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Aug 21, 2013

Want solar on my roof? Go ahead and pay me for it. Seriously. Here’s how.

 

In recent years, companies have made great strides in offering third-party financing to bring solar and energy efficiency to residential consumers with little or no money down. Consumers view it as free. For example, I can now put solar on my roof with a power purchase agreement (PPA) or lease and pay nothing up front. Because of recent and dramatic cost declines in hardware and an upsurge in the availability of financing, solar can provide power to customers for less than their utility’s electric rates in many locations. This is especially true when state and local incentives are taken into account.

In a typical third-party financing arrangement, I pay a solar provider a steady amount per month (for a lease) or per kWh (under a PPA). The amount I pay the solar company is less than the reduction of my utility energy bill, so I save money. My payments to my solar lease provider over time are enough to pay for the installation (for which the installer is paid up front) and cover their returns on investment, so my solar installer and financier (which can be one-in-the-same) do fine economically as well.

Free is great, and most people I speak with are thrilled to get solar for free. I’d argue, though, that third-party financing models haven’t gone far enough. Free is arbitrary. In fact, I don’t want the slow trickle of savings every month. I’d like third-party financing that is better than free, that pays me money up front for all of my expected monthly savings over the life of my lease or PPA. I suspect most consumers would prefer “better than free” financing as well, giving up monthly savings and just continuing to pay their current and future normal utility bill rates for a lump of cash today. This is why.

Consumers hate the future

Historical investment returns to the average American are pretty modest, like the ~three-percent-real (i.e., inflation adjusted) return on the S&P 500 over the last 30 years and barely-above-inflation long-term returns on home ownership (i.e., real returns barely above zero percent).

Yet, despite the fact that consumers have historically accepted such low returns on investments including stocks and real estate, they demand very high returns on many financial decisions. Numerous academic studies confirm that consumers hate the future, or more accurately, don’t value it very highly, at least economically. For example, in a study on refrigerators, 50 percent of consumers would not pay $40 more up front to generate savings of $22 per year on their energy bill. To a company, this behavior would sound like lunacy. To consumers, they just assume, rightly or wrongly, they have better immediate uses for the $40, and don’t like to think about $22 dollars next year. Economists regularly quantify this type of behavior in a metric called the discount rate, which is just a percentage used to convert tomorrow’s dollars into today’s dollars. High discount rates make future dollars worth less.

Consumers demonstrate discount rates approaching 60 percent per year through their behavior. Studies have found widely ranging consumer discount rates; all are quite high (30–60 percent in the refrigerator study, 25 percent in another study). Further, acceptable discount rates for consumers change based on circumstance. Poor consumers demonstrate extremely high required discount rates that decrease (often substantially) with increasing wealth.

This problem is more than academic. Low adoption levels plague energy-efficiency programs, even when incentives and overall value are quite high—the typical post-incentive return on solar in CA is 10 percent or higher; simple energy-efficiency investments like light bulbs can pay back in under a year. But most consumers just can’t get past the price tag. That’s one of the reasons adoption rates remain challenged: for instance, on-bill finance programs for energy efficiency are considered top-tier when they can exceed a measly one percent per year in customer uptake.

Compare this to corporate discount rates. Most firms pursue returns that are 2–10 percent above their cost of capital, depending on the risk of the cash flow. R&D expenditures, which have a high chance of failure, are often discounted much more.

So what has this meant for solar? Traditional programs that use incentives but not financing have largely been ineffective. Zero-down-payment financing has been vastly more effective in attracting residential customers, yet has still only helped bring us to the current ~0.5 percent adoption level. Of the 5–10 percent of consumers for whom solar makes economic sense on its current energy pricing fundamentals, a small subset, only about 5–10 percent (so about 0.5 percent overall), have taken steps to install systems.

Going beyond no-money-down solar with “better than free” financing

If one believes the data about consumer discount rates, even with “free” no-money-down financing, solar providers are missing a huge discount rate arbitrage opportunity on a product (a thirty-year savings stream on a utility bill) that consumers don’t value very highly, or at least discount aggressively.

Other industries have caught on to this discrepancy, and offer products that arbitrage discount rates between consumers and companies. For example, if you watch daytime television, you’ve probably seen commercials for companies offering to buy out annuities, pensions, or any other future payout with an immediate lump sum payment. In addition, most lottery winners today prefer and accept an upfront payment that is worth much less than the value of their 20-year payout, by any metric. A 2012 Business Insider reader poll found that an overwhelming 88 percent of respondents would take the lump sum option.

