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One of the harder things to write about, for me, is regulatory or political risk. It can always be somewhat delicate to bring analysis of government and policy into a discussion that is meant primarily to be about numbers and investing. Inevitably, such debates become more difficult when the cold but fair implacability of free market forces gives way to discussions of morality and what “ought” to be done, as of course it must when we are debating our values as a society.

Certain industries, however, are natural monopolies, and it just isn’t possible to make a fair assessment of their risk profile without discussing how the government is regulating that industry and how such regulations might change. The electric grid, in which Florida NextEra Energy (NYSE:NEE ) is the key player, is one such industry.

And to be fair, this time, they started it.

NextEra Energy just got an upgrade from KeyBanc, so as usual I’m taking a somewhat contrarian position. But I don’t read recent developments in energy policy as favorably as KeyBanc does for NextEra. In fact, some of NextEra’s own policy preferences could harm their prospects.

For the past few months, in two key solar power states, Florida and California, legislators have been considering proposals - pushed hard by NextEra’s Florida Power & Light in Tallahassee, in particular, though in Sacramento it’s a bit more of a group project between Pacific Gas (PCG) and Edison International (EIX) along with some smaller players - to fundamentally alter the net metering system. These proposals have been defended by supporters as necessary to remedy what they argue are fundamental moral inequities in the system that require low-income families who can’t afford solar panels to subsidize rich solar homeowners. “Solar welfare” is just one of the shorthands being thrown around.

These proposals include a shift from retail to wholesale pricing for the surplus power that solar owners export back to the grid as well as a new fixed fee for solar owners, dubbed a “solar tax” by opponents, that would compel those who have solar panels on their roof - and only those ratepayers - to pay a new fee of $8 (California) or potentially more (Florida) per kilowatt of solar capacity for connecting to the grid.

The proposals have been highly controversial, much as I suspect my interpretation of them is about to be, and already its sponsors are toning them down somewhat to try to mute opposition. So the first key point is simply to reiterate that, at least in California, this is, for now, only a potential threat to utility stocks, and its quite possible that political opposition means it simply doesn’t happen. But in Florida, the bill received final approval from the state legislature last week and now goes to the governor.

The thesis of this article is forward-looking and extrapolative, not something that is already happening, and for that reason as well as others I’ve no doubt it will prove provocative, as a lot of my regulatory articles have been.

But at least it is also simple and easily stated: I believe that this latest initiative by electric utilities companies themselves - which of course was not something forced on them by environmentalists or consumer groups - has the potential to backfire stupendously on them, and perhaps pose a threat bordering on the existential.

And yes, I recognize that is a very provocative statement.

But if utilities themselves are the ones pushing these changes, why do I think they’re so dangerous?

Net metering is widely seen as a subsidy because it pays full retail rate to homeowners, leaving nothing to cover the fixed costs of the electric grid, which are typically around 43% of the average bill. With most panels sized to cover virtually the entirety of a home’s energy usage, solar homeowners can end up taking their bills down to almost nothing.

This story, of a Florida homeowner who saw their bill drop from $350 to $10 after solar was installed, is hardly atypical. So people assume that solar homeowners are “free riding” because they stop paying, but the fixed costs of the grid aren’t going down.

But this isn’t quite right, by the numbers.

In the absence of a legal or contractual mandate to sell to the grid, in order to secure voluntary sales, the lowest price a utility can offer to buy excess energy from a homeowner is the rate they sell it at, minus the cost to the generator to store it.

The reasons for this should be fairly obvious. The heart of net metering is an arrangement whereby a house which generates extra solar power in the daytime, beyond what is needed, sells that excess back to the grid, and in turn buys power from the grid at night when the sun isn’t shining but various household appliances still need running.

But of course, an electric grid is not the only way to do that. Instead of sending and receiving the excess power, the homeowner also has the option to simply store it in a battery, then use it themselves later. And given the choice between the two, the consumer - or “prosumer” as some call it - should pick whichever option is cheaper. So the “subsidy” from the utility amounts to whatever the cost of that storage is. The subsidy is the "free storage" the customer got by sending the kWh back to the grid and getting another one later, and no more.

And that cost has fallen quite a bit since net metering was first implemented.

We can show that with a little math. The math here will be a little oversimplified, but nothing in the finer details we’re skipping over is large enough to materially alter the conclusion. What I am going to do is simply calculate how much it costs to store a kWh of energy in the average American home.

To start with, we take the 2021 cost of a kWh of lithium-ion battery storage capacity. We’re barely out of 2021, of course, but early reports have it at $132 per kWh. Currently, its true that home batteries such as Tesla’s (TSLA) Powerwall+ are selling for almost five times that, but that seems to be mostly a function of demand outracing supply as prices were barely half as high five years ago, when battery costs themselves were substantially higher than they are now. So that is not a long-term price imbalance that grid operators can count on.

It seems reasonable to assume that home batteries will be designed in such a way as to minimize the cost per cycle over their lifespan. As I noted in my research a few years ago, battery makers are increasingly designing batteries to cycle from 100% of charge to 20% instead of all the way down to zero. While this necessitates a 25% larger battery for the same discharge capacity, it also greatly lengthens the life of the battery, thereby reducing cost per cycle significantly. My research in 2017 showed that a lithium battery with a 20% charge floor could last for 10,000 full-cycles. There may well have been improvements since then, but I will use that figure. If we were a little too aggressive with our price estimates for the battery cells themselves, this should help cancel that out.

Now we simply combine these two numbers. A battery which can store a kWh 10,000 times before being exhausted amortizes its $132 cost over those 10,000 cycles. That puts total storage costs at 1.32 cents per kWh stored. There will be a little bit of loan interest on that, and we will not deduct the 26% tax write-off the federal government gives to batteries installed with solar panels. Let’s call it 1.5 cents per kWh all in.

