How to “solar” – Part II: Doing The Math

Hi, solar energy fans. Thanks to everyone who read my Location, Location, Location blog post.

Now that you’ve had a chance to consider whether you have a good place to put solar panels, I wanted to begin to answer the questions all of you have on your minds: How much money can I save?

I’m going to express my “savings” answer like a banker or an investment advisor: as an annualized rate of return on investment (ROI). I do this not just because I’m an accountant, but because going solar is a long-term investment. Defining money savings in terms of ROI lets you compare your solar savings apples-to-apples against all other long-term investment options. It also helps you determine how big a system would be right for you. Furthermore, there are a number of ways to finance your solar electric project, and your ROI number will help you distinguish the good from the bad.

ROI and interest rate are not the same thing. For instance, at the time of my writing, you could buy a 30-year US government bond and receive a 4.69% interest rate. So, for every $1000 invested, you’d get $46.90 in interest per year. If you’re in the 15% Federal Tax bracket and your state income tax rate is 3%, your governments will take away about $8.45, leaving you $38.45 and an ROI of 3.845%.

Return On Investment: A Sample Solar Electric System

Suppose you were able to buy the following solar electric system under the following terms (the system we purchase was slightly larger and at a lower overall price, but at a time when local utility incentives were about 10% higher than they are now):

· Rated capacity: 6000 watts DC

· Out of pocket cost after all tax breaks and utility incentives: $12000

· Warranty on solar panels: 25 years

While your solar panels usually will have a 25 year warranty (some have just 20 years), a key component will NOT. The inverter (the device that converts DC energy from the solar panels into AC electricity you can use in your home or, if/when you produce more than you use, put to the grid) usually will carry a 10-year or 15-year warranty. Out of the desire to be conservative, I’m going to assume you’ll need to replace this during the 13^th year of your solar array for $5000 (in year 2023 dollars).

Also, one negative feature of solar panels is that each year they’re less-effective than the last. The solar panels’ 20/25-year warranty usually provides for the panel to be producing at least 80% of the power on the last day of the warranty as it did on the day it was installed.

The ROI on this system depends upon 3 other things:

1. the current all-inclusive price of electricity during daylight hours,

2. your “noon-equivalent cloud-free sunshine” (also known as your Solar Resource)

3. the expected rate of electricity inflation.

In order to simplify things, my calculations are going to assume a 3.5% electricity inflation rate over the next 25 years. Relative to US electricity inflation since the 1980s, this inflation figure is moderately conservative. Actual inflation has varied from state to state; Arizona’s has been lower & the northeast US has been higher (as they say on CNBC: past performance is not an indicator of future results).

So that leaves two variables, electricity prices and Solar Resource.

In my bullet point above, I expressed the price variable as “all-inclusive daytime” price of electricity. Electricity is often subject to sales tax. In Phoenix, state and city sales taxes (plus fees that act like sales taxes) apply, totaling more than 12.5%. Under this scheme, daytime electricity nominally priced at about 14.5 cents per kWh actually costs me about 16.3 cents per kWh at the bottom line of my electric bill.

In my previous blog post, I gave you a link to a map that would help you determine your Solar Resource. Below is a listing of select cities and their approximate Solar Resource values (+/- 0.1).

City	Solar Resource		City	Solar Resource
Milwaukee WI	4.2		Dallas TX	5.2
Cleveland OH			Miami FL
Boston MA			San Francisco CA
Washington DC	4.7		Salt Lake City UT
Louisville KY			Boise ID
Chicago IL			Las Vegas NV	6.2
Minneapolis MN			Phoenix AZ
			El Paso TX
			Palm Springs CA

Below is a chart showing the estimated 25-year ROI at various Solar Resource points (corresponding to the cities above) and various electricity rates that might be in effect at the installation date.

Solar Resource	Price of Daytime Electricity (US cents per kWh)
(kWh/m2/avg. day)	8	10	12	14	16
4.2			5.8%	7.9%	9.8%
4.7			7.3%	9.5%	11.6%
5.2		6.2%	8.7%	11.1%	13.4%
6.2	5.6%	8.6%	11.4%	14.2%	16.9%

The table above has some conservative assumptions built into it. Your actual ROI would go up if:

1. The out-of-pocket cost of the system was lower either due to

a. Lower pre-incentive prices OR

b. More-generous tax or utility incentives.

2. The solar panels last longer than the warranty.

3. The solar panels perform better over time than indicated by the warranty.

4. The initial inverter lasts significantly longer than warranty.

5. Electricity inflation is higher than estimated.

Implications of Solar Power ROI

Investment Implications

First, let’s compare solar energy to the 30-year bond example I gave earlier.

· Where sunshine, electricity prices, and financial incentives are ample, solar energy’s ROI can be substantially higher than the ROI for government bonds.

· You pay taxes on bond interest, but not on your lower electric bill.

· The investment risk is comparable. Since the USA has existed, (a) the government has paid its debts every day and (b) the sun has risen in the east every day. Reputable manufacturers generally put out products to a quality level that vastly exceeds their warranties, and in the rare cases when the products fail, they make good on their warranty claims.

The fact that solar energy often pays a higher return than government bonds isn’t reason enough to go forward unless you have absolutely no debt and want a relatively risk-free place to put your money. Most of us have debt and many of us couldn’t fund a solar energy project without some debt. The values in the ROI table will help us determine whether solar power makes enough sense to go into debt (or to stay in debt).

If you plan to get a home equity loan, it makes sense if the term of the loan is less than or equal to the warranty life of your solar panels AND in the following scenarios:

1. Your interest rate is lower than your Solar ROI AND

a. The loan is a fixed rate loan OR a variable rate loan capped at or under your Solar ROI.

b. Every dollar of interest is tax deductible (consult your tax advisor)

2. Your interest rate is more than 3% lower than your Solar ROI AND either

a. The loan is a fixed rate loan

b. The loan is a variable rate loan capped at or under 3% less than your Solar ROI.

As for credit cards… in a word: DON’T. Your ROI is almost never as big as your credit card interest rate. The only exception to my credit card rule: it would be OK to use a credit card a bridge to a tax refund. And then, I only condone using a credit card for the portion of the cost you will recover within the next 15 months from credits on your federal or state tax returns (consult your tax advisor for more information).

In fact, if you have more than $2500 in outstanding credit card debt, don’t buy a solar power system now. Instead, pay your credit card debt down THEN go solar. That goes for any other debt over $2500 where the interest rate is higher than the ROI.

“Buy or Lease” Implications

So far, my post has focused on the purchase of a solar electric system. There are companies that will lease systems to you. Most leasing companies will charge you little or no up-front cost (especially if your credit is good). You won’t get any tax credits or utility assistance (because it wouldn’t be YOUR system).

The reasons I chose a purchase over a lease when I opted for solar power were

· the initial monthly lease payment quoted me were as high as 90% of the cost of the electricity the system would replace (where’s the ROI?)

· the lease also included an “escalator” clause, which would have increased my payment 5% or 6% per year (remember, in Arizona, electricity inflation has been about 2.5% in the past 20+ years).

· I would need to concern myself with replacing the leased system (or renewing the lease) in 15 years

· a purchased system has the possible upside of lasting much longer than the warranty and I wanted to capture that upside.

Sizing Implications

It isn’t worth it to build a system that will produce substantially more electricity than you use long-term.

Right-sizing one’s solar array is a topic unto itself, so I’ll reserve that for my next post.

Thanks for sticking with me.

 

You can read How to “solar” – Part I here.