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How to Value Distributed Solar Energy: The Net Metering Debate

distributed solar value

Utilities, consumers, solar installers, and others stakeholders are having a hard time agreeing on how distributed solar energy should be valued. The question is: how should the owner of distributed solar, for example a residential electricity consumer, be compensated for their electricity production? I will assume many of the strong claims made reflect the vested interests of the parties making those claims, but what are those interests? Where the friction points in this conversation occurring?

To take a first look at this we can simplify the issue into one where the points of contention between pro- and anti-net metering parties be illuminated. I do this by visualizing the dispute as trying to balance being fair to the owner of the distributed energy generation and being fair to all consumers of electricity. My definition of fairness is that the utility should compensate the consumer for the reduction in utility costs when the consumer uses less electricity or returns electricity to the grid, which I believe minimally depends on which side of the net metering debate you fall. We will use this as our starting point.

Solar panel owner perspective

Residential consumers see, truthfully, that a unit of electricity consumption is used to pay for a unit of utility costs. Residential consumers see electricity from this perspective because the majority of an electricity bill is the price per unit of electricity (fixed, or nearly fixed) and the number of units of electricity used. Thus, net metering appears to make perfect sense. Residential consumers do not get a discount when they consume more; they continue to pay the same. Why should residential consumers have solar production (negative demand) treated differently? This is the foundation that underlies net metering.

Utility perspective

The utility has a different perspective, specifically considering the overall balance of revenues and utility costs. First, some important details on the balance of utility revenues and costs:

  • The majority of a residential consumers’ electricity bill is a result of the per-unit cost of consuming electricity multiplied by the amount of electricity consumed.
  • Utilities must cover both fixed investment costs to have an electricity grid and the variable costs of generating (or purchasing) electricity.
    • Fixed costs are the costs of having an electricity grid, whether or not we use it, and do not increase with the amount we use the grid
      • Power lines, transformers, etc.
    • Variable costs are the costs of providing an additional unit of electricity
      • Fuel costs, usage related maintenance costs for the grid
  • When setting rates, utilities and regulators carefully consider all utility costs, which are caused by the demand for electricity and the characteristics of this demand, and electricity demand itself when determining electricity rates
    • In the simplest possible form, electricity prices are total expected utility costs divided by total expected electricity consumption.

Utilities see that some of the costs of our electricity bill will pay for fixed investment costs and some will pay for variable costs, all taken out of the constant price paid by consumers for a unit of electricity. It is important to note that fixed costs cannot be avoided if we want to have an electricity grid.

Friction points

There are several friction points between the two vantage points.  First, from the residential perspective solar offsets fixed grid costs because each unit of electricity has the same price but from the utility perspective solar does not offset fixed costs because each unit of electricity does not incur the same costs. Panel owners (and panel companies) benefiting from this arrangement have a clear incentive to argue in its favor.

Utilities, on the other hand, receive less revenue under net metering. In all states, utilities can lose revenue if rates increase and drive people off-grid. Going off-grid is not currently economical for the vast majority of customers, but it the idea behind the “utility death spiral”: a cycle where people move off-grid to escape rate increases, which increases rates and drives more people off-grid. For now, we can consider this a less-than-likely outcome. Even if all consumers had solar panels they would need to remain grid connected for times like nights and cloudy days, thus policy changes could provide utilities revenue from these customers. In states where utilities still make additional profits for each unit of electricity sold, distributed solar reduces demand and therefore profits. Utilities clearly have an incentive to avoid this.

The second friction point is a more nuanced view of the utility death spiral, except specifically with respect to who pays for the fixed costs of building and maintaining an electricity grid. As a society, we have decided that fixed grid costs are repaid by allocating a fraction of the flat price for each unit of electricity towards these fixed costs. This flat rate cost structure is a social decision that, for example, avoids uncomfortable discussions about why grandma used one unit of electricity but her average price paid was 100x that of a consumer using 200 units of electricity. You might even be able to say Americans learned the Econ. 101 lesson that goods should get more expensive as you demand more of them a little bit too well. This flat rate structure also means that the fixed costs of creating and maintaining an electric grid are largely shouldered by consumers that use average and above average amounts of electricity. The second and I believe more important long term friction point is that net metering allows consumers with solar panels to enjoy the benefits of the grid and high consumption while paying a smaller share of fixed grid costs. This is neither intrinsically right nor wrong, but does re-allocate more fixed costs of the grid to average and above average consumers of electricity without solar panels.  Implicitly, it gives people the option to invest some money (purchase solar panels) and reduce the share of fixed grid costs they are expected to pay, all without reducing their ability to utilize the grid.

