Distributed Energy: A Disruptive Force

Distributed Energy: A Disruptive Force

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Distributed Energy: A Disruptive Force

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    A New Wave of Innovation in DE

    In addition to the core economic benefits of DE that we have described, a new wave of innovation is helping to establish DE as a mainstream energy source and to encourage sustainable growth. While much of the growth to date has been driven by technological innovation, future growth will be driven mostly by financial improvements, such as leasing models, financing tools that lower the cost of capital, and improved targeting and segmentation of customers. These innovations are fundamentally changing the competitive landscape by opening new segments of customers and transforming DE from a technology play to a financing play.

    Most DE technologies require significant up-front costs, and lack of access to capital to cover these costs is a major barrier to adopting DE. To overcome this impediment, DE companies—from rooftop solar installers to providers of energy efficiency equipment and services—are introducing leasing, individual customer power-purchase agreements, expanding on energy performance contracts, and a variety of other financing options. Many solar installers, for example, offer a rooftop lease that can replace about $15,000 to $20,000 worth of up-front investment for the customer with monthly payments at a rate below the customer’s current utility rate.

    For DE lessors, these new leasing models provide an incremental value of as much as 70 cents per watt for each installation. This is in addition to the $1.20 per watt that they already earn as developers. In other words, financing increases the total profit by about 58 percent. This new leasing model does carry additional customer-default risk, but more sophisticated players are mitigating that risk through securitization of their DE leases, which also provides an injection of cash to the company.

    Tapping Cheap Sources of Capital. To fund these financing options, DE companies are tapping innovative and relatively cheap sources of capital. These financing tools range from the more conventional, such as traditional bonds or securitization of DE assets, to the more innovative, such as creating a separate publicly listed company for DE assets or crowdsourcing capital from private investors. Using the flexibility and leverage of these methods, DE companies are finding that they can lower their cost of capital to less than that of utilities, nullifying utilities’ traditional advantage.

    Companies that understand these models and have the best access to capital will be the ones to capture the biggest share of this emerging market. We expect these models to continue to evolve as companies become more comfortable with the risk associated with leasing and other financing agreements. In the next few years, DE may compete directly—without the aid of subsidies—in many states. At the federal level, the ITC is scheduled to be reduced in 2017 and could eventually be eliminated. This new competition may increase the scope of financing options because customers and installers will not have to rely on finding a tax equity partner to monetize the ITC.

    It is important to note, however, that today’s low interest rates favor the DE business model. A different financial environment in the future could significantly change the economics for the industry.

    Giving Consumers New Tools. The expansion of DE is causing disaggregation of the traditional power model, in which an integrated utility controls the market in each state. DE players are now forcing themselves into those markets, capturing part of the value chain by offering consumers an alternative and giving them greater influence over how they meet their power needs. Through leasing and other financing options, these companies are giving consumers the tools to price their power differently. For example, updates and services offered by DE companies can help commercial customers save money on energy while improving performance through efficiencies such as LED lighting and better heating and cooling controls.

    Unlike many utilities, which are required to serve every customer in their territories, DE companies may choose their customers and thus can focus on the ones they believe will be most profitable. They can also tailor their products to specific market segments and use home or commercial energy audits to determine which upgrades make the most economic sense for a particular customer. A quick check of a customer’s credit score allows a DE company to select the proper financing option. While many DE companies are struggling to make their marketing and customer acquisitions cost effective, expenses are likely to decline significantly as the companies gain experience, scale, and higher penetration rates.

    In addition, most successful DE players have demonstrated a better understanding of customer behavior than traditional energy-related services have. They have treated the energy space more like a consumer services market, with a stronger focus on customer satisfaction. Devices such as smart thermostats are targeted toward customer preference, with appealing designs and easy-to-use interfaces that reflect an understanding of what customers want. A focus on online platforms, ease of implementation, and customer service is becoming the norm. This focus is yet another factor pushing DE into the mainstream.