Buffett's Cash Overshadows Solar

They've got the size and capital to outshine rivals in the short term.

It is the best of times and worst of times for the U.S. solar power business, as these two charts demonstrate. First this one:

Sunny Uplands

U.S. solar capacity installations

Source: Bloomberg New Energy Finance

Note: Data for 2015 and 2016 are estimates.

And then this:

Hot Money

Indexed share price performance

Source: Bloomberg

For a clue as to why those two sets of data have gone in opposite directions, here’s an excerpt from something published this weekend by a reasonably well-known investor:

BHE is welcomed by regulators when it proposes to buy a utility in their jurisdiction. The regulators know the company will run an efficient, safe and reliable operation and also arrive with unlimited capital to fund whatever projects make sense.

“BHE” stands for Berkshire Hathaway Energy, so no prizes for guessing who wrote that. And, folksy as it is, it should strike fear into the likes of SolarCity.

As this Bloomberg Businessweek cover story discussed, Nevada has become a battleground in the solar business between the residential solar sector and NV Energy, the state’s incumbent utility owned by Berkshire.

In December, the state’s regulator changed the rules on solar panel users. In particular, it slashed the amount of money solar customers get for surplus electricity they sell back to the grid, an incentive known as ‘net metering’ that is often vital to making residential solar power worthwhile relative to regular, utility-provided volts. Rather than getting the retail price, solar customers will get progressively lower prices over five years. Meanwhile, their monthly fixed charge for the upkeep of the grid will triple in that time to almost $40. Most strikingly, Nevada isn’t even grandfathering in existing customers who have already paid to install panels on the basis of the old rate structure. All in all, any utility could hardly ask for more.

In an interview with CNBC earlier this week, Buffett said he has no problem with net metering, but in Nevada:

We do not want our million-plus customers who do not have solar to be buying solar at 10.5 cents [per kilowatt-hour] when we can churn it out for them at 4.5 cents or buy it for them at 4.5 cents.

This looks like a mixing of some distributed apples with utility-size oranges (now there’s an image). Solar installations measured in megawatts rather than kilowatts do, of course, enjoy economies of scale in terms of generating power. However, as utilities often point out themselves, the majority of the cost of such power delivered to the plug pertains to transmission and distribution, including less obvious costs, such as electricity lost as it travels long distances and the risk of outages that utilities bear. Berkshire Hathaway Energy didn’t respond to a request for comment, but it’s highly unlikely that figure of a few cents included those costs.

For independent solar leasing firms, though, this is small comfort.

Regulatory setbacks like the one in Nevada serve to highlight the power that incumbent utilities can exercise to protect their monopolies.

Another big advantage that isn’t dependent on canny lobbying and is sharpened by the current environment: a low cost of capital. Equity markets are effectively closed for big issues by the sector and, as this chart shows, things are none too friendly on the credit side, either:

Feel the Burn

SolarCity's 1.625 percent convertible bond due Nov. 2019, yield-to-maturity

Source: Bloomberg

This isn’t to say solar companies have been the victims of some Wall Street conspiracy -- far from it. As SolarCity has admitted, its costs have gotten out of hand. At some point, even the most enthusiastic solar advocates are going to balk at a quarterly cash burn rate approaching $800 million.

Still, even if solar companies do become efficiency superstars, Buffett’s boast of “unlimited capital” is hard to beat. And while not all utilities -- especially those on the hook for annual dividends to shareholders -- can make a similar claim, their stable cash flow and generally decent balance sheets mean they can afford to splurge on their own forays into 21st-century energy. Just look at Southern Co.’s spending spree over the past year, including paying 30 times 2016 earnings last month for micro-grid developer PowerSecure International.

Part of the reason Southern is suddenly embracing renewables and energy services so heartily is because growth in those areas is undercutting growth in the traditional utility business. Buffett boasts about the size of Berkshire's renewables portfolio precisely because it offers growth that is backed by falling technology costs and federal and state incentives.

Yet, while utility-scale installations will continue to grow, the genie is out of the bottle when it comes to distributed energy. Nevada's regulatory stance, especially its lack of grandfathering clause, makes it an outlier for now. And distributed energy's appeal is likely to grow, especially if battery costs continue to fall -- a risk Berkshire has acknowledged:

To date, renewables have helped our utility operation but that could change, particularly if storage capabilities for electricity materially improve.

One response for the utilities is to build their own unregulated, distributed energy arms to compete, and many have the financial wherewithal to do it. More questionable is whether such a radically different business could thrive inside a traditional utility, attract the right people and carry risk-averse, yield-loving utility investors along for the ride. One intriguing possibility to deal with those risks would be for utilities to actually strike partnership deals with distributed solar firms, swapping capital for a hedge against a strategic threat to their base business.

Blue-sky thinking? Perhaps. At least in the near term, stocks such as SolarCity will remain highly volatile on a combination of high leverage and the risk of  regulatory setbacks as well-capitalized utilities push back. It must continue to grind away at cutting bloated overheads to cope.

For utilities, though, a strategy of persuading regulators to raise fixed fees to protect local monopolies also looks untenable over the long term. Jim Lazar has been a consultant on utility regulation for over 30 years and is a senior advisor to the Regulatory Assistance Project, a non-profit organization that advises on reforming regulation to encourage more renewable energy sources. He says this:

The bottom line is the utilities will have to deal with competition and you don't deal with competition by charging customers $40 [a month] for the privilege of being a customer.

It's the sort of simple, thought-provoking line you might almost expect to read in one of Berkshire's letters.

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

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