The financial assessment of the costs and benefits of putting up a solar system should be carefully gone over with your solar installer. However having a rough estimate of the numbers involved can help a potential host gain the confidence to ask themselves and their installer the appropriate questions. One needs to remember that putting a solar array is an investment and the payoff is dependent on financial conditions in the future and so is necessarily uncertain. However the returns on the investment are probably more predictable than most other investments and the rate of return should be good—and of course you’ll be reducing your carbon footprint and helping the environment at the same time.
We’ll take a look at the financial costs and benefits of a model 5 kw system—a typical size for many households.
Costs: The costs for a solar system are generally given in dollars per installed watt. The costs could be further divided into hardware and labor (often called Balance of System or BOS costs) but for most families the important number is simply dollars per installed watt. We’ll use $4/installed watt for our calculations. The number will be higher if one uses high-efficiency panels and lower for less efficient panels. Efficiency is the per cent of solar energy hitting the panel that is actually turned into electricity. Higher efficiency panels can produce more electricity for a given sized panel. In other words if you covered your roof with high efficiency panels you might be able to put up a 6kw system while with lower efficiency panels it would only be 5kw. The size of system (5kw) refers to the maximum power generated by the system at a specific temperature and solar irradiance. Basically it is a the maximum power your array can produce under ideal circumstances. The calculation of the cost of the system then is simple. It is the size of system multiplied by the cost per installed watt. 5000 watts X $4/watt = $20,000. If your system price is less than $4/watt then your cost will be less and if your system price is more than $4/watt then it will be more.
Benefits: The financial benefits of the system can be divided into 4 parts: 1. The Federal Investment Tax Credit (ITC) 2. The Massachusetts state Income Tax Credit. 3. The SRECs that the owner can sell 4. The savings on the electric bill.
One: The ITC is a credit against the owner’s income tax bill worth 30% of the installed cost of the solar array. It is not just a tax deduction but a full credit against the bill. To take the credit the owner’s array has to be installed and functional. Unless the federal government extends the credit it will expire December 31, 2016. So a Belmont family’s solar array needs to be functional by that date. In the example above the ITC would be worth 30% of $20,000 or $6,000.
A peculiar consequence of this benefit is that the owner can only use this benefit if he or she has an income tax to use the credit against. While most Belmont residents pay at least $6000 on their income tax this is not true for non-profits or municipalities. This poses an issue when a town like Belmont considers putting solar on a school or a landfill. Because Belmont doesn’t pay any income tax it can’t take advantage of this generous credit. For this reason most solar projects on schools and landfills are owned by third parties who enter into 3 way agreements with the town (or other non-profit) and the utility.
Two: Massachusetts state Income Tax Credit. The state gives the lesser of a 15% or $1000 credit on your state income tax bill. For our model system this is simply a $1000 credit.
Three: SRECs are Solar Renewable Energy Certificates. They are incentive or bonus payments owners of renewable energy systems receive for each MWh (1000 kWh) of electricity their systems produce. An owner can print 1 SREC for each MWh their system produces for the first 10 years of their facility’s operation. The SRECs are purchased principally by the Investor Owned Utilities (IOUs) to meet standards set by the state. They are discussed in further detail here. For now, one only has to understand that unlike the ITC, SRECs are production subsidies. An owner gets paid according to how much electricity their systems produce. In order to calculate the value of the SRECs then one needs to know how much electricity their system will produce in one year. Let’s take a look at how that figure is arrived at.
Let’s go back to our model 5 kw model system. It produces a maximum of 5 kwh of electricity per hour. Here it is crucial to remember the difference between power and energy. Power is a rate of flow of electricity and energy is a quantity of electricity. High power is like a fire hose. Low power is like an eye dropper. A fire hose filling a shot glass is high power and low quantity. An eye dropper filling a pool is low power and high quantity. Our 5kw power system working under perfect sunlight conditions through an entire year would produce 5 kwh of electricity every hour of the 8760 hours in a year. A quick calculation shows such a system would produce about 44,000 kwh or 44 MWh in a year.
In reality no solar system can do that. First there is that pesky little problem called night. Solar arrays don’t produce at night. Secondly there are clouds and weather issues that interfere with ideal performance. And thirdly there are local factors such as shading from trees or leaf cover or snow. So no solar system will ever work to 100% capacity. The actual per cent of maximum capacity that a solar system can attain in a year is called its capacity factor and is location determined. There are data sheets that show average capacity factors in different locations. In the Boston area a figure of 13% is generally used. In Arizona it is closer to 19%. Note that the capacity factor of your system may be less than 13% if there are local factors that interfere with its performance.
So our 5kw system that in a world without night and weather could produce 44 MWh of electricity in a year, in reality would generally only produce about 13% of that if well located in the Boston area. 13% of 44 MWh is 5.7 MWh. That is the number we’ll use going forward for the yearly production of our model system.
Now we need to know how much the owner can get for each SREC. The value of SRECs are determined by a number of factors including initial auction price, alternative compliance costs that the IOUs must pay if they don’t meet their RPS (see here for a more complete explanation of RPS) as well as simple supply and demand. There is a market for them which can be looked at here. Note that there really is no predicting their value in the future so any dollar number one might use is a guess of sorts. The current price is around $285 and the initial auction price is scheduled to decline by about $12 every year. It is probably reasonable to assume the value of SRECs, then, will slowly decrease to some place about $170 over the next 10 years. I’ll use $225/MWh for my calculations below—an educated guess as to their average value over the next 10 years.
