The Economics of Solar Power

Energy markets are driven by economics. Throughout history, most attempts to internalize externalities have been fruitless. In the case of energy, it remains highly unlikely that an agreement for carbon pricing could be achieved—either globally or with the two largest emitters, the United States and China. Given this reality, the future of solar will only be as bright as its competitive stance vis-à-vis competing energy technologies.

Each of the previous chapters has addressed the critical components to the solar industry’s competitiveness. This chapter seeks to untangle the complicated—and often misleading—discussion on price parity, the point at which solar energy becomes truly cost competitive with fossil electric power production. At the outset, however, it is important to note that total cost is not the only important factor to consider. A safe and reliable electricity market requires diversity of fuel sources, peak-load management, and low maintenance, fixed priced production, all of which solar power offers in spades.

The economics of solar power are sufficiently complicated and difficult to understand, however, the amount of confusion—and outright misinformation—about the price of solar electricity is alarming. The general public, policy makers, and even some academics seem to be operating in an alternate reality of decades past, where solar electricity could not possibly compete with traditional energy sources.

In reality, price competitiveness is much closer than many think and has already arrived in many markets, especially those with strong subsidies. Reaching unsubsidized, levelized price parity is the holy grail of the renewable energy world, and recent market trends suggest that reality to be quickly approaching.

However, due to many applications of solar and uneven distribution of solar radiation as a resource, price parity can mean something very different depending on the conversation. This has resulted in a tower of Babel that is likely holding back the growth of the solar industry. In order to navigate the complicated solar economic landscape, it is helpful to outline the key considerations for cost comparisons.

While it may seem like an obvious point, defining the comparison set and identifying the competition is a necessary component to the analysis. There are three main components to this process: (1) ownership, (2) fuel source, and (3) capacity and infrastructure.

The first and most important consideration is whether the system is owned by an entity that pays retail or wholesale price for energy. Retail electric prices can range from two to three times wholesale prices. As a result, while the cost-per-kilowatt hour is higher for smaller, distributed generation systems, the higher price point of retail electricity is dramatically higher. Systems competing with retail electric prices achieve price parity (and beyond) much sooner than those competing with wholesale prices.

There are several reasons for this discrepancy. First and most important, owners of systems that compete with retail electricity are commercial and residential distributed generation systems. These systems have virtually no maintenance or overhead. They have nearly no electron loss because the distance from panel to inverter is measured in feet rather than miles. There are no emergency funds required for storm cleanups. And finally, there is no volatility in fuel prices, because it remains a constant zero.

Utility-scale solar systems, while benefitting from efficiencies of scale, are still not cost competitive because they suffer the same inefficiencies as traditional power plants. The utility-scale PV systems therefore need to produce power much more cheaply to compete with fossil fuels.

The difference between wholesale and retail electric price parity is the first opportunity for significant policy crosstalk. At the same time, failing to understand the difference minimizes the incredible potential for affordable, distributed energy production in a variety of markets.

The fuel source(s) is also an important consideration. Fossil fuels tend to have volatile prices that fluctuate based on supply, technological advances, and economic growth that fuels demand. Speculation is also a noted price driver. With such a wide array of global fuel sources and a price structure that varies dramatically, analysis of solar competitiveness should factor in the fixed price of solar production over the life of the system.

Capacity and infrastructure are also important to consider. As referenced previously, whether a system is distributed generation or utility-scale makes a big difference in cost comparisons. At the same time, the current overall infrastructure is important to consider because solar becomes remarkably more cost competitive vis-à-vis fossil-fuel generation when a new plant needs to be constructed as opposed to merely increasing the capacity of existing plants.

Stated differently, the cost of solar plants (whether rooftop distributed or large, utility-scale plants) is much more favorable when compared to the cost of constructing a new gas or coal plant. These comparisons are markedly different if new fossil plants are not operating near capacity and therefore only require more fuel to produce the competitive power.

