This is the third of a series of posts about the CSI data. Please check here for the original posts with some background about the data.

Today's chart shows the rapid emergence of the 3rd party financing industry in the residential solar industry. Companies like SunRun, SolarCity and Sungevity as well as new entrants like Clean Power Finance and Sun Edison are making solar more accessible for a broader market. Since 2008, that part of the industry has grown by a factor of 10x. It’s a sure bet to assume that in 2012 and beyond, 3rd party owned systems will represent the majority of all installed residential solar systems in California. As long as banks find this asset class attractive, the residential financing sector will become a lot more competitive. Customers will benefit.

Happy Holidays!

1)      Costs Will Continue to Come Down
  This might be trivial to most solar industry professionals but its importance cannot be overestimated. Without significant cost reductions, the solar industry will not grow to the size that could possibly justify the investments made into R&D efforts and manufacturing capacity. Cost reductions are also necessary to achieve grid parity without the industry’s reliance on government support and subsidies. As manufacturing and installation costs will continue to drop, by far the biggest lever to reduce LCOE will come from financing innovation and increased competition.

2)      State Level Hiccups and Blow-Ups
  As long as the solar industry is reliant on state subsidies, there will be significant shocks to different state markets. Over the last couple of years alone, Arizona and Colorado partly blew up. As did LADWP. Some new ones came online like New Jersey. With rare exceptions (mostly the CSI rebate program in California), most local rebates are badly designed and do not allow participants to plan and build long-term stable businesses. Anyone who wants to play has to be ready to get up quickly and move his chips to another table.

3)      Don’t Expect Help from Washington
  Washington’s ineptitude to implement a coherent energy policy for the 21st century will continue. The best thing we can hope for is that the solar energy policy landscape will not deteriorate. As we approach the expiration of the 30% tax credit in 2016, anxiety will increase.

4)      It Will be Difficult to Build Profitable Businesses
  The most basic law of the energy industry is that its end product is a perfect commodity. A kWh of electricity is as good as the next one. You can’t brand it, you can’t differentiate it. This basic law is like gravity: you can’t escape it and it affects every part of the solar ecosystem. Entrepreneurs, investors and large companies will have to either find niches or be (in true Jack Welsh fashion) number 1 or 2 in their respective segments. And there is a decent chance that on the hardware side none of those winners will be in the US or Europe. The Chinese might sweep that category with their winning mix of subsidized cost of capital, outstanding manufacturing expertise and an endless pool of cheap labor.

As for businesses that find a niche, they will still feel the pull from gravity. Take Sungevity, for example. Most people agree they have an excellent business model and a great team. They are carving out a niche with a great brand and their powerful online quoting tool to reduce friction in the sale. But despite their great strategy and successful branding efforts, they still have to compete against all the other companies trying to get the same customer. And for most customers, brand recognition and ease of purchase are mostly secondary considerations. If Sungevity’s implied LCOE is not highly competitive, they will have a slim chance of winning business from new customers. Applying basic game theory there will always be competitors who are willing to lower their margins to win market share which in effect lowers the margins for everyone else in the market.

5)      Installers Will Have to Find their Place in a Bifurcated System
Integrators will mostly fall into one of two buckets. There will be a small number of large installers with national reach that will gain a cost advantage through economies of scale. In this category, operational excellence will allow a few companies to build profitable businesses. At the other end of the spectrum, there will be an ever-increasing number of small mom and pop installers who will establish themselves in a local market. The only way for them to compete with the big guys is to work with razor-thin margins or possibly no profits at all. As long as the employees and owners can take home a decent salary, the doors will stay open and they will get a steady but small stream of customers. 

One of our investors just sent me this little online tool: 

http://www.pvcostconvergence.org/calculator.aspx

It's a powerful way to show the convergence of solar electricity to grid electricity costs. Make sure to play around with the assumptions to understand their impact. Enjoy.