Therein lies the win-win-win opportunity. Third-party solar companies make money, consumers get an upfront cash windfall they value, and rates of solar adoption (should) jump through the roof.

Here’s my proposal to third-party financiers on behalf of consumers everywhere: I’d like a product that maximizes my upfront payment, which I love, while minimizing the long-term cash flow from savings that I receive over time, which I don’t care about nearly as much as I probably should.

Being a good consumer, I’ve tried to calculate my value to you, and I’d like it paid up front. But also note, as any good lottery winner will tell you, I’ll likely settle for a lot less if you can give me cash now.

Here’s my pricelist for a rooftop example: Please pay me $1,200 for the right to put a solar PV installation on my rooftop. I’ll be happy to keep paying the total monthly cost of my regular utility bill, even if it’s technically split between the utility bill and a solar leasing/PPA bill.

 

Using a reasonable 10 percent corporate discount rate (nominal), some favorable incentives for the solar consumer, and a mere two percent spread between the historical growth of electricity prices and escalation of solar PPA/lease pricing, I estimate my solar PV savings versus my former utility bill has a net present value (NPV) of more than $2,400! (This is after third-party finance, so represents value after the installer/financier/servicer have taken their cut of profit.)

A solar provider could offer half of this, or less, and still have something enticing for a consumer. A typical consumer with a “mere” 20 percent discount rate should settle for a sum of around $1,400 dollars. The research cited earlier as well as an informal poll of my colleagues at RMI suggest that most would settle for less even than that. The implication is that there’s nearly $2,500 dollars of “lost” or misplaced value … $1,400 or less of which could go to a consumer, the balance of which could be profit for the third-party solar company.

Figure 1 shows how converting the savings strip to upfront payments reveals this massive value opportunity for solar providers. In finance, this conversion is known as a sale of a “forward strip.”

Figure 1. Conceptual diagram demonstrating value created through an upfront payment.

Solar companies, put your money where your mouth is and grow your market

It’s time for some inventive solar lessors to rise to the challenge and offer up money in our pockets today. Due to my and many other consumers’ seemingly irrational discount rate dynamics, we’re more than happy to be “exploited” to allow others to take advantage of our perceived versus real discount rates. These lump sum payments today could mean significant returns to solar companies tomorrow, not to mention the best opportunity for transformational market growth. So, solar companies, consider the gauntlet thrown! Please exploit me!

This blog post also appeared on Greenbiz.

Image 1 courtesy of Shutterstock

Join the Discussion


Showing 1-4 of 4 comments

August 30, 2013

A rather creative concept.


September 5, 2013

Luckily I've already cleared this hurdle, after installing 4.03 kW in May of 2012 on my three year old house, I haven't had to buy a single kWh from my utility. Because of the federal ITC, the Oregon Residential Energy Tax Credit and and incentive payment from the Energy Trust of Oregon the output of this system comes to me a zero cost, with an exception for the time value of money while the state pays back my portion of the installation cost over 4 years.


September 11, 2013

SREC's and TREC's are something missing from this evaluation (and from California, BOOO!). For those unfamiliar, SRECs let a residential solar owner sell their renewable energy credits back to a power company so that company can make its responsible transition to renewables. So rather than rely on power companies to perform their own solar strategy on a farm, the power companies pay residentials for the use of their mini power stations.

This is neither artificial nor boondoggle. It is a responsible way to transition power companies off of fossil and onto residential solar, and with this model residents have an additional incentive (as do installers) to own the solar, because it's a money maker, on top of the net zero energy costs that most well spec'd systems bear out.

SREC's are the reason we purchased our solar, as opposed to leasing it, as adoption of SREC rules in CA, will bring new income to whoever owns the panels. Unfortunately you need a public utilities commission who understands distributed generation means we deserve renewable production profits, when we are helping power companies to NOT have to build wind/solar farms.


January 20, 2014

Unfortunately, no money down solar leases and PPAs are two of the most expensive ways to have solar on your roof. A zero down solar lease will typically cost a homeowner more than 3 times what he or she would have paid had the system been purchased instead. In fact you'll pay so much more for a leased system that it will actually be you, who will be paying for your own repairs, insurance and monitoring many, many times over. Don't believe it ? Do the math. Add up your lease payments including the annual payment escalator over 20 years on that $0 down solar lease and then compare that to purchasing an installed system at today's much lower pricing of less than $2.10 per watt after the incentives are applied, and there you have it. More than 3 times the cost when you lease. Don't become a solar sheep. Shop before you sign that 20 year contract !

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