I recently argued that the regulated utility is not likely to enter a “death spiral”, but that the regulated utility business model is indeed under pressure, and the conversation about the future of that business model is a valuable one.

One area of pressure on the regulated utility business model is the market for residential solar power. Even two years hence, this New York Times Magazine article on the residential solar market is fresh and relevant, and even more so given the declining production costs of solar technologies: “Thanks to increased Chinese production of photovoltaic panels, innovative financing techniques, investment from large institutional investors and a patchwork of semi-effective public-policy efforts, residential solar power has never been more affordable.” In states like California, a combination of plentiful sun and state policies designed to induce more use of renewables brought growth in the residential solar market starting in the 1980s. This growth was also grounded in the PURPA (1978) federal legislation (“conservation by decree”) that required regulated utilities to buy some of their generated energy from renewable and cogeneration providers at a price determined by the state public utility commission.

Since then, a small but growing independent solar industry has developed in California and elsewhere, and the NYT Magazine article ably summarizes that development as well as the historical disinterest of regulated utilities in getting involved in renewables themselves. Why generate using a fuel and enabling technology that is intermittent, for which economical storage does not exist, and that does not have the economies of scale that drive the economics of the regulated vertically-integrated cost-recovery-based business model? Why indeed.

Over the ensuing decades, though, policy priorities have changed, and environmental quality now joins energy security and the social objectives of utility regulation. Air quality and global warming concerns joined the mix, and at the margin shifted the policy balance, leading several states to adopt renewable portfolio standards (RPSs) and net metering regulations. California, always a pioneer, has a portfolio of residential renewables policies, including net metering, although it does not have a state RPS. Note, in particular, the recent changes in California policy regarding residential renewables:

The CPUC’s California Solar Initiative (CPUC ruling – R.04-03-017) moved the consumer renewable energy rebate program for existing homes from the Energy Commission to the utility companies under the direction of the CPUC. This incentive program also provides cash back for solar energy systems of less than one megawatt to existing and new commercial, industrial, government, nonprofit, and agricultural properties. The CSI has a budget of $2 billion over 10 years, and the goal is to reach 1,940 MW of installed solar capacity by 2016.

The CSI provides rebates to residential customers installing solar technologies who are retail customers of one of the state’s investor-owned utilities. Each IOU has a cap on the number of its residential customers who can receive these subsidies, and PG&E has already reached that cap.

Whether the policy is rebates to induce the renewables switch, allowing net metering, or a state RPS (or feed-in tariffs such as used in Spain and Germany), these policies reflect a new objective in the portfolio of utility regulation, and at the margin they have changed the incentives of regulated utilities. Starting in 2012 when residential solar installations increased, regulated utilities increased their objections to solar power both on reliability grounds and based on the inequities and existing cross-subsidization built in to regulated retail rates (in a state like California, the smallest monthly users of electricity pay much less than their proportional share of the fixed costs of what they consume). My reading has also left me with the impression that if the regulated utilities are going to be subject to renewables mandates to achieve environmental objectives, they would prefer not to have to compete with the existing, and growing, independent producers operating in the residential solar market. The way a regulated monopolist benefits from environmental mandates is by owning assets to meet the mandates.

While this case requires much deeper analysis, as a first pass I want to step back and ask why the regulated distribution utility should be involved in the residential solar market at all. The growth of producers in the residential solar market (Sungevity, SunEdison, Solar City, etc.) suggests that this is a competitive or potentially competitive market.

I remember asking that question back when this NYT Magazine article first came out, and I stand by my observation then:

Consider an alternative scenario in which regulated distribution monopolists like PG&E are precluded from offering retail services, including rooftop solar, and the competing firms that Himmelman profiled can compete both in how they structure the transactions (equipment purchase, lease, PPA, etc.) and in the prices they offer. One of Rubin’s complaints is that the regulated net metering rate reimburses the rooftop solar homeowner at the full regulated retail price per kilowatt hour, which over-compensates the homeowner for the market value of the electricity product. In a rivalrous market, competing solar services firms would experiment with different prices, perhaps, say, reimbursing the homeowner a fixed price based on a long-term contract, or a varying price based on the wholesale market spot price in the hours in which the homeowner puts power back into the grid. Then it’s up to the retailer to contract with the wires company for the wires charge for those customers — that’s the source of the regulated monopolist’s revenue stream, the wires charge, and it can and should be separated from the net metering transaction and contract. The presence of the regulated monopolist in that retail market for rooftop solar services is a distortion in and of itself, in addition to the regulation-induced distortions that Rubin identified.

The regulated distribution utility’s main objective is, and should be, reliable delivery of energy. The existing regulatory structure gives regulated utilities incentives to increase their asset base to increase their rate base, and thus when a new environmental policy objective joins the exiting ones, if regulated utilities can acquire new solar assets to meet that objective, then they have an incentive to do so. Cost recovery and a guaranteed rate of return is a powerful motivator. But why should they even be a participant in that market, given the demonstrable degree of competition that already exists?