Distributed solar photovoltaic (PV) is a relatively small part of overall US electricity generation, at less than 1 percent of the total. But in 2012 installations of PV solar capacity reached 3,313 megawatts in the US, an industry record and an increase of 76 percent over 2011. Total solar installations in the US exceeded 90,000, including more than 83,000 in the residential market.

The global distributed solar PV market contracted slightly in 2012 due to reduced market activity in Italy and Germany. But growth in the US, China, Japan and other countries continued, driven by solar PV module price reductions, the growth of third-party financing models and the adoption of feed-in tariff policies.

According to a Navigant Research forecast, from 2013 to 2018 220 gigawatts of distributed solar PV will be installed worldwide, representing $540.3 billion in revenue.

The average price of PV solar dropped by 20 percent to $5.04 per watt in the fourth quarter of 2012 compared to the fourth quarter of 2011, and research by McKinsey & Company suggests PV prices will continue to fall, even absent government subsidies, as manufacturing capacity doubles over the next half-decade and underlying costs drop by as much as 10 percent annually until 2020.

Where third-party financing is available it’s proven to be popular with consumers. In California and Arizona, the two largest state solar markets in 2012, third-party financing accounted for more than 50 percent of new residential solar installations. The size of the third-party financing market, according to GTM Research, will grow from $1.3 billion in 2012 to $5.7 billion in 2016.

Feed-in tariffs ensure that anyone who generates electricity from a renewable energy source–including homeowners and businesses–is able to sell that electricity into the grid and receive long-term payments for each kilowatt-hour produced. More than a dozen US states have adopted some form of feed-in tariff over the past couple years.

Solar stocks have enjoyed renewed support in 2013, with the NYSE Bloomberg Global Solar Energy Index posting a year-to-date total return of 40.75 percent. That compares to 16.88 percent for the S&P 500 Index and 8.89 percent for the Dow Jones Utilities Average.

Publicly traded solar companies, including members of the Utility Forecaster How They Rate coverage universe Power-One Inc (NSDQ: PWER) and SunPower Corp (NSDQ: SPWR), are reporting improved sales numbers and better margins as well as sustained price increases after more than two years of declines.

Power-One and SunPower have actually outperformed the broader NYSE Bloomberg sector index, with 2013 total returns of 54.45 percent and 251.07 percent, respectively.

On April 22, 2013, Switzerland-based electricity-networks builder ABB Ltd (Switzerland: ABBN, NYSE: ABB) announced the acquisition of Power-One, which makes inverters that allow solar power to be fed into grids, for $6.35 per share.

Meanwhile, stocks of traditional US electric utilities, including venerable power generators American Electric Power Company Inc (NYSE: AEP), Duke Energy Corp (NYSE: DUK), NRG Energy Inc (NYSE: NRG) and Southern Company (NYSE: SO), are lagging the broader equity market rally.

AEP is up 10.66 percent this year, Duke 7.40 percent, NRG 13.70 percent and Southern Company 5.51 percent. Since hitting all-time highs on April 23 and April 25, respectively, however, Southern Company and Duke have slid more than 9 percent in price-only terms. AEP is off 8.71 percent, NRG 5.64 percent.

Myriad factors–including strong performances for these stocks through the first quarter of the year and into the second and subsequent consolidation of gains–contribute to recent weakness. In fact we continue to recommend Duke and Southern Company in the UF Growth Portfolio, as both have demonstrated the ability to build wealth for shareholders over time.

But compelling evidence is accumulating in support of the conclusion that the landscape is shifting rapidly for US electric utilities.  

For instance, the Energy Information Administration is projecting that electricity use in the US will rise an average of just 0.6 percent a year for industrial users and 0.7 percent for households through 2040. In the middle of the 20th century consumption grew by more than 8 percent a year. And these are unimpressive rates even compared to the years following the Arab oil embargo in 1973, when annual demand growth slowed to 2 percent to 4 percent.

