Siemens Energy Finance Week – Cambridge, MA

Francis O’Sullivan

February 15th, 2017

The Changing Utility Landscape – Complex

Realities and their Diverse Drivers

The new energy landscape – How wind and solar have joined energy’s big table

2

3

The past decade has borne witness to tremendous growth in wind and solar

generation capacity across the US – Together, wind and solar now account for

nearly 60% of all new annual capacity additions

0

50

100

150

200

2009 2015

Solar

Wind

Hydro

US hydro, wind and solar installed capacity

GW

Source: National Renewable Energy Laboratory, Lawrence Berkeley National Laboratory, Solar Energy Industry Association

0

15000

30000

45000

60000

75000

Other

Illinois

Iowa

California

Texas

2014 Cumulative capacity by state

MW

0

4000

8000

12000

16000

20000

Other

North Carolina

New Jersey

Arizona

California

Solar PV

Wind

71 GW of

new

capacity

4

Solar PV generation capacity has experienced secular growth across all scales

of deployment – Utility-scale facilities dominate capacity additions but residential

units are driving overall installations

0

2000

4000

6000

8000

10000

12000

14000

2008 2009 2010 2011 2012 2013 2014 2015 2016E

Utility

Commercial

Residential

Annual PV capacity additions by system type

MWDC

0

5000

10000

15000

20000

25000

30000

2016E

Other

Maryland

Texas

New York

Utah

Nevada

Massachusetts

North Carolina

Arizona

California

Cumulative PV capacity by state (2016)

MWAC

In the US, more than 60% of all PV capacity is in

the form of utility-scale units

Source: MIT Analysis, National Renewable Energy Laboratory, Lawrence Berkeley National Laboratory, Solar Energy Industry Association, European Photovoltaic Industry Association

5

The rapid adoption of residential solar points to the rise of a more proactive

energy consumer – There are now more than 1M solar PV installations in the US

and more than 900k are residential scale

Cumulative residential-scale PV installations in the United States

Source: MIT Analysis, National Renewable Energy Laboratory, Lawrence Berkeley National Laboratory, Solar Energy Industry Association

0

200,000

400,000

600,000

800,000

1,000,000

0.00%

0.25%

0.50%

0.75%

1.00%

1.25%

1.50%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Number of Systems % of households

Residential PV systems

Single-family detached houses

Though only 1.3% of all US households have PV, in some markets

levels are much higher: HI 25%, CA 7%, AZ 5%

The US surpassed

1M residential PV

installations in Q2

2016

6

Though overall US solar capacity is still modest relative to the overall

system, in some states solar now plays a meaningful role in overall

generation – Led by CA, four states now generate more than 6% of their total

electricity from solar

0

2

4

6

8

10

12

14

CA HI VT NV MA AZ NJ NM NC US

Solar generation as a percentage of total net generation

Percent (Oct 2015 to Sep 2016)

Source: MIT Analysis, National Renewable Energy Laboratory, US Department of Energy

> 6% of net generation

from solar

2.5-6% of net generation

from solar

1.2%

11.7%

7.5%

6.7% 6.3%

4.8% 4.4%

2.8% 2.8% 2.6%

7

The rise of residential PV has been driven by a few innovators focused on the

selling of solar as a value product – The combination of “value pricing” and

financial innovation is at the heart of the residential business model

Source: US Department of Energy, Corporate filings, SEIA

67 90

120 149 139

168 203 221

20

37

49

50 46

66

61 59

24

35

34

37 37

42

56 68

138

117

125

174 226

222

242

243

0

100

200

300

400

500

600

Q1 '14 Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15

Quarterly US residential PV installations by installer

MW

Others

Scale is key to the success

of the residential solar PV

business model

8

Solar PV’s evolving competitiveness

Over the past five years the competitiveness of utility-scale PV in the US has

improved dramatically with PPA prices falling by 70% or more – PV contracts

are now being signed for $40/MWh or less

9

Utility-scale solar PPA prices evolution since 2006

$/MWh

Sources: Bloomberg NEF, “U.S. PPA Market Outlook.” 07/08/15. GTM/SEIA, “US SMI Q1 2015.”

NV Power signed a

utility-scale solar

PPA in August ‘16

for $34/MWh

During H1 of 2016, the merchant value of solar generation in CA fell to less

than $20/MWh as it swamped the daytime market – Solar support policies are

driving this dynamic, which is now also materially impacting gas assets

10 Source: Bloomberg New Energy Finance

Merchant value of CA solar versus associated PPA prices and levelized cost

$/MWh

Pricing against the benchmark – How Value Pricing has driven the rise of the

rooftop solar sector

11

12

The residential solar business differs appreciably from the utility-scale model

and has involved cost decoupling – “Value Pricing” is a more prominent feature

in the residential solar market

Utility-scale PV – ~5MW and above Residential-scale PV – up to 10kW

- Utilities driving market by need to meet RPS

targets

- Strong competition among developers to

secure PPAs

- Pricing strongly linked to underlying cost

base

PV Pricing Mechanisms

- Emerging awareness and demand among

homeowners

- Installers developing innovative business

models reducing upfront costs to owners

- “Value Pricing” linking solar prices to local

utility rates

Source: MIT Analysis

The residential lease or PPA is not structured to reflect underlying system

costs, but to offer value relative to utility supplied power – Naturally, the

residential PV model is sensitive to local utility tariff levels and their structure

