Solar power is growing massively within Minnesota. In 2016 alone, our total solar capacity will grow from under 35 MW to over 500 MW — a 16-fold increase!
The reason for this exponential growth is that solar is the most profitable way to generate electricity in Minnesota.
So what makes solar such an economic success in the North Star State?
The High-Level Economics of Solar Power
A solar power installation requires a large amount of up-front capital to secure permits, negotiate contracts, and construct the facility. This investment is rewarded by decades of stable profits or cost savings. Additionally, the federal government provides significant tax benefits.
Up-Front Expenses: Permits, Contracts, and Construction
Solar power is sized in terms of capacity, specified in MW (megawatts, or one million watts) or kW (kilowatts, or one thousand watts). The capacity of an installation is its maximum power output in full sunlight. It’s directly proportional to the number (and size) of panels.
Solar power can vary greatly in capacity. The largest solar plant in the state will soon be the 100 MW North Star Solar Project, which will cover 800 acres of land near North Branch. On the other side of the spectrum, rooftop solar installations are often just a few kW. Because of Minnesota’s rules for Community Solar Gardens (more on this later), most plants currently under development in Minnesota are 1 megawatt or just a bit less.
Up-front expenses for solar power are considered in terms of cost per watt. Prices for utility-scale plants (500kW or larger) range from $2-3/W, fully installed. Thus, a 1MW plant can be expected to cost around $2.5 million.
It’s interesting to note that solar equipment itself costs only about $1.25 per watt. Another significant portion of the cost is installation labor. But for many projects, so-called soft costs account for much of the total expense: fees for permits, interconnection to the grid, and commissions for project developers.
Ongoing Revenue and Expenses
Once a solar power plant has been built and connected to the grid, it starts generating electricity — and correspondingly, revenue (or savings). Electricity is sold in units of power over time, e.g. kWh (kilowatt-hours, 1 kW for 1 hour) or MWh (megawatt-hours, 1 MW for 1 hour).
The amount of electricity generated by a power plant relative to its size is called capacity factor. This is determined as a percentage, where 100% means full-capacity output at all times. The main driver of capacity factor is geography: sunnier locations will have a higher capacity factor.
Since the sun sets at night, hides behind clouds, and shines indirectly to the surface of the planet (especially in the winter), capacity factors average about 15% in Minnesota.
Thus, a 1 MW solar facility in Minnesota can be expected to generate:
1MW x 24 (hours/day) x 365 (days/year) x 15% (capacity factor) ≈ 1,300 MWh each year.
Revenue (or Savings)
For facilities up to 1 MW, state law requires utilities to purchase all solar power generated by their customers. Depending on the circumstances, this price is either retail (~12¢/kWh) or wholesale (~4¢/kWh). Historically, electricity rates have increased by 2-3% annually.
Investor-owned utilities in Minnesota (e.g. Xcel) must pay or credit the full retail price for all of the following:
- All energy from systems up to 40 kW.
- Energy up to the customer’s actual usage over the course of a year for systems over 40kW.
- Energy from a Community Solar Garden that has been “subscribed” to a customer (more on this below).
If none of these apply, the utility must still purchase the power, but can do so at wholesale cost.
There are dozens of rural cooperative and municipal utilities throughout Minnesota. These companies have different requirements for purchasing solar that are not as favorable.
Community Solar Gardens
Community Solar Gardens (CSGs) are solar facilities falling under a relatively new Minnesota law. Customers can “subscribe” to a CSG by paying for a certain amount of solar energy, and in return, investor-owned utilities must credit the customer for the subscribed energy. Additionally, the utility must purchase all the subscribed energy from the owner of the solar garden at retail price.
A CSG can be up to 1 megawatt in capacity, and 5 gardens can be co-located to share common infrastructure. This enables solar developers to build utility-scale solar and get compensated at retail rates. Very few other states provide such a strong incentive for solar power.
By selling all its power at retail rates, a fully-subscribed 1MW CSG can earn about $150,000 each year. Since the utility is required to purchase each and every kWh, this revenue is quite stable — regardless of the overall economy.
Modern solar panels are extremely durable. They have no moving parts, are built to withstand severe weather conditions (including hail), and are fully warranteed by the manufacturer for 25 years or more.
This makes operation and maintenance for solar very inexpensive. In fact, the EIA estimates these costs to be less than 3¢/W annually. For a 1MW solar garden, this would be $30,000 (20% of revenue).
Hardware Lifetime & Degradation
Solar panels (and its associated equipment) last for decades. Most can be expected to last 30 years, and are under manufacturer warranty for 25 years.
Unfortunately, the panels degrade in performance over time — they lose about a half-percent of their output each year. This means that by the end of its lifetime, a plant will generate 10-15% less electricity compared to when it was first installed.
Federal Tax Incentives
Even with the highly-favorable Community Solar Garden law, the raw economics for solar are pretty bleak. Under standard tax treatment, a 1MW solar plant that costs $2.5 million would generate about $100,000 of profit (after tax) in its first year. Over the 30-year lifespan, this works out to a paltry 2.5% return on investment for project sponsors.
Fortunately, the U.S. government provides some significant tax incentives to spur the industry.
Business Energy Investment Tax Credit (ITC)
When a solar power plant goes into operation, its owner can immediately claim a tax credit for 30% of the cost of the system. Thus, a $2.5 million project is in effect a $1.75 million project, because it reduces the owner’s tax liability by $750,000.
It’s important to note that this tax credit is non-refundable; it can be used only to reduce taxes, not to get a rebate from the government.
Accelerated & Bonus Depreciation
Even though its lifetime is 25 years or more, solar power equipment can be depreciated on a 5-year MACRS schedule. Additionally, it is eligible for a bonus depreciation of 50% in its first year.
This allows businesses that invest in solar to report significant expenses for the equipment in the first few years, which are then deducted from their overall taxable income.
Assuming 35% federal and 10% MN state tax rates, our hypothetical $2.5 million solar project would create effective tax credits of about $570k in the first year and another $380k over the next 5 years.
Just like the ITC, this depreciation can only be used to reduce taxes, not to get a rebate.
Adding it All Up
Together, the ITC and depreciation can pay back nearly two-thirds of a project cost. This makes solar power in Minnesota quite profitable.
I’ll save the detailed financial model for another time, but for a solar garden that:
- Is installed for $2.50/W
- Is maintained annually for 3¢/W, increasing 2% annually
- Lasts for 30 years, degrading 0.5% annually
- Sells its energy at 12¢/kWh, increasing 2% annually
- Takes full advantage of the available tax benefits
The project sponsor would get 7.8% return on their investment.
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