“What is the payback period?

”
By Mike Bassett-Smith and Shane Robinson
Powersmart NZ Limited
www.powersmart.co.nz

This is the most common question asked on the

subject of solar electricity.

We seem to be naturally curious about a

technology that can produce a long-term supply
of electricity with no continuous financial input,
environmental side effect, or significant change
to our lifestyle. Yet industry, consumers, and
government only seem able to relate the value
of the investment to its energy ‘payback’.

At best, simple energy payback is a very weak

tool for describing the financial value of an
investment in a solar electricity system, and has
done little to encourage adoption.

Fortunately, it is possible to value investments in

solar in ways that make it comparable to other
types of investments, supported by research and
financial analysisi. As you will read in this
article, most places in NZ can achieve a solid
return on solar investments right now.

This article investigates the financial returns for grid connected solar installations that provide the
Grid Connected Solar – A Quick Overview benefits of solar electricity without the limitations associated with off-grid systems and batteries.

The global market for solar electricity generation is booming, and on pace to quadruple by 2015.ii Numerous countries are facing increasing electricity
demand with limited supply options, and many governments have responded by facilitating residential and commercial adoption of grid connected solar
systems. There is a clear acceptance of the performance, financial, and environmental case for grid connected solar systems around the world.

A grid connected solar system uses sunlight to generate electricity for internal consumption or export. They take advantage of unused roof space or can
be integrated directly into a home or commercial building. The systems are easily installed, have an exceptionally long useful life, and require no
significant maintenance or any input. They offer building owners the ability to invest in their own electricity generation, and provide a hedge against
rising electricity costs.
Grid connected systems have several advantages over the traditional method of using solar panels to charge batteries. Eliminating the need for
batteries significantly reduces the capital and ongoing cost of the system. And, since the building remains attached to the grid, there is no strict
requirement that system owners limit their electricity consumption or install systems of any particular size.

By world standards, NZ has an excellent solar resource. Germany is by far the

world leader in solar adoption (consuming approximately 55% of total global
capacity in 2006iii) and a solar system in Auckland will generate 40% more
electricity than it will in Germanyiv.

What Factors Improve Return on Investment?

Capital Cost

The initial capital cost of a grid connected solar system is widely seen by
consumers as the major limiting factor to more widespread adoptionv. Prices
actually vary quite widely. In 2001 for example, the Energy Efficiency and
Conservation Authority (EECA) were quoting the price of a 3 kW grid
connected solar system as $50,000 - $65,000 NZD ($17 - $22 per Watt)vi.

Typically, just the solar panels and the inverter make up around 80% of the
installed system cost. Solar industry manufacturers have been working very
hard on reducing the cost of these two components and at the same time they
have increased efficiency and durability. In the years since 2001, prices have
reduced dramatically and smart integrators have streamlined the system
engineering, design, and installation processes.

Retail prices for systems are now in the range of $11 - $15 per Watt, a 35%
reduction on the EECA’s quoted 2001 prices. Consumers can install a range of
system sizes that will provide a significant reduction in electricity bills.
Investments start at roughly $9,000 NZD, and the investment returns are
generally the same for all system sizes simply because larger systems use
more panels which increases cost, electricity production, and appraisable
value.

Metering and Billing Arrangements

Why should your electricity retailer allow you to sell (or export) solar
electricity back to the grid?

Not surprisingly, the common reason is that in most western countries

electricity retailers are legislated by their respective federal governments to do
sovii. This is not the case, however, in NZ.
Metering and billing arrangements for grid connected solar systems vary widely across energy retailers. Currently, Meridian Energy provides a ‘One to
One’ net metering and billing arrangement that is consistent with global best practice. Their arrangement supports the investment returns discussed in
this article by providing homeowners the ability to receive the full retail market value of the energy generated by the system while remaining able to
draw electricity from the grid as required.

Electricity Prices
“New Zealand’s increasingly shambolic
The rapid inflation of already high electricity prices is a widely recognized issue in NZ. Retail electricity electricity sector is inviting further
prices here are already very high, and over the past 8 years they have risen at an average compound blackouts, price hikes, and threatens to
annual rate of 8.5% per yearviii. turn off potential investors, business
leaders warn.”
For the purposes of the analysis contained in the article, we have assumed prices continue at 8.5% for the
Press, 04.09.06,
next 5 years and 3.5% thereafter to reflect average long term growth in line with regular price inflationix. Future Power Supply Queried

