What's Happening with Renewable Energy?

For financial advisors, most of the energy news is negative. The Department of Energy has forecast that home heating bills this winter could be 30% higher than last due to soaring natural gas costs. That means clients will have less discretionary income to apply to financial goals. Sky-high energy bills also dampen consumer confidence, making investors less willing to commit to financial markets.

But here's some good news you can tell clients. The Energy Policy Act of 2005 has created two new federal tax credits that will cover 30% of the costs (up to limits) for installing new renewable energy systems. The table below summarizes these credits.

These federal tax credits are in addition to other rebates, grants, incentives and credits offered by federal, state or local governments and utility companies. For example, New York State now offers a 25% credit for solar-electric or solar-thermal expenditures. In some part of the United States, it is possible to invest in renewable energy systems at an out-of-pocket cost of just 40-50 cents on the dollar, after all incentives. To learn more about incentives available in your state or through your local utility, check here:

• http://www.dsireusa.org/summarytables/financial.cfm

To counsel clients on whether such an investment makes sense, it helps to know a few basics about energy economics. We'll focus mainly on solar systems, because they are the most accessible. Just about any property with an unobstructed, un-shaded south-facing sun exposure is a candidate for a solar electric (photovoltaic) or solar thermal (water heating) system.

Solar Thermal Heating

Solar energy can serve two purposes in homes and businesses: 1) heating water (including swimming pools and hot tubs); and 2) generating electricity. According to Consumer Reports, water heating accounts for 11% of total U.S. home energy consumption.

About 54% of U.S. homes heat water with natural gas and 38% with electricity. The table below estimates national average costs per household for both fuels in 2005. Natural gas prices have been rising while electricity costs have held steady, so the cost advantage of natural gas vs. electricity has narrowed.

Solar thermal systems capable of generating 100% of a household's hot water can now be installed for about $2,500 to $3,000. These systems bypass the electrical grid by using "collectors" to absorb and store thermal energy.

After rebates and incentives, the out-of-pocket cost for these systems can drop to about $1,200 to $1,500. Since the monthly utility bill for solar thermal is virtually nil, savings to an average homeowner can be about $200 per year in the first year. The investment could produce an internal rate of return about 12-15%, assuming 3-4% annual inflation in traditional energy sources and system capital costs are amortized over 15 years. Since this investment eliminates costs instead of generating income, the return is income tax-free, similar to the interest produced by a municipal bond.

Photovoltaic (PV) Systems for Electricity

Evaluating the economics of a photovoltaic (PV) solar system for generating electricity is more complex, for several reasons. First, it is rarely feasible for a homeowner or small business to generate 100% of the electricity required with PV because the sun only produces peak power for six hours per day (9 a.m. to 3 p.m.) at most. Unlike solar thermal water collection systems, electricity can't easily and economically be stored. Secondly, retail electricity costs vary greatly from one part of the U.S. to another – from a low of 5 or 6 cents per kilowatt hour in the Midwest to a high of 12 cents per kilowatt hour in New York and California. The long-term cost of generating electricity through an efficient PV system can be estimated at about 6-10 cents per kilowatt hour, and virtually all of this cost is for equipment and installation. Currently, in states where electricity costs are low, PV systems are viable mainly as a hedge against energy inflation. However, as the cost of PV equipment keeps falling, the economics will improve.

A third complexity in evaluating the economics of PV systems is the concept of "net metering." When a PV system is installed in a home or business that already has a utility connection, it pays to connect the solar system to the utility grid. With recent improvements in PV technology, the cost of this "grid-tie" can be fairly low and the economic benefit can be significant.

In many states, electric utilities, by law, must offer renewable energy producers the right to feed excess production to the grid and receive a credit. When this credit is issued at the same retail rate that utilities charge customers to buy electricity, it is called "net metering." You can check net metering rules of your state or local utility at an online data base located here:

• http://www.dsireusa.org/summarytables/reg1.cfm

Click on the "Net Metering" column of the online table.

Where net metering exists, it allows the homeowner to "time-shift" solar electricity produced from peak sun hours to other hours. During peak hours, excess electricity is fed to the grid, causing the home's electric meter to "spin backward." At night, when solar power dries up and utility power is required, PV credits banked during the day can offset utility costs dollar-for-dollar. This not only allows PV producers to realize economic benefit from all the electricity they produce; it also allows them to generate a return that is 100% tax-free, in the form of utility cost savings.

An illustration of this concept, along with a useful PV modeling calculator, is provided by Sharp and accessible here:

• http://www.clean-power.com/sharp/default.aspx

We will use an example of a home in New York State that currently is spending $800 per year on utility electricity. We then assume that this home constructs a 4-kilowatt PV system at a gross cost of $7,000 per kilowatt ? $28,000 total. After rebates and credits, the net cost of this system could decline to $9,000, according to the Sharp calculator.

The graph below shows Sharp's illustration of net metering for this example, for a typical day in April.

The vertical axis is kilowatts produced or consumed per hour. The horizontal axis is hours in the day, starting at midnight (0). The red bars show electricity purchased from the power utility at retail rates. The green bars show electricity produced by the PV system and consumed on the spot. The yellow bars show excess PV electricity "net metered" back to the grid. In effect, the yellow bars produced on this day in April produce credits that cancel out the red bars. By clicking on the "Monthly Electric Bill" link on the Sharp model, it is possible to see an estimate of the monthly and total annual savings in the household's electric bill. In this case, cost savings are estimated at $708 for the first full year of PV installation.

