Friday, May 29, 2009

Avoided Cost

The strategy of the relative value analysis for solar investment that I outlined in Money from the Sun is to compare a traditional investment with an investment in a supplemental (i.e. grid-connected) solar electric system for your home or business. The value of the two competing investments was projected forward through the minimal (warranted) life of the solar electric energy system. In the analysis, the periodic returns from the traditional investment are reinvested. For the competing solar investment, the periodic savings from the solar investment are invested in a parallel traditional investment vehicle, as are the subsequent periodic investment returns for the parallel investment.

relative value analysis for solar investment

The keystone of the relative value analysis for solar investment is the concept of avoided cost. For the solar investment, savings are realized on your electric utility bill each month. In this circumstance, these are your avoided costs.

For the purpose of economic modeling, the calculation of avoided costs is not a simple matter. The complexity begins with the initial step of calculating the energy that will be produced by the system.

When generating the numbers that I published in 2004, I used conservative numbers for all parameters except the $6.50 cost-per-watt-installed for the solar electric system (in Arizona). I chose the low end of the range in order to emphasize the tipping point of system costs from where sales might begin to snowball.

The most conservative estimate for any parameter was for the utility energy cost increases: i.e. the estimated future avoided costs. I used a 2 percent annual increase. In the intervening years, the utility energy rate increases have dramatically outstripped my conservative estimate. Anyone who waited until recently to install a solar energy system lost several years of excellent investment returns. The same situation exists today. If you are a homeowner, then don’t wait to see if solar can work for you.

If you own a business in Arizona, then wait. Visit this blog often before you invest. One of the primary goals of this blog is to explain why supplemental solar electric energy fails as an investment for most businesses in Arizona.

Be sure to use a reputable, licensed, certified, experienced, and solid solar energy company that understands solar as an investment, and can clearly explain to you the specifics of your case.

One of the more interesting results of a relative value analysis is to highlight the point of diminishing returns when sizing a system for optimal return on investment. Very few solar energy companies understand the issue of sizing for optimal return. Many would prefer to sell a larger system than to deliver a smaller, but more economically optimal one. New retail net metering rules have alleviated this issue of sizing a system.

Finally, the term avoided cost is used in a related context that may affect your investment in solar energy. When an electric utility purchases energy, that energy can be priced based on their avoided cost. In the Southwest, this price is often determined by the wholesale price of electricity generated at the Palo Verde Nuclear Generating Station. For many years, while market rate net metering was in effect, it was a sad irony that the compensation for excess solar electricity was determined by the price of heavily-subsidized, nuclear-generated electricity.

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