Since we first posted this a few months ago, we’ve received many comments. The most common was a request to do the analysis assuming that utility and diesel prices don’t go up in the next two years. That’s not likely, according to the folks we’ve talked with in the industry. But even so, we don’t have a better crystal ball, so here’s a revision. This looks at a 3% utility or diesel escalator compared to no energy cost escalation over the next two years.
The short answer, for several reasons, STILL is do it now! No amount of price reduction in solar panels will make waiting a good investment decision. Even if electricity prices do not go up. Because of the present value of your money, and for the present value of carbon reduction. This is truly a triple-bottom-line winning proposition. Grab a cup of coffee and stay with me for 5 minutes if you are curious about the explanation.
Every few months, a client asks whether they should invest in a solar-energy system now or wait a couple of years. Recently, this question has come up more frequently since electricity prices are depressed by 25% or more over recent trending rates.
Really the only way to answer this question is to be a geek and crunch some numbers.
Since solar energy is technology driven, specifically solar panels, the price will continue to come down as technology gets better and economies of scale improve the market. It is a good assumption that solar panel prices might drop 10% a year, or 20% in two years. This is the approximate rate that the industry has experienced since before 2010.
The rest of the system includes electronics and racking systems. These aren’t as costly as the panels, and hasn’t been enjoying the same falling prices. The electronics are not new technology – data centers, for instance, have been using inverters for many decades.
Efficiency in that time might go up about 4% a year, again mirroring increases in the last half decade. This would reduce the cost for other parts and tasks that share in the total project cost, which translates to approximately another 1% annual cost reduction.
Offsetting those savings; the cost of energy will probably go up. The drop from 2014 to 2016 is an anomaly and was a surprise to industry experts. Typically utility or fuel costs go up by 4% to 8% per year, depending on the market. Let’s assume 3% annual increase for this analysis, along with the same 3% increase in insurance and the cost of everything else including the installation labor.
Next let’s recall that a dollar today is worth less in a year. For everyone that was asleep during finance class, that’s the “discount rate”, or the “time value of money”. Most of our clients like to evaluate investments with a discount rate of 4%, so we will use this rate for our analysis.
Then let’s look at taxes. We will consider two models at this point: a project in the US and a project in the Caribbean. Our assumptions are that our US client will pay 38% combined income tax and be able to depreciate the system on the MACRS schedule, and that our Caribbean client will pay no income tax and not be entitled to any depreciation.
Lastly, let’s consider incentives. Right now the US Investment Tax Credit (ITC) is in effect, representing a 30% first-cost reduction for buyers that are US taxpayers in US territories. The ITC doesn’t apply in the Caribbean (outside Puerto Rico or the US Virgin Islands), and it’s very possible that it might be completely nonexistent in 2-4 years.
The table below shows the outcome of the analysis for the four scenarios: invest now, wait two years, 3% diesel/utility escalation and zero escalation. For the Caribbean scenario, investing in the project today delivers a return of 28% compared to an estimate of 20% resulting from waiting 2 years. The straight-line payback drops from 4 years to 8 years. Add in the 2-year delay, and the overall payback from waiting now is 6 years. The Net Present Value (NPV) drops from $2.5M to $2.1M. Eliminating the utility or diesel escalator doesn’t change the impact – it still is an equal difference in favor of investing now.
To be sure, the performance resulting from waiting 2 years is still really good! But clearly it is not as good as investing now. Surprised?
Let’s look at the US project again, where the model is subject to income taxes, capital asset depreciation, and the ITC, but also enjoys a lower cost of utility energy. The bottom line on that comparison is in the table, below. Again, the project now out-performs the project that is delayed by two years. Return of 26% compared to 23%, and straight-line payback of 4 years compared to 6 years. With zero energy-cost escalation, the difference in performance is about the same – 24% IRR investing now versus 20% investing in 2 years.
Yes, there are a lot of assumptions in this model analysis. Costs and prices might vary more or less than these assumptions. But other than technology prices, anyone that buys goods or services will agree that prices always go up, and rarely go down. Specifically, over time, averaged over many years, utility and fossil fuel prices are sure to go up.
A percent here, a percent there, up or down. How will those changes affect the sensitivity of this analysis? It is hard to tell, but can we all agree that solar panel prices will never be zero? If so, consider this: even if solar panel prices went to zero in two years – manufacturers giving panels away and delivering them for free – it is still not possible to get better financial performance by waiting two years! The return and payback will continue to be better than the tables above, but not good enough to overcome the financial losses that happen by delaying the decision and reducing energy expense this year.
It’s true. Ask us to share this analysis with you if you need to see the numbers.
Finally, let’s touch on the non-financial reasons to act now, because a solar-energy project delivers marketing advantages and environmental benefits on top of the excellent financial performance. Most marketing experts will agree that a marketing advantage today is more valuable than a marketing advantage in the future. A bird in the hand…
The same thing holds for environmental benefits. Reducing fossil fuel consumption and carbon emissions starting today is more valuable to the planet than starting in the future. We call it the “time value of carbon reduction”! (Or the “present value of carbon reduction”.)
The reduction in energy and fuel costs that has been with us for 1-2 years also represents a good buying opportunity! Almost everyone that buys energy is spending less on energy this year as compared to two years ago. This is leaving more money on the table that can be invested in building improvements. Our savvy clients are taking advantage of this opportunity and kicking off their solar-energy projects that they have been thinking about for a few years. No matter how you slice it, the smart money is going into renewable energy today – for your bottom line and the bottom line of the planet.
We are open to your thoughts and questions. Please feel free to contact me about your solar-energy project or ideas at +1 314-378-1913.