I would like to note here that the numbers I’m using are very rough and intended to show how they might be calculated. They are not intended to be used to make decisions. For one I’m no expert on future SREC markets. Secondly I’m not an expert in electricity markets going forward either which will be an important factor when calculating the future income stream of the electricity your system produces. And thirdly I will make no attempt to calculate the present value of future income streams. Generally future income is discounted when calculating its present value. I will not do that. So take all numbers here with a grain of salt. They are intended to assist in understanding where they come from rather than to be taken as an exact estimate of the actual cost and benefit of your system.
So let’s get back to SRECs. Our system that produces 5.7 MWh of electricity in a year can print 5.7 SRECs which can be sold for $225 per SREC for a total value of about $1280. So for simplicity we’ll say our owner will make $1280 per year for the first 10 years of system ownership.
Four: Savings on electricity bill. Finally let’s take a look at the savings on the electricity bill that the system owner can expect to have for the life of the system. What is the life of the system? It would be best to ask your installer but I’ll use 25 years in my estimates here. You might also want to ask your installer how much less efficient you can expect your system to become as it ages. A figure of 1% per year is some times used but this will depend on the particular brand of panel you select. Solar panels (unlike the inverters) are generally long lasting robust systems that deteriorate only slowly. I’ll ignore these issues here and simply assume the system produces at full capacity for 25 years and then needs to be replaced.
Belmont’s new tariff pays 11 cents per kWh for energy produced by the panels and sent to the grid. Energy produced by the panels and used on premises, however, saves the solar host the full retail rate or about 19 cents per kWh. So to calculate the savings on the electric bill (also called the avoided electric bill) one needs to know what percentage of energy produced by the panels is sent to the grid and what percentage is used on premises. On the average solar hosts use about 40% of the energy in the house and about 60% is sent to the grid. But the range of values is large. A host who works at home during the day in an air-conditioned house doing the laundry and running the dish washer will use a lot more solar production on premises. A family that all go to work leaving a darkened home during the day and who uses most of their electricity at night will send most of their solar production to the grid. So the answer will be different for every household but in the spirit of keeping things simple I’ll use the 40/60 average split for our estimates here. 40% of the 5700 kWh of yearly solar production or 2280 kWh is used on premises and 60% or 3420 kWh is sent to the grid. 2280 kWh multiplied by the retail rate of 19 cents per kWh is $433 and 3400 kWh multiplied by the tariff rate of 11 cents per kWh is $376. The total yearly savings on the electric bill then would be the sum of $433 and $376 or about $809.
But of course the future stream of savings will depend on the future cost of electricity which will certainly change over the next 25 years while your solar panels are producing. How they will change is uncertain so the savings are uncertain. One would assume electricity rates will go up and most people who estimate these kinds of things think they well. But even this isn’t certain. A large increase in natural gas supply with a developed pipeline infrastructure could lower prices. A robust carbon pricing schedule would tend to increase prices. However, since this post is not a discussion of the future of energy markets I will make do with the figures assuming that energy prices will stay flat.
With all the caveats listed above, we are now ready to calculate our return on investment on our model 5 kw system costing $20,000. First we will take account of the Federal Income Tax Credit (ITC) and cut the figure to $14,000. Then we’ll subtract the State Income Tax Credit of $1000 bringing down the cost to $13,000. Next we’ll add the yearly income from SRECs ($1280) to the yearly savings on the electric bill ($809) to get $2090 as the yearly income from the system. Divide $13,000 (the cost of the system after tax benefits) by $2090 (the yearly income provided by the system) and you get a return on investment of about 6.2 years. After that your system will start making money for you. 3 .8 years later the stream from SRECs stop and the value of the system will simply be the energy savings. Of course there will be costs as well in terms of maintenance. Usually these are small but the inverter often needs to be replaced every ten years or so. You should ask your solar installer about the costs of maintenance. It should be noted that the estimate of 6.2 years for a return on investment is probably conservative as it assumes flat electricity rates.
And finally, what fun is a discussion of income streams without mentioning taxes. The issue comes up principally around whether proceeds from SRECs are taxable. As it turns out there is a lack of clarity on the issue and as a result a profusion of opinions. In the end one is left to follow their heart or the advice of their favorite tax expert. SRECTrade, the leading broker of SRECs, has a blog devoted to the issue which can be viewed here.
What is less controversial is the calculation of how paying taxes on SREC proceeds affects the return on investment. Of course it depends on your income tax bracket but we’ll keep it simple and say 1/3 of the proceeds from SRECs goes to taxes. In the above example that would drop the after-tax income from SRECs to $854 and as a result the return on investment goes up to 7.8 years.
So those are the numbers and the assumptions that one must make to calculate the numbers. For many people in Belmont with a southern-facing non-shaded roof a solar investment should be a very good one. Nothing of course is guaranteed but you should be able to count on the returns of your solar panels better than on returns from many other kinds of investment. And of course you are helping future generations at the same time. Not such a bad deal.