# The Basic Principles that Guide PV System Costs

## Costs Associated with a PV System

In order to determine financial returns, it is important to have a solid understanding of the basic economics that dictate PV system costs. There are two general categories of PV systems costs: capital costs and operation and management (O&M) costs.

### Capital Costs

Capital costs refer to the fixed, one-time costs of designing and installing the system. Capital costs are categorized into hard costs and soft costs.

Hard costs are the costs of the equipment, including modules, inverters, and BOS components, as well as installation-related labor.

Soft costs include intangible costs such as permitting, taxes, customer acquisition costs, etc.

Figure 1. Cost breakdown of PV systems. Source: B. Fiedman, et al, “Benchmarking Non-hardware BoS Costs for US PV Systems, Using a Bottoms-Up Approach and Installer Survey,” National Renewable Energy Laboratory, Second Edition, December 2013.

Figure 1 illustrates the relationship between soft and hard costs, and breaks down hard costs into its components. According to SEIA, while hard costs have come down dramatically over the last decade, soft costs have remained largely constant.

### Operation and Management Costs

O&M costs refer to costs that are associated with running and maintaining the system. These can include fuel, repairs, and operation personnel. PV systems generally have low O&M costs.

## Incentives and Policies that Benefit Solar Energy

The high capital costs are one of the biggest factors that discourage people from going solar. To combat this, there are a number of incentives and policies in place to make PV systems financially competitive.

### Cost-Based Incentives

Cost based incentives, such as the Solar Investment Tax Credit (ITC), allow those who invest in a solar system to apply a tax credit towards their income tax. The incentive is determined by the cost of the system, and is independent of its performance.

### Performance-Based Incentives

Performance based incentives (PBIs) encourage PV system owners to install and maintain efficient systems through payments that are based on the monthly energy production of the system.

### Net Energy Metering

In addition to incentives, many states, such as California, implement a net energy metering (NEM) policy that allows consumers who generate excess electricity to be reimbursed at the then-prevailing rate of electricity. For instance, if a residential PV system produces an excess of 100 kWh over the course of the month, the owner will be reimbursed for 100 kWh at the market rate of electricity for that time period. The owner is then free to use that reimbursement credit towards electricity they consume from the grid when solar is not meeting their current energy load. Therefore, households with solar PV and NEM are able to significantly reduce their electricity bill.

Figure 2. Visualized relationship between PV energy production and household electricity use for an average home in New South Wales, Australia. Source: solarchoice.net.au

Figure 2 shows the relationship between PV electricity production and electricity consumption during the day. Note that while the PV system can generate more than enough electricity during the daytime, it can fail to deliver electricity during peak consumption hours.

## Basic Financial Calculation for a Residential PV System

In return for a large upfront investment in a solar installation, homeowners that go solar benefit from a reduced monthly electricity bill. Thus, for NEM regimes the benefit of solar comes in the form of avoided costs.

For instance, assume that upon installing a rooftop PV system, a home electricity bill is reduced by $1,500 per year and the cost of the hypothetical PV system is$10,000 after incentives. In order to calculate the simple payback period, which is the approximate time for a PV system to pay for itself, we divide the cost of the PV system by the savings.

Simple Payback Period=System Cost / Annual Savings
=$10,000 /$1,500/year=6.7years

Thus, the payback period for a system that costs $10,000 and reduces the electricity bill by$1,500 per year is 6.7 years.

However, a PV system can last much longer than the duration of its payback period. A typical rooftop PV system has a lifetime of about 25 years. This means that for the last 18 years of its life, after it has paid itself off, the hypothetical PV system described above will generate revenue in the form of additional savings. To calculate this revenue, we multiply the annual savings by the remaining lifetime of the system, after it has paid itself off.

Net Revenue=Annual Savings×Years left in lifetime after system is paid off
=$1,500/year×18.3 year=$27,450

Based on this simple analysis, the system will generate approximately $27,450 in savings over its lifetime. It is important to note that this is an approximation, and does not take into account factors such as maintenance costs, changes in electricity price and usage, as well as system degradation over time. The figure below shows another financial analysis for a hypothetical residential PV system. In both graphs, the y-axis is the dollar amount and the x-axis is the year. Figure 3. The cumulative (top) and annual (bottom) cash flows of a hypothetical PV system. Source: Aurora Solar The top graph, which shows the cumulative cash flow of the project over time, and indicates that the project has a payback period of approximately four years. Additionally, the dollar amount in the 25th year, which is about$25,000, is the cumulative net revenue that the system generated. The bottom graph is the annual cash flow of the project. The first year is characterized by a large negative cash flow, due to the large upfront cost required to install the system, but after that there is positive annual cash flow with the exception to this is in the 14th year, which is when the inverters are being replaced.

### About Solar PV Education 101

The Basic Principles that Guide PV System Costs is part of Solar PV Education 101, a six-article series that serves as an introductory primer on the fundamentals of solar PV for beginners.