13

Range of future utility

prices: PU, t

Power Price

¢/kWh

Years 0 1 2 3… …N

Predefined future PV lease

or PPA price: PPV, t

PU, 0

PPV, 0

Source: MIT Analysis, United States Department of Energy, Company filings

Portfolio Average

Metrics:

- Generation: 1,391

kWh/kW

- PPA Price: $0.13/kWh

- PPA Escalator: 2.2%

“We believe that our primary competitors are traditional utilities that supply energy

to our potential customers” – SolarCity 10k

14

Data available for the residential market highlights how effective the “third

party owned” model is at Value Pricing – Though expensive it does help

eliminate barriers like high capital cost and the need for tax appetite

Source: California Solar Initiative and other state reporting systems

Average system price by major state market and ownership type

$/Wp

$0

$2

$4

$6

$8

$10

$12

2009 2010 2011 2012 2013 2014 2015

AZ

CA, Host-owned

CA, 3rd-party

MA, Host-owned

MA, 3rd-party

MD

NY, Host-owned

NY, 3rd-party

Even with falling system cost prices in markets like

MA have barely moved since 2012

Of course, the ability to sell higher priced systems is advantageous for the

residential business model – Higher priced contracts provide higher cost-basis

for ITC purposes and this helps release cash for growth

15

- The cost method is the most straightforward and is based on the assumption that an informed

purchaser will pay no more for a system than the cost of replacing it.

- The market method relies on data from recent sales of comparable systems.

- The income method estimates FMV based on the cash flows generated by the system.

Allowable methods for establishing the solar ITC cost basis:

How the ITC cost basis is established based on the “income method”

Source: MIT Team Analysis

In many contemporary US residential solar markets, allowing the ITC cost

basis to be established via the “income method” amplifies the subsidy by

50% or more – In highly competitive markets this amplification would be

eliminated

16

UnsubsidizedCost

Lease PV Subsidy PV Total IncomePV

Lease PV Subsidy PV Total IncomePV

Subsidies:

ITC: $0.98/W

MACRS: $0.26/W

$4.24/W

Cost Method Income Method

$3.00/W

Subsidies:

ITC: $1.45/W

MACRS: $0.39/W

$3.00/W

$4.84/W

$3.25/W

Source: MIT Team Analysis

17

Distributed energy resources – Their technical benefits and the dynamics that

drive customer adoption

18

DER adoption and its capacity to add value across the system is ultimately

linked to its economics at various scales – The realities of economies of

scale are well illustrated by the variation in contemporary PV costs

48

98

229

0

50

100

150

200

250

300

350

30 MW Utility-scale 1.5 MW Community 1 MW C&I Rooftop 5 kW ResidentialRooftop

Premium on utility-scale

Utility-scale

LCOEs of NY solar PV installations of various scales given 2015 system pricing

$/MWh

Source: MIT Analysis

Then why distributed? – Distributed energy resources can deliver a broad suite of

benefits to the power system, some site specific and some system wide. Locational

values may add sufficient value to justify distributed opportunity cost

19

Locational Non-locational

Power system benefits - Network capacity

- Constraint mitigation

- Loss reduction

- Voltage control

- Power quality

- Reliability and resiliency

- Energy

- Firm capacity

- Operating reserves

- Price suppression

- Price hedging

Other public benefits - Land use

- Employment

- Emissions mitigation

- Energy security

Source: MIT Analysis

20

Capturing the locational benefits that DER deployment can deliver requires a

bespoke quantification and assessment relative to the distribution

opportunity cost

Distributed Opportunity

Cost

Locational Benefits Locational Benefits

Bounds Distributed Opportunity

Cost Bounds

To

tal co

st d

iffe

rence r

ela

tive

to

hig

h

vo

lta

ge

($

)

Unit scale (e.g. MW)

LV MV HV

Net p

rese

nt v

alu

e o

f loca

tion

al b

en

efits

($)

To

tal co

st d

iffe

rence r

ela

tive

to

hig

h

vo

lta

ge

($)

Unit scale (e.g. MW)

Net p

rese

nt v

alu

e o

f loca

tion

al b

en

efits

($)

LV MV HV

Negative benefit-cost

gap

Positive

benefit-

cost gap

Locational benefits << distributed opportunity

cost

Locational benefits > distributed opportunity

cost in certain deployment

Source: MIT Analysis

Congested region

Thoughtful deployment of DERs to optimize distribution network performance

can yield significant locational value for DERs – However, optimized DER

deployment requires price signals to reflect this potential value

29 Source: MIT Analysis

Solar PV

HVAC Controls

Flat, volumetric tariffs Cost-reflective tariffs

Cost-reflective tariffs are central to aligning consumer DER adoption

behavior with system needs – With cost-reflective tariffs in place a more

optimized DER investment patter should emerge

30 Source: MIT Analysis

23

A New York case study highlights just how varied the value associated with

DER deployment can be and how sensitive this value is to economies of

scale

-5

0

5

10

15

20

25

-5

0

5

10

15

20

25

SD of Zonal Congestion Zonal Average Congestion

Zonal Average Congestion

Std. Dev. Of Zonal Congestion

Zonal average congestion across NYISO zones

$/MWh

Consider Long Island vs.

