Solar Power: The Killer App

on November 15, 2012 at 9:00 AM


Solar power reduces electricity prices. As more solar is added to deregulated power grids, power prices fall lower. The secret sauce is the markets.

Deregulated power markets are invisible to many Americans, yet every few minutes they set the price for much of their electric power. There are ten separate power markets currently operating in the North America. According to the ISO/RTO Council, they serve approximately two-thirds of electricity consumers in the United States and more than half of all consumers in Canada.

While each market works differently, they all set the price for electric power using sophisticated auctions, which repeat every few minutes, 24 hours a day, 7 days a week. Market managers forecast expected demand for energy and generators, including solar power producers, bid in prices to meet that demand.

Typically, generators bid in based on their production costs. So if an independent power producer owns a power plant, they will carefully examine their production costs and bid a price slightly higher than those costs. Any amount they receive over their production cost creates gross margin, which can be used to pay other operating and indirect costs.

Many are surprised to learn that the highest bid that clears the market sets the market price for all generators. Many believe the market price should be the average bid, but if that were so, half the successful bidders would lose money and exit the business.

The last generator that clears the market is the marginal unit. In all likelihood, their gross margin would be near zero and they would be considered operating on the margin. It’s not a place most independent power producers want to be, so they always hope there is a more expensive generator that will clear the market.

Since there is virtually no oil in North America’s electricity, the marginal unit is typically an older and less efficient power plant, which uses either coal or sometimes natural gas as fuel. As daily demand rises and peaks, more costly units clear the market and set higher market-clearing prices.

Solar Rides the Peaks

This is where the magic of solar power appears. Most everybody knows solar power produces energy only during the daytime. But from a market perspective, the daytime is when peak demand for power begins to appear. In effect, solar power facilities make natural peaking plants.

Since solar power’s production cost is near zero, solar power will generally clear the market and it will be one of the first sources to be dispatched. Any price solar achieves above production cost is gross margin and it contributes to their operations, maintenance and capital costs, as well as any potential profit.

Because their production costs are so low, when solar power is dispatched, it will always displace the marginal unit(s). When the marginal unit is displaced, the market-clearing price falls to the next marginal unit. As more solar is dispatched, more marginal units are displaced and the price of wholesale power falls even further.

It would be very difficult to build enough solar to displace baseloaded power plants, such as commercial nuclear power plants or large coal plants. But dispatching low-cost power production does affect the gross margins of nuclear and other fleets owned by companies like Exelon, Entergy, and NRG Energy. It also affects gross margins of natural gas players like Calpine. Since the market-clearing price applies to all market participants, more solar power reduces gross margins for everybody, including solar power producers.

Solar power offers a double benefit for those concerned about the impact of pollution. Solar power produces zero emissions. Inefficient power plants produce the most emissions. As the market displaces inefficient power plants, carbon and greenhouses gasses are also displaced and eliminated.

Even Sunlight Isn’t Always Free

A big question is cost. Many incorrectly believe solar power is uncompetitive. True, on a levelized cost basis, solar power appears to be expensive. But when tax credits and renewable energy credits are considered, solar’s adjusted levelized costs fall below natural gas. That’s why private investors flocked to New Jersey, California, Arizona and other solar states to invest tens of millions of dollars in utility-grade solar farms.

It is important to appreciate tax credits are not cash grants. Contrary to political rhetoric, federal agencies are not writing checks to solar developers. All they are offering is reduced income taxes on solar profits, and only for a limited time. After six years, most utility-grade solar farms find themselves at the maximum possible federal and state income tax brackets; all government benefits received are repaid and more.

Yes, state-sanctioned renewable energy credits are ultimately paid by retail consumers. But when the costs of those credits are spread over an entire state and then offset by lower energy prices, the credit’s net cost to consumers can begin to approach zero.

The utility-grade solar farm is the killer app. Solar power does the opposite of traditional peaking plants: it lowers energy costs at the same time it lowers the costs of pollution.

At the time of publication, Glenn Williams had no position in any of the stocks mentioned.