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Solar Power in NZ - What is the payback?
Article by Mike Bassett-Smith
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This is the most common question we are asked on the subject of solar power systems. People are naturally curious about a technology that can produce a long-term supply of electricity with no continuous financial input, environmental side effect, or lifestyle change. Yet industry, consumers, and government only seem able to relate the value of the investment to its simple ‘payback’.
At best, simple energy payback is a weak tool for describing the financial value of investments in solar power systems, and has done little to help anyone understand their value. Furthermore, the government has analysed the cost benefit of solar power systems incorrectly resulting in the perception that they are too expensive to generate worthwhile returns.
Fortunately, it is possible to value investments in solar in ways that make it comparable to other types of investments, supported by research and financial analysis. As you will read in this article, NZ investors in solar power systems can achieve compelling investment returns right now.
So what is the payback on solar now? (2011/2012)
Solar systems produce two qualities for retail investors that generate value: direct savings in electricity bills and an increase in the appraisable value of residential and commercial properties. The likely return on investment for any investor and system can be calculated prior to purchase.
Direct Savings in Electricity Bills
Solar electricity systems produce predictable direct savings in electricity bills. The annual output of any size of solar system for any region can be accurately calculated before the purchase is made and remains reliable throughout the system’s working life. These qualities allow solar investors to make reliable system sizing and budget decisions when considering the purchase of a solar power system.
For example, a Powersmart Solar 3.04 kW system currently costs $15,245 and will produce approximately 4,256 kWh of electricity each year in Auckland under relatively ideal mounting conditions. At current electricity prices of $0.27 per kWh (Auckland) this translates into direct electricity savings of $1,150. As years pass the system’s electricity output remains reasonably constant so rising electricity prices translate directly into increased savings.
If electricity prices rise at a simple inflationary rate of 3.5% per annum, those savings will be over $1,300 per annum by year 5 and over $1,600 per annum by year 10. The accumulated direct savings would repay the initial capital cost of the solar system by year 11, long before the end of the system’s useful life which is well in excess of 25 years.
It is highly likely that electricity prices will inflate much more rapidly with some commentators calling for prices to double within 5 years. It is the protection from these rising prices and the reliable energy savings that produces a solar power systems second quality as an investment; an increase in the appraisable value of the home or building.
The graph above shows the cumulative savings generated by the solar power system over a 25 year period. Even at very low rates of electricity price inflation the system returns the original investment in less than half its warranted
Increase in Appraisable Value
An increase in the value of properties with solar power systems occurs for a number of reasons. Most importantly this is because the systems produce annual electricity bill savings and protect homeowners from future inflation in the price of retail electricity. Both are quantifiable.
A 1999 paper by The Appraisal Institute analyzed seven different surveys dating back to the 1970s about the increase in the market value of homes and buildings with energy efficient designs in the USA. The results were remarkably consistent, showing that the increase in value was 20 times the annual utility bill savings produced by the energy efficient design aspect(s). The study showed that since energy efficient designs incorporated into the home have the same life as the home; buyers were prepared to pay the mortgage premium based on an interest only basis. One can make the same argument for solar systems since they too will survive the basic life of the home.
The rationale is that money saved in annual bills can be used to pay larger mortgage costs with no net change in the cost of ownership. The multiplier of 20 reflects the increased interest-only mortgage possible in the USA noting that average after tax US interest rates are 5.0%.
In NZ, after tax, fixed interest rates have averaged approximately 7.0% since 1997 and therefore the multiplier is diluted to 15 times. If the solar system saves the homeowner $500 in annual electricity bills it has added roughly $7,500 in appraisable value to the home (“Appraisal Institute Value (Interest Only”)).
The multiplier analysis also indicates that solar power systems can appreciate in value over time because they produce increasing returns (electricity bill savings) as retail electricity prices rise. It is not practical in theory, however, for solar systems to appreciate continuously because they collide with a second limit, which relates to the system’s remaining life.
The graph above shows that the appraisable value of a solar power system remains relatively constant through-out the systems working life. This is very logical given the qualities of the system. A well designed and integrated feature of a home that produces direct income without maintenance or input certainly has value and can be sold. Consider also that many other investments are valued this way. For example, if a bond will pay $100 per annum with very low risk, many investors would be happy to purchase those bonds for $1000 each. It is this aspect of solar power systems that has been most overlooked when considering their cost and benefit.
The valuation method that accounts for the system life simply relates the absolute value of the remaining electricity production capability left in the system to the current retail electricity price. This is the absolute value of the system as a hedge against future increases in the price of electricity, and is equivalent to purchasing future electricity supply at current prices (“Useful Life System Value”). For the purposes of the minimum value analysis we have assumed the system is dead at the end of its warranty period in year 25. In practice however the system will not be dead or valueless at the end of the 25th year. Many solar systems have been in place for over 40 years and are still working well.
It is therefore reasonable to consider the two valuation methods proposed as maximum and minimum boundaries, and to consider the real appraisable system value as the average between the two. The result shows that the value of a grid connected system is relatively consistent over a long period of time.
Real Return on Investment
At current prices, the 3.04kW solar power system in this article produces an annual after tax return of 7.7% in electricity savings alone. This is the equivalent of an 11% interest return on a bank account or term deposit (pre RWT).
When both the appraisable value of the solar system and the direct electricity savings are considered, the payback is almost immediate. It is then very realistic to expect a complete realisation of the investment with potential for profit within 3 - 5 years.
The only requirement for these returns to rise is the inflation of retail electricity prices. Using this article’s predicted rise in retail electricity prices the annual after tax returns become increasingly attractive. Rises in retail electricity prices also underpins the value of the system as an asset on the building.
The graph above illustrates the real investment returns from the solar power system using the lesser of the two appraisable values and low inflation of retail electricity prices. It is compelling that given these conservative drivers that the system is paid back in only its second year and profitable thereafter.
Government, solar industry, and media are all to blame for the common misconception that solar power systems are too expensive to generate worthwhile investment returns. The Government in New Zealand has analysed the cost benefit of solar power systems incorrectly and in the wrong context. This has provided a foundation for the misinformation and poor analysis that has made up much of the solar discussion for the recent past.
Nevertheless, the forces that will influence and enhance the probability of achieving the investment returns described in this document are clear and at work. Unlike many other comparable investment choices there is a very clear and relatively predictable path to understanding the benefits of solar power investments. By using and understanding this article homeowners can make an informed decision about the value of a solar power investment for their home, and compare it against other choices.
By investing in solar power, a property owner will take control of their electricity costs and add value to their property. This investment is likely to produce a reasonable short to medium term return, comparable to investments in stocks, bonds, or term deposits. The alternative is remaining subject to a monthly expense that is inexorably rising, increasingly volatile, and therefore unpredictable.
Article by Mike Bassett-Smith from Powersmart Solar