Your Stake in Utilities’ $300 Billion Investment

David Fessler By David Fessler, Energy and Infrastructure Strategist, The Oxford Club

Alternative Energy

Over the next three years, U.S. utilities will spend more than $300 billion to upgrade a key aspect of U.S. infrastructure: the electric grid.

Suffering from age and a lack of capacity and security, today’s grid is woefully inadequate to support our growing thirst for energy.

A good portion of that $300 billion is going to be spent on utility-scale solar. This year, roughly 70% of all solar installations will be utility-scale.

That’s good news for investors.

To better understand the opportunity, let’s look at where the solar sector is headed and, more importantly, where it’s not.

In every quarter last year, solar energy installs broke records. In Q3 2016, 4.143 gigawatts of solar came online.

That was a record quarter for solar installations. And it was nearly 200% higher than the amount installed in Q3 2015.

And Q4 2016 didn’t just beat Q3 2016. It’s expected that 5 GW of additional solar capacity came online, according to GTM Research. That means solar capacity grew more than 20% quarter over quarter.

That’s fantastic growth.

Residential Solar Growth Is Slowing

That said, not every aspect of the solar industry has kept up the pace…

Third quarter home installations fell 10% compared to the number of installations in Q2 2016. That’s because third-party financing (introduced six years ago and made popular by SolarCity) is losing favor with some customers in the top solar markets.

For example, nearly 40% of all residential solar lies in California. And that market is quickly reaching full saturation. Customers there are getting tired of being hounded by residential solar installers.

The next nine states are responsible for 44% of the residential market. The remaining 16% is spread across the other 40 states and Washington, D.C.

California’s installed base is high for several reasons. First, it’s home to more people than any other state.

Second, it has some of the highest electric rates in the country. Lastly, it has lots of sun, as well as incentives and policies that promote solar.

But just because California is almost fully saturated doesn’t mean there isn’t room for residential installations to pick up.

After all, from 2010 to 2015, residential solar grew 55% annually.

With the continuation of the investment tax credit, residential solar installs will continue to grow, just at a slower pace.

Future growth will come from states where solar penetration is not as deep as it is in California. There are many other states with incentives to install residential solar.

The price of solar will continue to drop. And it should continue to be attractive to install, especially on rooftops.

Utility-Scale Solar Is Booming  

A utility-scale solar energy system is capable of producing 1 megawatt or more of power. Unlike the residential market, which is experiencing a slowdown, utility-scale solar is on fire.

That’s primarily due to the increasing number of states (29 as of the end of 2016) that have been adopting or increasing renewable portfolio standards (RPS).

These standards require that specific percentages of the electricity utilities sell come from renewable sources.

In addition to the 29 states with RPS, eight states have renewable energy goals.

Utilities, driven by state RPS mandates and goals, are investing in solar like never before. As I mentioned earlier, this year, 70% of solar installs will be utility-scale.

Some utilities have solar power plants built for them. But most prefer to purchase the power they produce.

A utility generally contracts for a minimum amount of power, as stated in a power purchase agreement (PPA). PPA terms are generally 15 to 20 years in length.

Currently there is 19.4 GW of utility-scale solar projects in the sector’s pipeline. But many of the new projects are going to be smaller than before.

That’s because economies of scale have continued to drive down the cost of solar. PPA prices are now between $35 per megawatt-hour and $50 per megawatt-hour.

This is below the avoided cost (the cost utilities would pay another utility for power) of many utilities. As a result, many utilities are now interested in PPAs from smaller systems.

Utilities are also viewing long-term solar PPAs as hedges against swings in the price of natural gas. This allows them to use solar energy systems for peak power needs instead of natural gas-fired plants.

The Investor’s Angle

As many of you know, I’m a prospector when it comes to investing. I like pick-and-shovel plays.

In the case of solar, it doesn’t mean solar panel or module makers. The margins are just too thin.

I like the inverter space. Every solar system needs an inverter.

Inverters change the DC voltage produced by solar modules into AC voltage compatible with home circuits and the grid. They disconnect from the grid when it goes down to protect utility workers.

The inverter sector in the U.S. is very fragmented. There are hundreds of solar installers. Each has a different inverter preference.

Nonetheless, there are a few worth mentioning here. The first is Enphase Energy (Nasdaq: ENPH). This company primarily makes microinverters for the solar industry.

In addition, it sells gateways and cloud-based software. That allows customers to manage their systems.

Enphase is different from other inverters. Its inverters provide power conversion at the module level.

Most other companies have one or two inverters that provide power conversion at the array level. These inverters combine all the DC power produced by the modules before converting it to AC power.

Prospective investors take note: Enphase has a very small market cap of $102 million.

This puts it in the speculative category. The company is not currently profitable.

A slightly larger (and profitable) competitor to Enphase is SolarEdge Technologies (Nasdaq: SEDG). Like Enphase, SolarEdge offers inverter solutions for solar PV systems.

It also offers monitoring software and services, smart energy management, and energy storage products. It currently trades at a very low P/E of 7.57 and has a market cap of $539 million.

Both of these companies stand to benefit from the growth of utility-scale solar here in the U.S. But that shouldn’t stop you from checking out other inverter manufacturers in the sector.

As costs drop, adoption will rise. Well-positioned companies – along with shareholders – are sure to prosper.

Good investing,