Tuesday, November 21, 2006

Solar Panels: Financial Analysis

Were the solar panels a good deal? To answer that question, we need to do a cost-benefit analysis. We can compare the cash flows assuming we did and didn't purchase the panels. There are many assumptions about presently unknown variables, such as the cost of power in 15 years.

The bottome line is that putting in the panels as an investment isn't necessarily a slam-dunk, but it does help tremendously from a risk management perspective, and if one is taking a view of the future of tight energy supplies, then the analysis is pretty good. Whether or not it was a good decision from an investment point of view will only be determined by what happens with energy prices in the future. Let's explore.

The cost for the array was $10,878.20. This was after the CT Clean Energy Fund rebate (which was handled by the installer) but before the $2000 federal tax credit. We used this tax credit to offset the cost of cutting down some trees. These trees were probably going to be cut down anyway, so should we include that amount or not? The difference is rather large (16% cost difference). I suppose one can show both scenarios to see the difference if we include the credit or not. As one of the trees we cut down was our neighbor's tree, to be honest about it, we need to keep the federal credit out of our calculation, because we wouldn't have cut that one down if we hadn't needed to. In the meantime, let me just say "Thank you very much" to our neighbor, for without that one tree gone, we wouldn't have met the requirements for the rebate at all.

A simple way to look at the financials is to ask how long will it take for the array to pay for itself. With a cost of 17.0 cents/kwh and 2422 kwh generated per year, we save $411.74 per year thereby requiring 26.4 years to pay for itself [1]. Is it really that bad? The answer is "no" for a couple of reasons. The first one is that we get clean energy credits for each kilowatt-hour (kwh) we generate, and the second is that the cost of power can change, and at this point, it looks like it will be going up. Let's look at the credits first.

Many municipalities have voted to require a minimum amount of their power to come from renewable sources. Also, most if not all utilities give consumers the option of selecting a green source for their power. Practically, all electrons get mixed together on the power grid, so it isn't possible to select exactly which power source you are getting your power from, but from a mix of sources, you can allocate your load to greener suppliers. For instance, our power provider, Connecticut Light & Power, allows the consumer to pay a little extra for supplies from a green source through their "CTCleanEnergyOptions" program (http://www.cl-p.com/community/environment/clean.asp). By selecting a clean source, you pay about 1.1 cents more per kwh, but you can feel good by knowing you are helping support renewable energy projects.

We have sold our renewable energy certificates to Massachusetts Energy Consumers Alliance at a fixed rate of 6 cents per kwh (http://www.massenergy.com/Solar.REC.Sale.html) for the next 3 years. Somehow they can afford to pay us this amazingly good rate just for being green. It is a big difference to us, for that gives us an extra $145.32 annually in income that can be applied to our capital costs. That reduces the payback time to 19.5 years and makes the present annual rate of return on investment just over 5%.

This "renewable energy certificates" may leave some people scratching their heads. It certainly does me. Frankly, it seems to make more sense to generate the clean power and sell the credits than it does to fork out more money for somebody else to collect. But, that may not be possible for some people, either because they rent their residence and/or because of the high capital costs to install the array, and, if the decision has been made on the municipal level, it may not be possible to meet the demands of the citizens without a renewable credit market from which to buy green power.

So, present value gives us a return comparable to investing in treasuries. An added benefit is that the savings we get from the panels in electricity cost is not taxable (although the renewable credits presumably are), but treasury interest is taxable, thus improving the economics from an after-tax perspective.

What about the power cost? For starters, power costs in CT are one of the highest in the USA at the moment. The economics would be different in the Midwest where cheap coal rules even with the generous CT rebate. But what about the future? Over the past 10 years, we've risen from about 10 cents per kwh to the present 17 cents, but most of that rise has been in the last 2-3 years. Could it go back down? Certainly. Will it? I'm suggesting not.

What could make the power costs go down? One of the issues in CT is the fact that we don't have enough transmission lines for the present load. This is known as congestion, and it can be a serious problem, especially in high demand times in the middle of the summer. There is a federally mandated congestion charge that is part of the transmission cost. This charge should be reduced once a new underground transmission line goes into our area. However, the biggest contribution to the power cost is the cost of the marginal fuel, and that is presently natural gas, and for the foreseeable future, this will be the prime driver of price increases in the future, and thus the economics are tied to the price of fossil fuels.

Power prices hit a low in CT in 2003 at 10.5 cents/kwh, and it was as low at 10 cents/kwh back in 1990. Let's use this as our risk scenario for possible bad outcome on our $11,000 investment (Frankly, as we still get most of our power from our grid, we'd be happy if this happened). Also, let's also assume the renewable energy credits go away, and then our savings is only $254 annually. In this case, we are only receiving a return of 2.3% annually, and it will take 42 years to get our money back. On the flip side, power prices rose 22% annually for the last 3 years! Assuming that rate continues (also highly unlikely--substitution would come in a big way if this were to happen), the panels pay for themselves in 7 years and earn a tremendous return thereafter.

So here is the bottom line. If I am wrong and power prices go down, we are out maybe $4-5000 after 20 years. If prices stay where they are, we break even from an investment standpoint relative to treasuries, and if power costs continue to rise, we do better. The only argument that can now be made is that you shouldn't compare the solar panels to treasuries but to a better investment class such as equities that give you a better return. I have to argue that I'm doing one better, because, I have fixed my future expenses--known expenses-- and have insured for a consistent and stable power source, and so now I have more certainty. I know I'm going to use the power, and I am now in control of it as opposed to the power company or the state.

There is also the risk of the alternative investment class to consider. My own equity investments have not been particularly stellar in performance, and the cost of the array is definitely less than what I lost in the the stock market crash of 2000. For me, installing the panels was a no-brainer, and I'd do more if it weren't for the remaining issues of shading from other trees on our neighbor's lot.

[1] In the original analysis, the annual savings was 17.7 cents which made the economics a little better.


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