Massachusetts (which happens to be the home state of the author, and situ for his grid-connected PV system) is an excellent exemplary state to review these issues. It has aging fossil (and nuclear) infrastructure, an old electrical grid, no coal or gas (and therefore an importer of fuel) resources, and is operating near full capacity at peak hours. It also sits in the Northeast of the United States, which is not the first place that would come to mind for solar cost competitiveness, due to its minimal solar resource when compared to the sunny Southwest. In fact, for utility-scale systems, Massachusetts is near the middle of the pack in terms of achieving price parity (it should be noted that with no traditional energy resources in-state, Massachusetts relies on volatile import prices for fuel).

However, as of 2013, Massachusetts distributed generation for residential applications has the shortest payback of any state. This is primarily for three reasons: (1) high cost of retail electricity at 12.7 cents/kWh, (2) a $2000 state rebate, and (3) renewable energy credits, sold in the private market, that can be worth as much as $6600 over the life of an average rooftop system.

This, coupled with third-party financed solar leases with cheap financing rates, results in overwhelmingly competitive pricing. In fact, the prepaid price for 20 years of average, single family electrical usage in Massachusetts can be as low as 4.3 cents/MWh, nearly one-third the retail rate from the utility.

Several more scientific approaches have been conducted that demonstrate the many considerations for comparing solar electricity as a competitive alternative to other sources. These sources include various ways of addressing competitiveness and also address the history that has driven solar—and particularly PV—price competitiveness across the globe.

A recent paper by Bazilian et al. summarizes the dramatic shift that has occurred since 2008 in regards to the price competitiveness of solar PV power.¹ In 2008, module prices were essentially “flat at $3.50–4.00/W despite manufacturers making continuous improvements to technology and scale to reduce their costs.”² This was reported to be mainly due to shortages of raw materials and fixed price schemes in Europe, which hampered production and restricted competition.³

As raw materials, and particularly, silicon, became more readily available (and at a lower cost), the soaring profit margins led to the rapid expansion of manufacturers across the globe. At the same time, technological advances continued to drive down module costs, allowing “manufacturers to drop their prices by 50%, and still make a positive operating margin.”⁴ Since then, prices have continued to decline dramatically, to a point where most manufacturers are not profitable. In late 2001, module prices fell below $1.00/W for the first time, a significant benchmark for the industry and prices currently sit between $0.85 and $1.01/W.⁵

Cost per watt is an important component to the price of generated solar electricity, but it is only one component. As a result, many analyses rely instead on Levelized Cost of Energy (LCOE). According to Bazilian et al., “LCOE analysis considers costs distributed over the project lifetime and as such supposedly provides a more accurate economic picture, which system operators prefer over a simple capital cost-per-watt calculation.”⁶ Globally, the LCOE has declined from $0.32/kWh to as low as $0.11 in 2013 (which may include federal and local incentives in the United States).⁷ Of important note, this level is below the average kilowatt hour retail price of $0.115 in the United States.⁸

BNEF identifies the following factors as most important for determining LCOE: (1) capital costs, (2) capacity factor, (3) cost of equity, and (4) cost of debt.⁹ Despite these varied factors, a recent analysis by Stefan Reichelstein of Stanford University suggests that northern US locations (and also many locations in Europe and across the globe at higher altitudes) will never be competitive due to the capacity factor.¹⁰ This is not supported by BNEF analysis, suggests that the variables are too great to make such predictions.¹¹

Already the Emirates Solar Industry Association has demonstrated that across its climate the LCOE for solar is (unsubsidized) $0.15. “At this level, PV is cheaper on a simple LCOE basis than open-cycle peaking units at gas prices at higher than $5.00/MMBtu,” and PV has already replaced some of these plants in the United States, including in San Diego, CA.¹² That this is an outlier rather than the norm, despite clear economic advantages in favor of PV facilities, speaks to the confusion and misinformation provided to policy makers.