Electricity prices are expected to rise faster than this analysis predicts for a number of key reasons.
Demand for electricity is growing and a supply gap, due in part to the loss of the Maui gas field, is
incomingx. Even with significant energy conservation the only way to fill the gap is to invest in new “If we continue the way we are, we will
generationxi. Most new generation sources are not necessarily going to be carbon neutral and may be see higher prices and more blackouts –
subject to carbon taxes and/or ‘cap and trade’ schemesxii. New generation sources are also more likely to that’s the bottom line.”
be large centralised projects that require new transmission infrastructure to distribute the electricity
John Walley, CEO, Canterbury
throughout NZ. New distribution projects are already highly controversial and well over budgetxiii. Further Manufacturers Association
projects will be more controversial and thus expensive, providing another investment that will demand
repayment through higher electricity prices, lines charges, and/or taxesxiv. Electricity is also expected to
become a substitute for other diminishing non renewable fuels like petroleumxv. Any substitution such as
rail electrification and/or adoption of electric vehicles will reinforce the demand/supply gap and provide
further increases to the retail price of electricity. “We’re going to need everything we can
get from biomass, everything we can get
Consumers who invest in grid connected solar will be well insulated from these pressures. from solar, everything we can get from
wind. And the question still is, can we
get enough?”
Subsidy and Incentives
Michael Pacheco, Director, National
Subsidy and incentives typically either reduce the amount of initial investment required to purchase the Renewable Energy Laboratories
solar electricity system, or increase the value of the system’s electricity production. They generally improve (NREL), USA
the accessibility of solar systems for those who lack the capital required for the purchase. Unfortunately,
the current NZ government provides neither subsidies nor incentives for solar investmentsxvi.

This is a glaring omission in comparison to our international peersxvii. For example, in Ontario, Canada,
“We’ve got 20 or 30 years of renewable
energy retailers have been legislated to pay 42c per kWh for electricity generated by solar systems when electricity options that do not take away
the retail price of electricity is an average of $0.06xviii. (That’s equivalent to being paid $1.54 per kWh vs. some of our precious rivers, or damage
retail prices of $0.22 in NZ.) In the US, the Federal Government provides a tax rebate on the system our precious landscapes. There is no
purchase. In California, energy retailers allow net metering on ‘tiered’ and ‘time of use’ rates, in addition to need to rush off to hydrocarbons.”
a state wide rebate program which can repay up to 50% the original cost of the systemxix.
Dr. Keith Turner, CEO, Meridian
Energy
Several other US states and European countries are offering similar incentives to get homeowners to invest in grid connected solarxx. Even our
neighbours in Australia have a generous rebate program in place for residential grid connected solar installationsxxi.

Not surprisingly, homeowners are quickly adopting solar and reaping significant benefits in these markets.

So what is the Payback?

Solar systems produce two qualities that generate value as an investment: direct savings in electricity bills and an increase in the appraisable value of
residential and commercial properties. The likely return on investment for any investor and system can be calculated prior to purchase.

Direct Savings in Electricity Bills

Solar electricity systems produce predictable direct savings in electricity bills. The annual output of any size of solar system for any region can be
accurately calculated before the purchase is made and remains reliable throughout the system’s working life. These qualities allow solar investors to
make reliable system sizing and budget decisions when considering the purchase of a solar system.

For example, a Powersmart 2.88 kW system will produce Appraisable System Value
approximately 4,440 kWh of electricity each year in Auckland under
ideal mounting conditions. At current electricity prices of $0.22 per
kWh this translates into direct electricity savings of $957. As years
pass the system’s electricity output remains reasonably constant so
rising electricity prices translate directly to increased savings.

If prices continue to rise according to the forecast used in this article,

those savings will be over $1,100 per annum by year 5 and over
$1,300 per annum by year 10. The accumulated direct savings
would repay the initial capital cost of the solar system by year 22,
long before the end of the system’s useful life.

NZD
Increase in Appraisable Value

An increase in the value of residential properties with grid connected

solar systems occurs for a number of reasons. These include the fact
that the systems produce annual electricity bill savings and protect Useful Life System Value
homeowners from future inflation in the price of retail electricity.
Both are quantifiable. Appraisal Institute Value (Interest only)

Average Value
A 1999 paper by The Appraisal Institute1 analyzed seven different
surveys dating back to the 1970s about the increase in the market
value of homes and buildings with energy efficient designs. The 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
results were remarkably consistent, showing that the increase in Years

1
The Appraisal Institute is a global membership association of professional real estate appraisers, with 22,000 members and 92 chapters throughout the world. The Appraisal Institute is the
acknowledged worldwide leader in residential and commercial real estate appraisal education, research, publishing and professional membership designation programs.
value was 20 times the annual utility bill savings produced by the energy efficient design aspect(s). The study showed that since energy efficient
designs incorporated into the home have the same life as the home, buyers were prepared to pay the mortgage premium based on an interest only
basisxxii. One would make the same argument for solar systems since they too will survive the basic life of the homexxiii.

The rationale is that money saved in annual bills can be used to pay larger mortgage costs with no net change in the cost of ownership. The multiplier of
20 reflects the increased interest-only mortgage possible in the USA noting that average after tax US interest rates are 5.0%xxiv.