Mohawk Valley

Source: MIT Analysis

The path forward – Getting the incentives for an optimized system right

24

25

Net metering subsidizes residential PV more than utility-scale PV at the

expense of other customers – This has already produced conflict

Wholesale

energy price

Retail price

including

network

costs

Utility Customers

A B C

Network cost paid by customer per kWh

Energy cost paid by customer per kWh

System before A installs solar

…N

Wholesale

energy price

Higher retail price

with cost shifted

Utility Customers

A B C

Network cost paid to customer A per kWh

Energy cost paid to net-metered customer per kWh

System after A becomes a net solar seller

…N

Net-metered rate

paid to Customer A

Additional network cost paid by customers without solar

Utility Rate

$/kWh

Utility Rate

$/kWh

- When A sells power, she gets the retail price, while utility-

scale sellers get the wholesale price, often much lower

- When A stops covering any network costs, the retail rate

must go up so the other customers cover those costs –

plus the network cost paid to A!

26

However, the simple elimination of net metering or its replacement with some

energy-only approach will not solve the issue – The only mechanism for

efficiently integrating DERs is the adoption of cost-reflective tariffs

Time varying energy cost paid to customer per kWh

System A becomes a net solar seller

Additional network cost paid by customers without solar

Wholesale

energy price

Higher retail price

with cost shifted

Utility Customers

A B C …N

Time varying energy

price paid to

Customer A

Utility Rate

$/kWh

Energy cost paid by customer per kWh

27

Utilities now face competition on new fronts – Tariffs and electricity service

prices must reflect the real cost of these services and the value delivered by

utilities

1. Unbundle network (“delivery”) charges

from energy (“generation”) charges

and other “public purpose” charges

like taxes, conservation programs,

and renewable energy support

28

We need time and location-specific energy charges – Value of energy

consumption and production varies by time and location, and the energy

component of electricity tariffs must reflect this real value

2. Energy charges: hourly wholesale locational marginal prices (time

and location-varying), adjusted to reflect losses in distribution network

(approximations initially, metered eventually as AMI rolls out)

Could eventually give way to distribution-level locational marginal prices that

include local congestions in distribution networks

0

50

100

150

200

250

300

350

400

1 25 49 73 97 121 145 169 193 217 241 265 289 313

Long Island Hourly Locational Marginal Prices – Jan 1-14, 2015

$/MWh

29

We need cost-reflective network charges – Volumetric network charges do

not reflect true cost drivers in electricity networks or value of network

reinforcements

3. Network charges:

Peak-coincident network usage

charge to reflect long-run

marginal cost of network

expansion (and value of

network capacity deferral); and

Fixed charge to recover sunk

network costs (goal: minimize

distortions in marginal

incentives).

30

Public purpose charges, taxes, etc. distort competition and confuse value

signals in electricity markets

4. Other public purposes charges must be recovered in minimally distortive

manner to enable fair competition between utilities and other service

providers

0%10%20%30%40%50%60%70%80%90%

100%

Belgium

France

Germ

any

Italy

Netherlands

Spain

UK

California-Sce

Connecticut

Maine

Massachussets

New

Jersey

New

York

Texas

Canada -Ontario

Australia

Brasil

% o

f ele

ctri

city

bill

Taxes

Other costs

Networks

Wholesale

Other charges

31

Some concluding thoughts

- Wind and utility-scale solar PV are now at or very near the competitive frontier for new generation

investment in many US markets

- The continuing rapid growth in zero-marginal cost generation (particularly solar PV) will place further

downward pressure on wholesale power prices over the medium term

- DER innovation has yielded a set of technologies that provide new options for optimizing the grid, both in

terms of technical performance and cost effectiveness

- The economic and technical benefits that DERs offer only arise in operational circumstances that are

specific to the conditions of local and regional grid

- The rise of consumer-level DER adoption, and particularly that of smaller-scale solar PV systems has

come about through a combination of technology cost reductions and very generous deployment support

policies that often fail to appropriately reflect the cost-benefit balance of such technologies

- The business models that have driven rooftop solar adoption rely heavily on “value pricing,” and are

exquisitely sensitive to tariff structures, the ability to maximize cash yield from investment tax credits, and

the availability of counterparties interested in cash-yielding asset-backed security products

- The efficient realization of the benefits that DERs offer requires that tariffs are structured in a

disaggregated manner that accurately reflect the costs

- Cost reflective tariffs will enable the efficient realization of the broad set of benefits that DERs offer in a

manner that reduces conflict between traditional utilities and new energy service providers.