You have probably heard about the Department of Energy's ambitious initiative called SunShot. The goal: "make large-scale solar cost competitive without subsidies by the end of the decade". To achieve this, the DoE estimates that fully installed costs have to come down to $1/W. Considering that today's utility-scale systems cost about $3.50/W to build, this is a REALLY ambitious goal. Appropriately, the DoE's website introduces the program with the famous JFK quote: "We choose to go to the moon in this decade and do the other things not because they are easy, but because they are hard." I like the DoE's willingness to stick their neck out and challenge the industrious ingenuity of researchers, businesses and policy makers to push solar from "the right thing to do" to an economic inevitability. 

Like most people in the solar industry, the first question that popped into my mind was: is $1/W realistic? I will try to answer that question for residential solar. Since the DoE's SunShot initiative is focusing on (centralized) utility-scale solar, we'll need to convert the goal of cost competitiveness into fully installed cost for (distributed) residential roof-top systems. We know that residential electricity costs on average $0.12/kWh in the US today (see earlier post The Cost of Solar Electricity). Assuming an  inflation rate of 2%, that will increase to $0.14/kWh by 2020. Taking a financing rate of 5%, installed costs for a residential roof-top system would have to decrease to $2.50/W by the end of the decade for solar to compete with distributed electricity. Given that currently the cost to install an average sized residential system costs about $6/W, this is an equally ambitious goal as getting utility-scale solar to $1/W. So can it be done?

Let's first break down the current cost structure for a standard 5kW residential system:
     
                                                  $/W             Total $                   Possible Cost Structure
     Modules:                          $2.00/W        $10,000                           $0.50/W       (1)
     Balance of System:        $1.00/W          $5,000                            $0.50/W      (2)
     Installation &                   
     Project Management:    $1.00/W          $5,000                            $0.50/W       (3)
     Permitting Costs:           $0.50/W          $2,500                            $0.25/W       (4)
     SG&A                              $1.50/W          $5,000                            $0.75/W       (5)
                                              $6.00/W        $30,000                            $2.50/W

Thoughts on the possible cost structure:
(1) The DoE hopes for module prices to come down to $0.50/W by 2020. We have seen prices decrease significantly over the last years and further reductions are expected especially as manufacturers build out capacity and optimize manufacturing processes. First Solar is already at $0.75/W manufacturing cost. Conclusion: $0.50/W is possible.

(2) Similarly to module pricing, there is significant potential for balance of system costs to decrease. Especially inverters should come down in costs as competitors enter the market and the large players scale up production. Conclusion: $0.50/W is possible.

(3) Let's assume a fully-loaded hourly cost of an installation crew worker of $50 and that it will take a crew of 3 to install a 5kW system about 15 hours, that means labor costs add up to $2,250. Additionally, there is project management involved to manage the installation crews, communicate to customers and fulfill their unique wishes. Plus maintenance and leasing of trucks, etc. These costs can definitely be managed better and efficiencies can be achieved through innovation of faster installation techniques but the cost reduction curve is not going to be as steep as for hardware costs. Conclusion: $0.50/W is overly ambitious especially if you factor in wage inflation.

(4) Permitting costs are often underestimated. I wrote about permitting nightmares before here. I am hopeful that some cost reductions can be achieved through streamlining and standardizing permitting procedures in mature solar markets. Conclusion: $0.25/W is possible.

(5) The last cost bucket is a catch-all which includes sales, marketing and general business overhead. The costs of customer acquisition are particularly high in residential solar. Getting a homeowner's attention through advertising and other media is difficult, especially with a non-urgent product like solar electricity. Other general expenses are also high in the construction industry and difficult to reduce. Just look at Real Good Solar's financials. It's difficult to be profitable in this industry. Conclusion: $0.75/W is overly ambitious.

Overall, it becomes clear that there is a lot of potential for hardware costs to continue to decrease but I am doubtful about the potential to reach similar cost reductions for soft costs. As module and inverter prices decrease, the soft costs become a bigger and bigger percentage of total installed costs. Therefore, the cost reduction curve will flatten out. The good news is that a) even at $3.50/W, residential solar is cost competitive in large parts of the US, and b) soft costs means local jobs that cannot be exported to other countries.