And now for my two cents:  I think we could get a lot of bang for our buck by splitting the residential consumer price for electricity into a charge for how heavily you use rely on the fixed investment in our grid (also known as a demand charge for the maximum number of kilowatts you draw over the course of a month) and a charge for each unit of electricity you consume. 

Photo Credit: Value of Distributed Solar/shutterstock

Nate Gilbraith's picture

Thank Nate for the Post!

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Jim Kennerly's picture
Jim Kennerly on Oct 11, 2014 9:54 am GMT

It kills me to hear folks talk about “what the market will bear” and “letting the market work” when we’re talking about a monopoly utility. There is no “market” on the distribution system – there’s not even anything on that system that is not structured, controlled, or costed by an electric utility, with minimal regulatory supervision.

So just like you wouldn’t want John D. Rockefeller to charge “what the market will bear”, neither would you want utilities *deciding* how much to charge distributed energy resources. This is exactly why New York is doing what it’s doing with the Reforming the Energy Vision process – utilities’ market power has to be overcome, or it will overcome that of everyone else.

Jim Kennerly's picture
Jim Kennerly on Oct 11, 2014 6:45 pm GMT

Nate, I’d really encourage you to read up on how utilities allocate their costs, and how rates are actually designed. No utility is ever going to charge its customers a fluctuating demand charge unless they had perfect, minute control over their energy usage. People barely even know how to read their bill each month – how in the world are they going to respond to a fluctuating $/kW charge? 

http://wpui.wisc.edu/wp-content/uploads/2012/07/Cost-Allocation-2012.pdf

Nate Gilbraith's picture
Nate Gilbraith on Oct 16, 2014 5:36 pm GMT

Jim, 

 

Thanks for commenting.  I’m glad you raise the point of how utilities allocate their costs.  I think this is at the heart of the net metering debate.  However, I’m not sure how to interpret your comment.  Are you saying that rates will never include a $/kW charge because customers do not know how to interpret the charge or because the variability of customer kW charges is likely to lead to angry consumers when bills fluctuate month over month?  

For the first, I agree that helping customers understand a peak demand charge would be necessary. I also understand that it could be an uphill battle to change the billing scheme because these changes could result in bill volatility (though, no change in average bills if the system does not change due to this pricing scheme) and harm some customers. We diverge in that I believe moving towards more accurate price signals will benefit the system overall and should be a goal of electricity pricing

The issue of upset customers is difficult.  I do not know how the politics or rate setting work nor the power of consumer groups. You may be completely right that such a change could never be implemented in the real world.  


Nate

 

 

Nate Gilbraith's picture
Nate Gilbraith on Oct 16, 2014 5:54 pm GMT

Tom,

Thanks for the comment.

Another comment above touched on the political aspects of electricity pricing. This is an area outside of my expertise! However, I do think that providing policymakers with rational and evidence based recommendations has a place at the table. These ‘ideal’ outcomes may be pared down to something nearly unrecgonizable, but I’m my opinion is still better than starting with an unsupported or unrealistic position. Severin Borenstein has done a lot of great economic research on identifying rational and evidence based starting points and his previous post actually inspired my post.

 

On the second part of your comment.  I agree, many economists argue that real time pricing could send the correct signals to generators, including possible owners of solar panels. This idea does not exclude placing people on a rate scheme where they are charged for their demand (kW) and energy consumption (kWh). A per kW charge may be a simple proxy for how much a given consumer ‘uses’ the grid, in other words, a re-allocation of fixed costs from those with low kW to those with high kW demand. Solar production could still be compensated by the regulators favorite compensation scheme, including based on real time energy prices. 

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