The right way to value solar

Australian households have installed over 1,000 megawatts of small-scale solar PV, and there will be more installed as module prices continue their fall. Now is the time to resolve confusion about the value of solar power, "grid parity" and the role of support mechanisms for solar PV. How do we decide what solar PV is worth? What does this mean for feed-in tariffs and the concept of grid parity?

The question of the value of power from residential PV systems is hard to answer. It differs at various points in the supply chain, and depends on whether the power is used on site or exported. The solar power households consume substitutes for electricity from the grid, valued at the variable (per kWh) charge that comprises the bulk of retail electricity prices (often at least 20c/kWh). Therefore, households ‘earn' close to retail prices for the solar power they use. The notion of grid parity – when the cost of power from a distributed source, like solar PV, equals the cost of grid-connected electricity – is relevant here.

However, solar power that is exported is different, and grid parity is not the right benchmark for valuing it. Unless households change and limit their consumption to align with PV output they will still need grid electricity. For electricity retailers, who usually purchase solar power fed into the grid, the costs of grid connection and administration of an electricity account remain.

For operators of distribution networks, the value of solar PV may be even less – they will still need to provide poles and wires to homes with solar panels, with enough capacity to meet peak demand. The output from standard, north-facing household PV panels peaks around midday and drops by late afternoon – just as demand, and use of distribution networks, peaks. Thus, at present, most PV output is of relatively little value in offsetting network investment.

However, Grattan Institute's forthcoming report points out that this could change dramatically with new metering and grid technologies, demand management and electrical storage – and this is an option distribution businesses should be examining closely. AEMO's recent National Transmission Network Development Plan reached a similar conclusion.

Today, the starting point for valuing exported residential solar power, without subsidies from government or other customers, should be its direct and known benefit: the avoidance of purchasing and transporting alternative power. That is, the default value should be wholesale prices (including transmission losses) at that time. This may be close to what IPART suggests is ‘fair and reasonable' for feed-in tariffs (8-10c/kWh in NSW). To be fair and accurate, the tariff should reflect wholesale prices at the exact time the power is provided to the grid, and should reflect differences in terms of location of generation. To make this possible, electricity pricing reform and new metering technologies will be needed.

Importantly, there is a wrong way to value solar power. The value should not be manipulated to meet other objectives. The value of solar PV should not include a premium for environmental outcomes, like avoided emissions. This should be automatic once the carbon price is in place and if the value of solar PV is linked correctly to wholesale electricity prices (and assuming subsidies for existing fossil fuel generators are removed).

We should also be cautious incorporating the broader economic and employment benefits of a solar industry in the price paid for solar power, in part because of the distortions and unforeseen consequences that come from meddling with the market price for the good itself. Ideally, the price paid for solar power should not be changed to correct existing problems in our electricity market. In particular, paying a premium for solar power is an inadequate and possibly expensive way to correct wider barriers to investment in distributed generation and demand side participation, which industry and regulators must act upon.

The price paid for household solar should not attempt to account for the merit order effect (that new generation displaces the current most costly generator, thereby reducing wholesale electricity prices). The merit order effect can apply to all types of generation, so the most efficient approach is to ensure that prices received for all generation accurately reflect the marginal alternative source of supply at the time they generate.

There are imperfections in Australia's electricity markets and energy policies, many highlighted in the Commonwealth Government's draft Energy White Paper. These would be most effectively tackled head on, rather than via second-best interventions often characterised by multiple, confused objectives. Valuing solar (and every form of generation) appropriately, for its direct and known benefits, will mean that energy sector players and consumers face the right incentives, that there is economically efficient investment, that there are fewer cross-subsidies in electricity prices, and that solar PV is deployed when it offers the best option for low-emissions electricity.

Helen Morrow is an Associate (Energy Program) at the Grattan Institute