Green Energy as Investments

Feb 7, 2009

I work in renewable energy. My company sells and implements efficiency and solar projects. I speak with people daily about renewable energy projects that they are considering at home, or at their business. Many people want to 'do the right thing', but many times are disuaded by what they say is an insufficient return. "It's not worth it." "It is too expensive." "I'll never get my money back." I've heard many similar responses from people. What is interesting about people's response is that they use different measures of 'worth it' in different areas of their lives without realizing it. It is a mistake that the common homeowners make just like professional managers in large corporations do.

Money is money, and return is return, regardless of what type of project you are evaluating. You can qualify investments based on other factors as well, such as risk, or social effects, such as effects on people, communities, or the environment. However, if you are looking at financial returns you should treat your home or business just like your savings and retirement account. You should look at a risk weighted comparison of investment options. In my experience, I am finding that people underestimate or undervalue physical investments in their home or business as equals to their investments in their retirement accounts or other 'paper investments'. By doing so, they are missing the opportunity of a very good yielding investment [as well as a good thing to do for the world].


Green Energy as an Investment

I believe that the traditional view of efficiency and renewable energy projects has revolved around the concept of 'years to payback'; this concept best suits 'non-durable goods', or things that wear out quickly. This concept is not a good fit for long lived durable assets such as solar energy systems. In these cases the concept of yield gives better comparison with alternative investments to solar, which would be bonds. The concept of the growing annuity is the best comparison for solar energy systems.


The math

A growing annuity is usually a product that a person buys from an insurance company as a safe investment. The product has a yield, which would pay at regular intervals during the year. The growing annuity, as opposed to the standard annuity, would not only yield cash on investment. Its yield will increase over the years. This behavior is a good match for the solar electric system. The yield is the savings on electricity purchases divided by the investment cost of the system.

How can we compare these investments?

The annuity yields 10% and grows at 3% per year. With a $10,000 investment, the yield is $1,000 in the first year, and $1,030 in the second year.

If the solar system has a similar yield and growth rate to the bond, it would also cost $10,000, yield $1,000 in the first year and $1,030 in the second year. If power rates increase 3% per year, then this scenario would hold true. We will look at power inflation in a later issue.

Can we compare these results? No, because the bond delivers cash to the investor which is taxed at the state and federal unless the bond or annuity is government debt and is tax free at the state or federal level. This means that we must consider the investor's marginal tax bracket and its affect on the return. If the investor earns $80,000 per year, is married, and lives in California, he/she pays 25% federal and 9.3% state tax (marginal rates). That is 34.3 %, which must be considered to convert the bond result to a post tax rate.

The solar system does not return cash to the investor, but defers electricity purchases. Since a deferred purchase is not income to the investor, it is not taxed. It is tax free. So we must convert the bond result with the investor's tax bracket to compare the results with a solar system's yield.

Bond yield is 10%, but the investor loses 34.3% of that yield to taxes, leaving 65.7% of 10%, or 6.57% after tax yield.

The solar system's yield is 10%, but since the result is tax free, the yield remains 10%.

Lesson: Know whether you are comparing pre tax or post tax results when comparing solar investments to other investment options. The comparison may be different that you initially thought.


Topics that will be covered in future installments include:

- Risk adjusting yield in renewable energy system comparisons.

- What is your cost of capital and how does that affect your investment decisions? How to make consistantly good decisions.

- The value of small predictable savings - How even big companies don't get it.

-Hans


" Hans is President of Altadena Energy and Solar. He has his MBA from University of Southern California and MSEE from Penn State University"