California's bold ambition to fully decarbonize what is effectively the world's fifth-largest economy before the middle of the century has become a defining mission for the state.

But concerns are spreading over how to keep California's clean energy transition on track amid skyrocketing electricity rates, as reflected in the heated debate over reforming the state's decades-old rooftop solar program, known as net energy metering. This is part of a broader discussion over the future of distributed energy in the semi-deregulated market.

"It's our position that California ... has done a lot right and has led the way in a whole bunch of areas and is a world leader, but we are really at a crossroads right now," Matt Baker, director of the California Public Utilities Commission's Public Advocates Office, said at a recent solar industry convention in Anaheim, Calif. "And unfortunately ... [the policy] is not helping us now. We have outgrown it."

California regulators are expected to soon release a revised net-metering proposal after shelving a heavily criticized version in February that would have slashed payments for solar exports to the grid, imposed hundreds of dollars of new annual fees on customers and abandoned a previous grandfathering agreement. (R20-08-020)

The Public Advocates Office of the California Public Utilities Commission, or CPUC, along with utilities and some environmentalists, backed the proposal. Many environmental groups and most solar companies dismissed it as draconian. One independent economist who previously represented utilities in net-metering battles across the U.S. called the proposal "extremely radical" in an interview with S&P Global Commodity Insights.

As state regulators seek to strike a better balance between costs and benefits, some are calling for more moderate adjustments.

In a September letter to CPUC President Alice Reynolds, 16 California members of Congress cautioned against using the expanded tax incentives for small-scale solar and batteries in the Inflation Reduction Act as "perverse justification to impose discriminatory fees on these assets." Instead, they requested "reasonable reforms."

Solar and storage companies are poised to adapt, by adjusting business models and by focusing on growing opportunities outside of California.

"If they make it anti-consumer here in California, we will shift our business elsewhere," Sunnova Energy International Inc. President and CEO John Berger said in an interview. The executive believes the reform ultimately will "still end up on the side of utilities," but said Gov. Gavin Newsom, who faces reelection in November, risks a potentially "tremendous negative backlash" if the decision goes too far.

'Point of crisis'

For Baker, whom Newsom appointed as the state's top ratepayer advocate in February, the need to forge ahead with an aggressive reform boils down to affordability and equity.

"We are in a period of relatively extreme rate inflation: Over the last 10 years, rates, depending on the utility, have increased by 50[%] to almost 80%," the state's top ratepayer advocate said in a panel discussion at the RE+ symposium and trade show. "We're beyond using rates as a means to push many of these policies. We just can't do it anymore."

The Public Advocates Office calculates that net metering is responsible for roughly 15% of the average residential rate for customers of the state's big three investor-owned utilities who do not have on-site solar arrays, including 25% for customers of San Diego Gas & Electric Co., Baker said.

The Sempra utility subsidiary, PG&E Corp. operating arm Pacific Gas and Electric Co. and Edison International's Southern California Edison Co. tallied the annualized "cost shift" at $4 billion as of June, according to a regulatory filing.

Because wealthier households are more likely to have rooftop solar, California's net-metering system, which currently awards payments for solar exports at the full retail rate, makes an "effective electricity tax" in the state "substantially more regressive," according to a University of California, Berkeley, paper released Sept. 22.

The report, co-authored by Professor Severin Borenstein, a member of the board of governors at grid operator California ISO, defines the effective electricity tax as the rapidly growing gap between retail electricity prices and the cost to the utility of providing additional electricity to customers. The report considers relying on the state budget rather than ratepayers to compensate rooftop solar — an approach Baker also supports.

But net metering is only part of the cost conundrum riddling California's power system, the report noted.

"There is a fundamental tension between the way that California pays for electricity and its stated goals of achieving decarbonization while fostering equity and ensuring that energy is affordable for all," said the UC Berkeley report. Escalating costs, caused by climate change and grid upgrades to support the state's broader ambition to replace fossil fuel use in buildings and vehicles with electricity, "are bringing the state to a point of crisis," it said.

Business model migration

Amid widespread expectations that net-metering payments for solar generation will drop significantly in coming years, solar and energy storage companies are innovating new uses for their technologies.

Sunnova earlier in September asked the CPUC for approval to function as a "micro-utility" operator of new solar-powered, battery-backed master-planned communities. The microgrids would be designed to work independently of the primary power grid or connected to it.

"I'm tired of being given lip service when I want my power bill lower and my reliability higher. And if you think you're gonna get that out of a monopoly, think again," Berger said. "That's why we have the Federal Trade Commission. That's why we bust monopolies up."

California's investor-owned utilities are exposed to some competition for retail electricity, including from about 12,000 MW of net-metered solar at homes and businesses. Moreover, local government-owned community choice aggregators, or CCAs, now purchase power for over 11 million residents, about a quarter of the state's population.

But utilities still deliver the physical power for CCA customers, manage billing and provide other services, and there remain legal obstacles for proposals like Sunnova's.

"This is crazy. I can't cross a power line, of no matter what size, across the property line because that's a monopoly right for [investor-owned utilities]," Berger said.

"That model has some merit to it," Enphase Energy Inc. founder and Chief Products Officer Raghu Belur said of Sunnova's proposal. The supplier of solar panel power electronics, energy storage systems and electric vehicle chargers has considered a similar concept. But Enphase is more focused on collaborating with network operators to provide grid services, including through software-controlled clusters of distributed energy assets, sometimes referred to as virtual power plants.

Whatever shape California's net-metering reform takes, "technology will find a way," Belur said. "There's value in the investments that have been made over the past 125 years. There's tremendous value in network effect ... but if push comes to shove, homeowners may choose [to go off-grid]."

Companies including Sunnova, Enphase, Tesla Inc., Shell PLC affiliate Sonnen Inc. and Sunrun Inc. are working on various virtual power plant projects to provide grid services that could help move small-scale solar in California beyond net energy metering. Such software-controlled clusters of solar-plus-storage systems showed their capabilities during a recent record-breaking heat wave, when tens of thousands of customers helped to keep California's lights on.

And that business model has only begun to emerge.

"We're not concerned about net metering," said Sunrun Vice President of Public Policy Walker Wright. The California Solar and Storage Association and the Solar Energy Industries Association in 2021 already proposed annual 20% cuts in solar export rates over five years, Wright noted. "We don't want to argue about the value of an exported electron at three in the afternoon on a July Tuesday. We actually want to keep that electron in the battery and we want to export it at peak when it's valuable to the grid."

Imposing new discriminatory fees on customers with solar and battery systems, however, could impede that, Wright cautioned.

"You can't have a cost shift conversation over here and ignore all the good stuff that these aggregations of customers can do for the ratepayers," Wright said.

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.