In NZ, after tax, fixed interest rates have averaged approximately 7.0% since 1997xxv and therefore the multiplier is diluted to 15 times. If the solar
system saves the homeowner $500 in annual electricity bills it has added roughly $7,500 in appraisable value to the home (“Appraisal Institute Value
(Interest Only”)).

The multiplier analysis also indicates that grid connected solar systems can appreciate in value over time because they produce increasing returns
(electricity bill savings) as retail electricity prices rise. It is not practical in theory, however, for solar systems to appreciate continuously because they
collide with a second limit, which relates to the system’s remaining life.

The valuation method that accounts for the system life simply relates the absolute value of the remaining electricity production capability left in the
system to the current retail electricity price. This is the absolute value of the system as a hedge against future increases in the price of electricity, and is
equivalent to purchasing future electricity supply at current prices (“Useful Life System Value”). For the purposes of the minimum value analysis we
have assumed the system is dead at the end of its warranty period in year 25. However, the system is not dead or valueless at the end of the 25th year.
Many solar systems have been in place for over 40 years and are still producing electricityxxvi.

It is therefore reasonable to consider the two valuation methods proposed as maximum and minimum boundaries, and to consider the real appraisable
system value as the average between the two valuation methods. This shows that the value of a grid connected system is relatively consistent over a
long period of time. The current multiplier also increases to 18 times. When both the appraisable value of the solar system and the direct electricity
savings are considered, the payback is reduced to 10 years, well within the warranty supported lifetime of the solar panels.

Payback - Direct Savings Only Payback - System Value and Direct Savings

Investment

Savings (cumulative)

Investment

Cumulative Savings

System Value

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
1 2 3 4 5 6 7 8 9 10
Years
Years
Annual Return on Investment

At current prices, grid connected solar systems produce an annual after tax return of 2.7% in electricity savings alone. If the average appraisable value
of the system is included the annual return increases to 5.0%. These returns are comparable to the current after tax returns for government bonds,
savings accounts, and term deposits.

The only requirement for these returns to rise is the inflation of retail electricity prices. Using this article’s predicted rise in retail electricity prices the
annual after tax returns become increasingly attractive: 8.46% by year 5, 12% by year 10, and 13% by year 15.

Commercial enterprises can achieve enhanced returns because of tax advantages as well as the direct impact reduced expenses have on business value.
The ability to increase sales from positive marketing is also another factor that can boost investment returns.

Conclusion

The forces that will influence and enhance the probability of achieving the investment returns described in this document are clear and at work.
Enhancements to the investment returns discussed can come from many other sources including carbon taxes, electricity substitution for non-renewable
fuels, enhanced net metering agreements, price support for the increase in property value resulting from grid-tie solar systems, and government
subsidies.

Carbon taxes on dirty forms of energy production are on their wayxxvii, as well as significant increase in fuel taxes for vehiclesxxviii. Price support for solar
systems is thoroughly documented with the analysis performed by the Appraisal Institute. Price support is also apparent in recent studies in Californiaxxix
and consistent with NZ market researchxxx. Government subsidies, if any are forthcoming, will have their largest effect by reducing the capital required
to purchase solar systems. Still, under current conditions, there are several other non-financial reasons to adopt grid-tie solar immediately. It can
appeal to consumers on many levels.

By investing in grid connected solar, a property owner is making a positive long-term contribution to NZ’s environment as well as taking control of their
electricity costs and adding value to their property. The environmental impact is significant – every kilowatt installed is the carbon offset equivalent to
planting approximately 0.3 Ha of regenerating native bushxxxi or permanently removing 0.25 cars from servicexxxii. Among several carbon offset options,
grid connected solar investments are considered one of the most crediblexxxiii. In addition, each system repays the energy required to make them in 12 -
18 monthsxxxiv. This quality means that by the end of 25 years they have produced 17 - 25 times their energy input in environmentally ‘free’ electricity.

The homeowner is also making an investment that will produce a reasonable medium to long-term return, comparable to the value of investments in
stocks, bonds, or term deposits. The alternative is remaining subject to a monthly expense that is inexorably rising, increasingly volatile, and therefore
unpredictable.

About the Authors

Before founding and running Powersmart Mike worked in the NZ Investment Banking industry. He has studied how finance relates to the renewable energy industry since
early university and his understanding of this relationship lead the University of Victoria, Canada, to offer him an open invitation to pursue a self directed PhD in this field.

Alongside managing Powersmart, Shane continues to work at the forefront of LED lighting technology. He is currently named on 18 separate international patents and
patent applications, and provides consulting expertise to Philips’ solid state lighting unit. He has strong expertise in renewable energy technologies and, among many roles,
leads the development of Powersmart’s products.
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ii
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iii
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iv
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vi
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vii
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viii
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xiii
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xv
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xviii
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xix
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xx
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xxiv
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xxv
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xxvi
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xxvii
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xxviii
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xxx
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xxxi
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xxxii
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xxxiii
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xxxiv
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