It seems that in NSW, the success of residential solar has resulted in a reduction in how much consumers get paid for their solar energy.

It is looking like solar has shot itself in the foot by becoming a victim of its own success.

How does this work? Well, there is currently a somewhat esoteric debate going on amongst energy industry specialists and renewables advocates that is relevant to this. The debate is about the value of residential solar PV to the electricity grid. That is, how do you quantify the financial benefits to the entire energy system, of installing solar rooftop panels on your house?

Although it sounds very theoretical, this matters a great deal to those who are trying to determine the rate that should be applied in the so-called “feed-in tariff schemes.” These tariffs have been used as a subsidy mechanism since the early 2000s to help drive the uptake of solar photovoltaic panels that at that time were a significantly more expensive way of providing electricity than the conventional grid.

These schemes were used as a renewable technology development mechanism as well as a climate change mitigation method. Initially, they were particularly popular in Germany and Spain and at that time the funding came from the government budget. Other countries followed suit, including Australia, although here on the most part, the costs were not paid by the government but spread amongst all electricity users. These were paid at a standard rate, as high as 60 cents per kWh either in a gross, or net form. In the first case, the subsidy is paid on all the energy generated by the solar panels, while in the second it is only paid on the difference between what is produced and what is consumed internally by the household.

The level of this tariff is revisited every year as the state based regulators adjust these tariffs, as well as the standard retail tariff. This has happened recently with the August decision by the Independent Pricing and Regulatory Tribunal (IPART) of NSW that reduced the rate paid by energy retailers from 5.6 cents per kWh to 4.8 cents per kWh.

The way they justify the calculated rate is based on the principle that owners of solar PV should be paid at a rate commensurate with the value they are adding to the system. There could be two extremes to the range of values that you might calculate, at the top end, is the retail tariff itself, so you should get paid around 30 cents per kWh for example. The logic here is that you are supplying the grid at the same point in the network that someone without solar would be drawing power and paying the grid rate.

The other end of the scale is that solar should be treated just like any other power generator, the rest of which have been large centralised generators getting paid a wholesale price. The figure below, based on 2011 estimates of wholesale generation costs, shows a range of 7.5 cents per kWh to 15 cents per kWh (the graph shows dollars per MWh so one needs to simply drop a factor of 10 for the conversion to cents per kWh)

The cost components of the retail electricity price as a guide to value of solar

The impact of this rate is measured through its influence on the payback period for an installed solar system. The higher the rate, the shorter the payback, and generally consumers like a payback period of five years or less. In theory however, one should be willing to accept an arbitrarily long period, up to the lifetime of the solar system, which is considered to be around 20 years.

What has happened is that these rates have steadily come down from their peak in the beginning of the roll-out of these schemes in Australia that began around 2008. Some were as originally as high as 60 cents per kWh for the net, and 44 cents per kWh for the gross scheme. They are now uniformly around five cents per kWh, and only the net schemes remain.

This is where it gets interesting due to politics and economics. Labor state governments around Australia launched these feed-in schemes, and at that time the cost of PV was very high, greater than $10 per watt for installation of the system. This coincided with the start of a rapid decline in the cost of PV systems to as low as $2 per watt. We have the Germans and Spanish to thank for that, their massive feed-in schemes drove the production of large amounts of PV to feed their hungry markets. This led to the natural decline in the cost through the phenomenon of “Technological Learning.” The Rudd federal government’s newly expanded federal renewable energy target policy (RET) also fed the uptake of PV, as it added another revenue stream to those installing residential solar systems.

Following those heady days when Australians’ PV capacity started at close to zero in 2009 and skyrocketed to nearly 5,000 megawatts today. That’s more than 10 per cent of Australian electricity systems’ peak demand (when the sun shines!)

However, a range of coalition state governments have slashed the feed-in schemes and cancelled the gross feed-in scheme in NSW. Of course, while their motivation was ideological on the whole, they chose to justify this through an economic argument. This argument was based on the value of solar to the grid and unsurprisingly, the state governments chose to use the lower value based on the wholesale cost of generation. The first time these were set this way, the rate of eight cents per kWh was used, in alignment with the figures above based on the graph.

So what is the justification for the drop to 4.8 cents per kWh? Clearly it would have to be because the wholesale price has dropped since the tariffs were first set at the lower rate. This is in fact the case, and is a consequence of the approximately 7.5 per cent decrease in energy demand since 2009. This was driven by the Global Financial Crisis accelerating the existence of some large energy intensive industries, the uptake of more energy efficiency appliances and a general effort to reduce energy use in response to the massive more than 100 per cent increase in residential electricity prices in the last 10 years, and of course, the growth of solar PV.

Solar PV impacts are particularly problematic for PV’s own value to the wholesale market. The correlation between the times of high wholesale prices – which occur at periods of high demand and are driven by high temperatures on sunny days – and high PV output results in a double whammy reduction.

So PV is contributing to its own problems here! This seems a bit counter-intuitive. The challenge lies in two issues:

1. This effect in markets is very common; higher supply means lower prices. This is really just bad luck in the short term, but in the long term should lead to exit of the more expensive generation. Some more coal plants will be withdrawn and prices will rise.
2. Solar’s benefits should be valued both based on its impact on generation costs and network costs (transmission and distribution). Its impact on network costs won’t be so responsive to increased supply, as the networks are monopoly regulated and therefore network prices do not drop as demand drops. In fact they increase (which is the source of the so called “death-spiral.”)

In the long term, however, both should decrease as the solar PV benefits to network can be realised through regulatory asset write-downs when demand is not growing and through deferral of network capacity increases when demand is growing.

Finally, it should be noted that the discussion about how to calculate the value of PV is really confounding two different issues. One is the provision of subsidies to residential solar for environmental/climate change reasons, and the other is the economic justification – the position on whether one should use wholesale only versus full price stack impacts. In my view, both sides of the argument are guilty of using whichever justification best suits them. The opponents of PV really just don’t want it there at all, while the proponents should just be honest and say that it is worth a lot more than just its precise economic value.