In order to compare that storage cost to the fees being proposed, we need to plug in the average electricity consumption of the average American home. That was around 900 kWh per month in 2021, not too far from where it’s been the last few years.

Now, let’s go really crazy in the utilities favor. Let’s assume that every last kWh a home consumed had to be stored first, even though a lot of electricity consumption happens during the daytime and comes straight from the solar panels, bypassing the battery and reducing wear and tear on it. At 900 kWh per month of cycling, a home is spending $13.50 on storage. The fee being proposed in California for a typical 6 kW system comes to over three times that. If we chop the amount of energy being stored to half of total consumption, the fee is seven times what customers can pay in monthly battery costs to simply leave the grid behind.

It is certainly possible to tinker with these numbers a little, but the final conclusion is clear: the fees utility companies are proposing to charge are utterly out of line with market fundamentals by a multiple of several, except perhaps in the least sunny parts of the country where solar power is least disruptive to the existing system and the fees are therefore least necessary. In other words, places that are nothing like California or Florida, where the fees simply look ludicrous.

Utility managements won’t say so out loud, but they seem to think investors shouldn’t worry about this, for one simple reason: is almost all states, it is actually illegal to disconnect from the grid. Or at least, we think it is: the laws tend to be rather vaguely written. But most lawyers who look at them tend to come down on the side of, “if you try to cancel your power completely, you’ll probably be convicted in court.” They don’t say so openly, but the working assumption seems to be, among both management teams and industry analysts, that if fixed fees are levied all customers will have no choice but to pay.

At present, there is little effort under way to change these laws…but it seems to me that the reason for that is precisely because of the current net metering system. The volumetric nature of current electric grid billing - with no fixed fees - makes mandatory connection an ultimately financially harmless requirement for homeowners. In other words, mandatory connections tend not to be controversial right now because of the absence of fixed fees. Yes, the government requires you to connect to the grid, but you don’t have to actually pay to be connected. You only pay for the power you use, and how much you use is up to you.

The new proposals will fundamentally alter this dynamic, and in a way I can’t help but feel is almost guaranteed to kick up a huge storm. What the new proposal envisions is essentially forcing solar customers to pay a monthly fee to the grid and leaving a sort of vague, half-baked, but plausible threat of jail if they try to walk away from the grid entirely.

This seems especially true considering that the lack of fixed fees has been held forward even by defenders of current law as justifying mandatory connection. Even in Florida, historically among the most hostile to standalone electricity, the defendant actually won on two of the three counts, though one victory for the state was enough for her to be found in violation, fined and ordered back to the grid. Among the arguments the city put forward to justify their decision? She only had to connect to the water/power grid, “she does not have to use it.”

The Obamacare mandate debate, which created a massive political firestorm and sent not one, not two but three major cases all the way to the Supreme Court, had nothing on this. Regardless of what you thought of the individual mandate, it at least could claim to be economically justified as an attempt to prevent free-riding: the Congress didn’t want people waiting until they got sick to get insurance. By contrast, solar power customers are by definition fully prepared to pay the cost of their own energy; they’re not free-riding on anyone.

So this will look a lot like a racket, a government-sanctioned scam; forcing someone to sell something valuable to a company and then buy that same thing back from the company later for four or five times the initial selling price.

My guess is that this almost has to produce a massive uproar, of a kind almost guaranteed to provoke a policy change. If that policy change is simply reinstating the old net metering system minus a 1.5 cent per kWh carrying charge, NextEra can simply shrug and say they tried, no harm no foul, and at least they’ve got a little discount now.

If, however, that policy change is to leave the new net metering scheme in place, but clarify a customer’s right to grid defection, the utilities haven’t “no harmed” on their foul. They haven’t even given the other team a penalty shot. They’ve positively put the puck in their own net - pardon the mixed sports metaphors - in game seven overtime. The departure of solar homeowners would require raising prices to distribute fixed costs over a smaller customer base; which would induce further defections; which would produce still further price hikes and start the process all over again, similar to what is happening to the cable industry.

This article is focused on NextEra and Florida, but much the same analysis could be applied to any other utility that tries to enact a fixed fee. The key variable, since solar panel and battery costs don’t change that much, is how much sunlight a given utility’s territory gets and by extension how easy it is to simply leave the grid completely with a panel and battery. More Sunbelt focused companies like Southern Company (SO) will presumably face more risk that more northerly operators like Dominion Energy (D) don't, but any large fixed fee has a much greater chance of driving grid defection now - again, assuming mandatory connection repeal - than ten years ago simply because of how much battery costs have come down.

At one point in time, net metering was indeed a massive subsidy for the solar industry because it offered a retail rate for power when battery storage of that power for later use was prohibitively expensive, and solar owners would presumably have been willing to sell it for far less. Now, however, the subsidy net metering offers solar is vastly diminished, albeit not eliminated entirely. While one could make an argument for eliminating the remaining subsidy, even just the lower rates per kWh that the utilities in many states propose to offer would result in a new subsidy from solar owners to the grid, which would almost be reason enough to defect right there. But the real issue will probably be the fixed fees, which in any reasonably sunny locale will make grid defection the clearly financially superior option for a solar residence.

Of course, if NextEra successfully fights off attempts to repeal mandatory connection laws, this won’t be a problem. But it seems to me that to simply assume repeal efforts won’t get off the ground, as everyone currently seems to be, is not an accurate assessment. In my opinion investing in NextEra just became somewhat more risky than it was when the old “wasteful” net metering system was in effect.

I am avoiding NextEra stock, though I am not currently contemplating a short.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.