for net metered electricity and raise the fixed monthly charges all solar customers pay the utility -- the better to make solar panel users pay their share of maintaining the grid.

The state also opened the door to customers with distributed energy systems eventually paying so-called "time-of-use" rates for electricity, which adjust pricing depending on demand. This would effectively cut into the economics of residential solar power even further; in states where solar power has made big inroads, time-of-use rates can shift the burden of buying electricity from the grid further toward the evening, when solar power isn't available.

Oh, and Nevadans who already leased panels on the basis of the more favorable existing regime won't be grandfathered in. All in all, the proposal is a utility's dream and a solar leasing company's nightmare.

SolarCity's stock has retreated about 10 percent this week in anticipation of this ruling. Both SunEdison and Sunrun have been hit, too. Before you reach for your handkerchief, though, it's worth looking at how SolarCity's stock has done in the past few weeks.

Dusk Till Dawn
Source: Bloomberg

That big drop in October was due to worries about another set of incentives for solar leasing disappearing -- namely, the federal tax credit and the net metering regime in the biggest market in the U.S., California. When SolarCity's chief executive Lyndon Rive told investors on a quarterly results call at the end of October that the company would refocus on cutting costs in preparation for lower incentives, growth investors abandoned the stock and short-sellers had a field day.

The subsequent stock-price jump came courtesy of Congress lifting the oil export ban in exchange for a multi-year extension of the tax credit and California's regulator reaffirming its commitment to net metering. At least eight Wall Street analysts tracked by Bloomberg have raised their recommendation, target price, or both on SolarCity in response.

Against all that, Nevada's knock-back ranks pretty low in terms of SolarCity's near-term growth prospects and the solar industry may well mount a legal challenge. Make no mistake, though, it is a vital reminder that, despite the favorable outcomes in California and Washington, D.C., SolarCity mustn't lose its commitment to favoring cash flow over growth.

Nevada has joined Hawaii, another key battleground state for the solar and utility sectors, in effectively overturning net metering. That will send a signal to other states.

The more insidious element in Nevada's proposal is the lack of a grandfathering clause. As Hugh Wynne at Sanford C. Bernstein pointed out in a report on Tuesday, it could mean existing customers in the state find their leasing deal no longer delivers promised savings, raising the potential for defaults. And that could have knock-on effects for the nascent market in bonds backed by packages of solar leases that SolarCity is trying to establish.

Other states may balk at taking such a radical step. Yet even in California, there are signs the incentives underpinning SolarCity's rapid growth face erosion. For example, the state's otherwise supportive proposals on net metering also contained a provision mandating that residents installing panels from 2018 would have to pay time-of-use charges for electricity.

The common thread here is that, while some might wish for SolarCity to get back to "ludicrous speed" growth -- to borrow a phrase from chairman Elon Musk's other vehicle -- the company should instead stay focused on reversing the increase in its overheads and cash burn. Politics is just too capricious an ally.

Overcast
SolarCity's panel installation cost
Source: Company presentations

This theme was actually raised in the run-up to the deal on the federal tax credit by the CEO of another solar power firm, Sunnova's John Berger. He urged Congress to let the credit drop away as planned, forcing the industry to become more efficient and move toward other forms of financing that aren't tied to tax equity. Cutting the credit would almost certainly have shrunk solar's prospects and the industry itself, at least initially, as SolarCity's own commitment to stop chasing marginal customers forewarned.

Berger didn't call for all incentives to be scrapped -- he made a case for extending the ability to use master limited partnership structures to the solar business. And it is possible that Sunnova's business model, which emphasizes partnerships with local contractors, translates into lower unit costs versus a vertically-integrated one (it's a private company, so it is hard to tell).

The bigger point is that, while reliance on incentives is nothing new anywhere in the energy industry, residential solar power firms should do all they can to mitigate that dependency as quickly as possible. They aren't just in a battle with utilities, but also against the likes of utility-scale and community solar projects, which tend to enjoy scale economies.

Besides improving the economics of the business, greater efficiency would help in the political arena, too, by reducing the number of fronts on which the industry fights. For example, it just doesn't become a self-styled 21st century energy sector to argue against something like time-of-use power tariffs, which send price signals to customers about when to use electricity.

As Severin Borenstein, a Berkeley professor at the Haas School of Business put it in a recent blog post, if you don't like time-varying electricity pricing, then "you are probably puzzled, or outraged, at how much more expensive wrapping paper is on December 15 than on January 1." 

The strongest argument solar power can make about upending the existing power industry is to show that it can finance itself and operate efficiently. Congress and California have given it some extra time to make progress on that front. Nevada has shown it shouldn't squander it.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net