Given these assumptions, a 4-kilowatt PV system makes economic sense. But here's why a larger system may not be as viable. Under net metering rules of most jurisdictions, the utility is only required to issue a retail-price credit against (and up to the amount of) electricity consumed. If you produce more electricity than you use, either the utility will keep the excess free of charge or else you must sell it back at wholesale rates. A typical modern household consumes about 25-30 kilowatts of electricity per day. On average, a PV can generate about 4-6 kilowatt hours per day for every kilowatt installed (depending on weather and season). After adjusting for a small loss in converting a PV system's DC power to AC power through an inverter, figure that a 4-kilowatt system with net metering can produce most of the electricity an average household needs, without overbuilding. (4-kilowatts X 6 peak hours = a little less than 24 kilowatt hours).

Capital Improvements and Capital Gains

What is the internal rate of return on this PV system? Answering that question requires an understanding of another tax benefit embedded in renewable energy. These systems are considered home improvements that increase the cost basis in property by the amount of equipment and installation cost. If homes are then sold that qualify for the Section 121 capital gain exclusion ($250,000 per person; $500,000 per married couple), any increase in home value added by the system is realized tax-free. For businesses, PV systems qualify for five-year depreciation under the Modified Accelerated Cost Recovery System.

Let's assume that this hypothetical 4-kilowatt system (in the example above), costing $28,000 gross, is installed at a net cost of $9,000 after incentives and produces electric cost savings of $709 in the first year. The savings then increase by 2% per year in the future with utility cost inflation. After the 10th year, the home is sold and the homeowner is able to obtain an extra $10,000 on the home sale price as a result of the PV system improvement. (Note: PV systems have a useful life of up to 30 years; by the 10th year of this example, annual utility cost savings would increase to $847.)

The internal rate of return on this investment over the full 10 year period is 9.1%, all of which is tax-free.

Now, suppose instead that the era of cheap electricity is over. This is a distinct possibility because the majority of all U.S. electric power is produced by burning coal, a primary source of the carbon dioxide (CO₂) emissions threatening the ozone layer. If electric power costs increase by 4% annually in the future, cost savings in the 10th year increase to $1,009. On that basis, assume that the system value added to the home sale price increases to $11,000. Now, the IRR of the PV system increases to 10.5%, which serves to illustrates the inflation protection that this investment can offer.

Of course, this example of a profitable PV investment combines "best case" assumptions ?a high-cost state (New York), great incentives, and economical capital costs. Many of your clients are not yet in position to benefit from these factors. But the trend is favorable because incentives keep increasing, while PV technology keeps getting better and cheaper.

One quick word about wind-generated electricity: Micro-turbine wind systems can generate electricity even more efficiently than PV when conditions are ideal. Those conditions include local wind power of Class 3 or better and the ability to install the wind turbine on a tower at least 30 feet high, in an area clear of obstructions for at least 300 feet in all directions. To check wind power in your area, consult the Wind Energy Resource Atlas of the U.S. here:

• http://rredc.nrel.gov/wind/pubs/atlas/

Clients Who Are the Best Candidates

Which clients are the best candidates for renewable energy?

• Heavy electricity users – Start asking clients how much they spend on electricity. Manufacturing firms, farms, and residences of more than 4,000 square feet are good candidates. Average U.S. household consumption is 830 kilowatts per month, according to the Department of Energy.
• People in disaster-prone areas – After Hurricane Wilma struck Florida, more than five million people were without electricity for weeks – and all that sunshine beating down! PV can be a viable back-up for utility electricity, sparing consumers the cost of buying generators and storing fuel oil. A reliable PV back-up system includes at least one industrial-strength "deep-cycle" battery for storage.
• Swimming pool and hot tub owners – It is senseless to heat pools and tubs with electricity or natural gas when solar collector systems are so much more cost-effective and qualify for a 30% federal tax credit.
• Seniors living on fixed incomes – Senior citizens can't do much about spiraling health care costs. But they can take control of their utility costs, especially if they live in Sunbelt states where PV power is plentiful.
• Remote dwellers – PV systems with storage batteries make economic sense for locations that can't easily or economically be tied to the utility grid including vacation cabins, RVs, boats, ranches and farms.
• Environmentalists – The financial benefits may matter less to environmentalists than personal contributions they can make to reducing CO₂ emissions and helping the ozone layer. According to the Sharp online calculator, the 4-kilowatt system illustrated in this article would eliminate 5,720 pounds of CO₂ emissions in the first year.

How to Get Paid

How can you earn a living helping clients evaluate investments in renewable energy? Three ways:

• Direct fees – This makes the most sense if you are already a CPA or consultant who advises clients on complex financial and tax issues. Become familiar with the incentives available in your area and sell your technical expertise.
• Cross-referrals – This may work best if you want to be the financial expert on a team that also consists of: 1) a tax specialist who knows the incentives; and 2) a renewable energy system supplier/installer. You can offer the other team members referrals to your clients in return for referrals to theirs.
• Cash flow management – Help clients convert the tax-free income they are generating from electricity savings into long-term financial security. If a client can save $150 per month through a combination of a solar hot water heater and PV system, that's $1,800 per year that can be applied to a dollar cost averaging investment program or permanent life insurance premiums.

Clearly, this is an outside-the-box idea for a financial professional to offer today. But as the U.S. lumbers toward energy self-sufficiency, renewable energy will go mainstream eventually. At some point, consumers and businesses in your market will need help evaluating incentives, cost advantages and options.

One of the best ways to become a leader is to install a renewable energy system yourself – then invite your clients over to see how it works. Even if they don't bite, it's a happening!