How much should utilities pay for distributed solar power?

Close-up of completed project - Gibbs Dairy goes solar

In the energy and climate circles, there is a lot being written lately about the threat to the traditional utility model from distributed, renewable energy sources.  David Roberts has been running a series describing the problem and looking for solutions.  Chris Nelder also has a good read on the topic.

One of the key issues is the idea that utilities want to avoid “stranded assets”, or infrastructure they still have to pay to maintain with a shrinking pool of customers.  As some customers get more power from solar, sales of electricity shrink, leaving utilities with the same distribution infrastructure to maintain using less revenue.  Some utilities, the latest being a municipal utility in San Antonio profiled by David Roberts, argue they shouldn’t pay customers the “market” rate for electricity their customers generate with rooftop solar, but instead should pay them a wholesale rate, or the same as they pay for other electricity on the grid.

The thinking here is that paying the wholesale price will put renewable energy on an even playing field, and help keep the old utility model more financially whole, since wholesale prices are typically much lower than market prices.  For example, the 5-year average wholesale price for electricity in the grid area that serves Minnesota was $53.62 per MWh for the period ending in 2010, according to FERC.  This is for the “peak” time of day, meaning the afternoon, which is also the time solar is most productive.  That’s equal to roughly 5 cents per kWh, which is the unit at which typical household sales are measured.  Last month I paid about 11 cents per kWh to Xcel before taxes, fees and other charges like WindSource.

At 5 cents/kWh, rooftop solar would take a very long time to pay off.  Many fewer people would likely choose to install it.  However, those in the renewable energy world will tell you that 5 cents/kWh doesn’t pay the owner of a system for some of the benefits solar energy has over wholesale electricity.  We should actually be looking at a “value of solar” that includes not just the wholesale energy price, but reimbursement for other values.  There is movement right now in Minnesota to legislate that a true “value of solar” be computed for future projects.  So what other value does solar energy have that utilities might value?

For one, it can be more efficient.  Whenever you transmit electricity or long distances, you lose some due to resistance (heat).  EIA estimates these loses at 7% nationally and 7.4% in Minnesota.  That means utilities are generating more kWhs than are needed to make up for the losses, and thus the customer is paying more for each kWh.  If you’re generating power very close to where you use it, you minimize these losses and the extra generation.  Distributed solar energy should actually be valued 7% above wholesale prices by a utility if you think it will reduce these line losses.  If you include that 7% bump, 5 cents becomes almost 6 cents per kWh.

The other value is the reduced environmental cost of solar generation.  There is plenty of discussion about what the optimal cost of carbon should be, and it all depends on what you adopt as your discount rate.  Here is a must-read on discount rates, also by David Roberts.  If you think that climate change will have a net drag on the economy in the future, your discount rate is likely low, and the optimal cost of carbon gets up into the $50 to $100/ton range.  Carbon levels per unit of electricity produced vary quite a bit across the county, but in Minnesota and parts of the upper Midwest, they averaged 0.738 metric tons per MWh in 2009 (the latest year for which EPA has data).  At that rate, a high carbon tax might add between 3.5 and 4.5 cents per kwh.

If you add all this up, (an economically optimal price on carbon, savings from transmission losses, and a wholesale price consistent with the 5-year peak average), you get a value of solar energy between 9.5 and 13 cents per kWh.  That’s at or above the market rate I’m paying in Minnesota right now.  Check out my extremely messy spreadsheet if you want to see the math.

Keep in mind there are other values of solar energy I haven’t considered in my calculus.  The Minnesota House legislation includes the savings from delaying capital investments in distribution infrastructure, savings from not having to build more generation, fuel price hedge value savings (not having to bet on fuel costs), and the value of local employment generated by manufacture and installation of solar energy.

One thought on “How much should utilities pay for distributed solar power?

  1. Great post. Given that you linked Roberts’ article on discount rates, I’m sure you’ve seen this as well:

    Your calculations assume only that the cost of electricity would go up only in relation to the carbon the power plants emit, but their costs would also go up if their suppliers were charged carbon taxes as well. In effect further upping the ante beyond some of the items you list at the end, and that’s not even considering some of the other stuff in Roberts’ other piece such as water use, water pollution, and land use that have real economic costs that are never internalized to our economic system.

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