Just and Reasonable Rooftop Solar: A Proposal for Net Metering Reform

Abstract

Recent technological, economic, and political developments have turned the electric power sector--traditionally a quiet and stable industry modulated by heavy government regulation--upside-down. Plummeting natural gas prices have enabled natural gas combined cycle plants to challenge coal power plants for baseload generation. Falling capital costs for wind and solar power have underwritten significant growth of renewable capacity on the grid. Smart meters and advanced energy efficiency technology have reconfigured the relationship between the customer and the utility through the potential for conservation. Greenhouse gas emissions from the power sector--30% of total US emissions in 2015 --have made the industry a central focus of climate change mitigation efforts. One of the main developments challenging traditional power sector organization is distributed generation--the presence of small, customer-owned, generating sources connected to distribution grids. The most common distributed generation technology is solar, accounting for over 97% of the installed capacity. Households, businesses, and industrial facilities are installing solar panel arrays on their buildings and land, thereby providing for their own electricity needs. *58 State and federal policies encourage the development of distributed generation through a variety of incentives, including tax credits, renewable portfolio standards, and rate design. The rate design for distributed generation utilized in most states is known as “net metering.” Under net metering, when distributed generation customers produce more electricity than they consume, they are allowed to run their meters in reverse. At the end of the month or the year, they pay only for the net amount of electricity consumed. Such an arrangement is important as solar power supply imperfectly matches with customer demand. In the middle of the day, solar panels may be generating more electricity than the customer needs. After sundown, the customer draws power from the grid. Net metering allows the customer to receive compensation at retail rates for excess electricity provided to the grid during the day and preserves access to electricity from the grid overnight. Net metered customers are a small minority, only 0.4% of all utility customers nationwide, but their numbers are growing rapidly. The major electric utilities, seeing the growth of potential competition, have begun to push back against net metering and call for reform. The utilities argue that net metered customers benefit from the grid but pay nothing for its costs, instead shifting these costs onto other customers.9 Solar power companies and advocates counter that solar power provides extensive benefits to the grid. This debate has *59 recently played out in administrative proceedings in Nevada, Arizona, and California, and many other states. Decisions if and when to reform net metering have important ramifications for efforts to mitigate climate change. Solar installations are expected to play a substantial part in reducing greenhouse gas emissions. One widely cited analysis asserts that solar could provide as much as a seventh of the emissions reductions required globally to prevent the worst impacts of climate change. Distributed generation solar (DG solar) accounts for over a third of installed solar capacity (complementing utility-scale solar) and is one of the fastest growing segments. Net metering reform that chokes the growth of DG solar weakens society’s ability to address climate change. Alternatively, the continuation of net metering policies that disproportionally benefit net metered customers may create widespread public backlash and similarly jeopardize important support for solar power. Smart policymaking requires a careful assessment of competing interests to create a fair and sustainable level of support for these technologies. This article conducts an integrated economic and legal analysis of net metering to investigate the opposing claims made by utilities and solar proponents and to assess the need for reform. Specifically, it examines whether and to what extent net metering causes cost shifting, what costs net metered technologies avoid and what benefits they provide, and how regulators should take these facts into account in setting net metering policy. The economic analysis quantifies every category of avoided costs and provided benefits. The legal analysis determines whether net metered customers should be compensated for the value of the costs and benefits in *60 each category. This determination hinges on the considerations regulators are permitted to take into account when setting rates. Primary among these considerations are economic efficiency and alignment of rates with cost of service. Secondary considerations for rate setting include environmental protection and distributive equity. This article concludes that the current extent of cost shifting is negligible. The present ratio of net metered customers to other customers is low enough that any unmet costs through net metering do not amount to a significant burden on other customers. The impacts of net metering on distributive equity and alignment of cost of service are minimal in the short term. By contrast, the environmental benefits from supporting development of solar technologies are significant. Thus, reforming net metering to address cost shifting is not recommended in the near future. However, as DG solar achieves significant penetration in the long term, the current net metering regime will tax the legal bounds of the public utility regulatory framework. Utility regulators have some latitude to pursue social goals at the margin, but their core mission is to set rates based on cost of service and thereby ensure economically efficient outcomes. Eventually, the amount of DG solar on the grid will lead to a substantial conflict between the use of net metering rates to promote environmental goals and the core regulatory mission of economic efficiency. At that point, net metering will require reform. Net metering reform based on principles of avoided cost and open access need not and should not choke the growth of DG solar. Regulators should apply those principles, taken from the Public Utility Regulatory Policies Act (PURPA), in conjunction with a modernized conception of electricity supply and use. Namely, electricity today should not be treated as a commodity with a single price, unvarying in time and across space. Rather, a marginal unit of electricity has significantly more value when it is supplied in the peak demand hours of the day, *61 when the grid is near capacity and the highest cost generators are operating. Similarly, a marginal unit of electricity is much more valuable on a distribution grid proximate to end-users rather than far from demand centers on a transmission line. DG solar has many such valuable attributes, as it is available during the day close to peak demand and on local grids. Reform to net metering should utilize a sophisticated view of avoided cost in order to correctly value and compensate these attributes. Compensating net metered customers at retail rates without any additional charge may fall short of optimal economic efficiency, but compensating such customers at a fixed wholesale rate (as many utilities have suggested) is grossly inefficient. While not legitimate to subsidize the environmental attributes of DG solar through the rate structure, correctly valuing their economic attributes will both increase efficiency and allow for fair and sustainable solar development. An ideal reformed net metering rate would retain the retail rate structure with a shift to time-based rates, and allow for the addition of a small monthly fixed charge. A retail rate compensates net metered customers for legitimately avoided costs, namely generation costs and variable costs of transmission and distribution. Specifically, compensation for variable transmission and distribution costs recognizes that electricity is more valuable close to the end-user. Similarly, time-based rates compensate net metered customers for their availability close to peak demand. A small fixed charge accounts for the components of the retail rate that net metering does not avoid, namely the fixed costs of transmission and distribution. Additionally, such a charge should incorporate solar integration costs and a discount for avoided future grid upgrades. Rate reform should occur simultaneously with the removal of caps on the sizes and aggregate capacity of net metered installations, allowing for unconstrained development of the *62 resource at a fair price. Together, these policy changes would push the amount of net metered capacity on the grid to efficient levels, and continue to provide substantial environmental co-benefits. Part II of this article offers a technical, legal, administrative, and economic background on net metering and the power sector. Part III proceeds to an economic analysis of net metering, modeling cost shifting at a high-level and conducting an in-depth analysis of avoided costs and added benefits. Part IV overlays a legal analysis on the results of the economic analysis, examining the roles of regulators in ratemaking and how these play out in the net metering context. Part V synthesizes these analyses and makes policy recommendations. Part VI offers concluding remarks.