The Opportunity Cost of Solar Power

Your family requires 1kW of power.  You can purchase a solar photovoltaic (SPV) system and generate the electricity yourself, or you can buy it from the electric company for $80/mo[1] @ $0.11/kWh[2].  Although it varies with the amount of sunlight in your area, to produce 1kW of power requires something on the order of a 6kW system.[3] At $7/watt installed, the entire system will cost about $42,000.[4] If the SPV system has a 20-year lifespan, which option offers the better return?

Assume the price of electricity increases by 5% per year and that the market returns 7% for investments having the same level of risk as the SPV system.  You have $42,000.  If you choose to buy electricity from the power company, you can invest that money in the market at 7%.  Even if you pay for all of your electricity out of this fund, it will still grow to be worth more than $100,000 after 20 years.

On the other hand, you could spend the $42,000 on a new SPV system.  If the system costs $400/yr to maintain, then the total cost for cleaning, making repairs, replacing worn components, etc., over its lifetime will be $8000.  After 20 years, the system is depleted and its value will fall to zero (or become negative if you have to pay someone to dismantle it).

Although both solutions provide 1kW for 20 years, by opting to buy power from the grid your initial investment of $42,000 not only covers the cost of electricity but also more than doubles in value.  And if you could have invested the $400 per year spent on maintenance, those savings would have grown to be worth more than $16,000.  In a very real sense, choosing solar leaves you $116,000 poorer.

It’s true that you might receive other, non-financial benefits from solar panels that can’t be captured by this sort of analysis.  For example, it’s difficult to put a price on the tingle of joy you feel whenever seeing them reminds you just how much more you care about the planet than your neighbors.  But what can be said is, for the purchase to be profitable, you’d have to enjoy the panels so much that after 20 years you’d be willing to burn $116,000 of your own money.

What if the government offers incentives?  Assume the price of the SPV system, after the application of various rebates and tax credits, falls to $20,000.  Should you buy it now?  The answer is still no.  A $20,000 “electricity fund” would pay for all of your electricity for 20 years and still leave you with more than $15,000.  Add in the $16,000 you’ll earn from saving what would have otherwise been spent on maintenance and you’ll be more than $31,000 ahead.

How big must the rebate be to make solar financially viable?  Under the assumptions of this analysis (5% energy inflation and 7% market return) government would need to contribute no less than $30,000 toward the purchase of a $42,000 system.  A $12,000 electricity fund would pay for your electricity for 14 years before running out of money.  After that you’d have to pay for it out of pocket, spending about $16,000 over the final 6 years.  This $16,000 just offsets the $16,000 opportunity cost of maintaining the SPV system, leaving both solutions equally attractive.

So should the government dole out enough cash to make it worth your while to install the SPV system?  The answer is yes, so long as 1) you don’t have a problem forcing other people to pay for your electricity, and 2) you’re the only person who receives the rebate.  Because if everyone was eligible and took advantage, you’d be no better off than if there was no government rebate at all.

You’d be no better off because if everyone received one, the average taxpayer would see his taxes increase by the full amount of the rebate.[5] Although everyone would be forced to help pay for your system, you’d be forced to help pay for everyone else’s.  The only way everybody could receive a $30,000 rebate check from the government is for everyone to pay an additional $30,000 in taxes.  (Realistically, the waste associated with these kinds of programs means the tax would need to be even higher.)

But the real economic damage comes not from government waste but from government meddling, in the form of so-called “green” policies that induce consumers to choose less efficient means of producing energy over more efficient ones.  Using the parameters above, if government induces 50,000[6] people to choose solar over conventional power, the world will be $8.3 billion poorer after 20 years than it would have been had government not intervened to distort market prices in the first place.

Notes

  1. 1kWh/h @ $0.11/kWh x 730hr/mo = $80/mo
  2. Average Retail Price of Electricity to Ultimate Customers by End-Use Sector, by State“. Energy Information Administration.
  3. Devlin, Lee (Jan 2008).  “How much does it cost to install solar on an average US house?“. Solar Power Authority.
  4. Ibid
  5. Advantages stemming from an uneven tax distribution are beyond the scope of this article.
  6. A fair yearly estimate, according to Sherwood, Larry (July 2009). “U.S. Solar Market Trends, 2008” (PDF).  Interstate Renewable Energy Council.
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