It is interesting to note that the term typically used to describe competitiveness, “grid parity,” appears to be out of favor because it further confuses the issue. According to Bazilian et al., the term comes from a time when solar was an “underdog” and no longer has much utility for real world decision making.¹³ It is specifically problematic because it “does not take into account the value of solar PV to the broader electrical industry, and is often used to compare a retail technology against a wholesale price.”¹⁴ Of course, this again addresses the key point about the utility of solar, in that it need not be driven by utilities, but that the retail sector is where it is likely to be most competitive.

Much has been made of Chinese production and negative operating margins that have been supported by government subsidies. While the Chinese actions have clearly had some impact on these lower prices, the cost curve resulting from greater efficiency (often called the learning curve) has been even more important. This is critical because it means that while prices are not likely to decline as rapidly as they have in the past, they are expected to continue to decline by 10–20% each year for the next decade.

It is not just traditional Chinese (and non-Chinese) PV panels that will decline in price. The NREL and the US Photovoltaic Manufacturing Consortium (PVMC) have partnered to find ways to reduce the cost and enhance the competitiveness of US thin film based in copper–indium–gallium–sulfide. The partnership is an important part of PVMC goal of reducing the installed price of thin film solar energy systems by 75% by driving down costs in manufacturing.

The partnership, which is funded in part by funds from the SunShot Initiative, includes major research institutions including SUNY-Albany, as well as Sematech, a consortium that covers 50% of the worldwide chip market.¹⁵ Importantly, the research will not only seek to drive down manufacturing costs of current technologies, but to spur newer, cheaper forms of solar.

While manufacturing price declines sound like a boon to the solar industry, it is not the module price declines that will be significant because the module cost only makes up about 20% of current system costs. Other considerations include labor efficiency (in the installation process), streamlined permitting, and other components that will need to be addressed in mature markets to drive down prices.

One of the primary issues in the United States is lowering some of the nonmodule price restrictions in the proliferation of third-party financing and solar leases. According to the SEIA and GTM Research, the first two quarters of 2012 illustrate a trend where third-party leases make up 70–80% of the residential market in states where it is allowed. This success led to the attraction of over $600 million in investments in early 2012 that help to fund the booming installations.¹⁶

Third-party systems offer flexibility and cost savings to consumers, frequently allowing for low- to no-upfront cost solar installations, or favorable prepayment options for consumers. The low cost of these systems is driven by all of the same components as a purchase system (labor cost and efficiency, module prices, consumer incentives, State Renewable Energy Credits (SRECs), etc.) and also a few additional items. First, because the systems are owned and operated by companies rather than individuals, the depreciation of the system is tax deductible. Allowance for deductions as well as accelerated depreciation has been a key factor to the proliferation of the systems as well as low financing costs driven by historically low interest rates.

The current structure and trends in the industry illustrate a rapidly approaching cost competitiveness in many high-solar resource locations. However, much of the optimism in the sector stems from the potential of developing markets, including several new markets in the Middle East, Africa, and India. Where the traditional source of energy is diesel-electric production, solar PV is already cost competitive.¹⁷

Most of the information regarding potential future scenarios can be found in Chapter 9, however, several global trends are important to consider when thinking of the continued competitiveness of solar energy. As most experts and industry professionals expect solar subsidies to decline in the future, the following must occur for solar to keep on its current trend towards cost competitiveness:

Even with these factors, several other issues are of critical importance to determining the economic competitiveness of solar electricity. These include:

Utility-scale PV is currently not cost competitive with “build-new” gas and coal-fired plants. However, the steep declines in prices and market volatility in the fossil sector suggest that such systems will—in markets with carbon pricing schemes—be competitive by 2020, and on par with high-quality wind power prices.²² Further declines are nearly certain, all but guaranteeing a much more competitive marketplace in the future.

Solar is rapidly approaching cost competitiveness in a variety of applications. As it gains in competitive advantage, more and more countries will increase solar capacity. Chapter 8 reviews the outlook for several important solar countries.