But there are other tributaries to this confluence, starting with a January 2013 paper published by the Edison Electric Institute, the trade group that represents investor-owned US electric utilities, entitled Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business.

The paper also cites the declining price of natural gas, slowing economic growth trends and rising electricity prices in certain areas of the country that, in combination, could be “game changers” for the US power generation industry, with impacts on customers as well as investors and the availability of capital to fund future investment.

This paper, issued by a group whose interests are one and the same with the electric utility industry, focused on technological and economic evolution that will “challenge and transform” incumbents. What the EEI calls “disruptive challenges” are the function of several converging factors, including, most significantly, the declining costs of distributed generation and other distributed energy resources (DER).

The EEI paper notes:

Due to the variable nature of renewable DER, there is a perception that customers will always need to remain on the grid. While we would expect customers to remain on the grid until a fully viable and economic distributed non-variable resource is available, one can imagine a day when battery storage technology or micro turbines could allow customers to be electric grid independent. To put this into perspective, who would have believed 10 years ago that traditional wire line telephone customers could economically “cut the cord?”

In other words, EEI is imagining the beginning of the downward spiral from essential service to tired vestige for US electric utilities.

In March Duke Energy CEO Jim Rogers said, “If the cost of solar panels keeps coming down, installation costs come down and if they combine solar with battery technology and a power management system, then we have someone just using [the grid] for backup.”

If large numbers of customers start generating their own power and using the grid only as backup, the EEI report warns, electric utilities will suffer “irreparable damages to revenues and growth prospects.” And this is perhaps a fatal blow to a model that’s provided long-term and reliable dividends and growth for investors.

The cost investment in fossil-fuel-burning power plants, along with investments in grid maintenance and reliability, are spread by utilities across all ratepayers in a service area. But if ratepayers start generating their own power, growth and maintenance capital expenditures have to be spread over a smaller base. That means higher rates.

And that means more ratepayers will look to alternatives, including the installation of their own PV solar panels, which will look more affordable by comparison as rates rise. This is a vicious circle for electric utilities:

The financial implications of these threats are fairly evident. Start with the increased cost of supporting a network capable of managing and integrating distributed generation sources. Next, under most rate structures, add the decline in revenues attributed to revenues lost from sales foregone. These forces lead to increased revenues required from remaining customers … and sought through rate increases. The result of higher electricity prices and competitive threats will encourage a higher rate of DER additions, or will promote greater use of efficiency or demand-side solutions.

Increased uncertainty and risk will not be welcomed by investors, who will seek a higher return on investment and force defensive-minded investors to reduce exposure to the sector. These competitive and financial risks would likely erode credit quality. The decline in credit quality will lead to a higher cost of capital, putting further pressure on customer rates. Ultimately, capital availability will be reduced, and this will affect future investment plans. The cycle of decline has been previously witnessed in technology-disrupted sectors (such as telecommunications) and other deregulated industries (airlines).

Following the release of the EEI paper, in March 2013, during the MIT Energy Conference, NRG Energy CEO David Crane said his company, which is the largest independent power producer in the US and the largest provider to US utilities, would bypass its utility clients by installing solar panels on rooftops of homes and businesses. In future, but soon, NRG will offer natural gas-fired generators to customers to kick in when the sun goes down.

NRG owns all or part of 94 power plants and is the largest independent power producer in the US, with nearly 47 gigawatts of generating capacity. All but about 1.5 percent of its generating capacity is driven by fossil fuels. And it’s the largest provider of power to US utilities. NRG in many ways is the US electric power industry.  

A headline in the May 29, 2013, edition of The Wall Street Journal suggests that statements made by Mr. Crane may have captured the zeitgeist among US electric power providers: Utilities Weigh a Turn to the Sun. (The link is to the online version of the same story.)

The WSJ notes that executives at AEP and Southern Company, “seeing a potential threat to their business model on the horizon,” are considering “how and when they might enter the market for installing solar panels at businesses and homes.”

We are in the very early stages of a process that is likely to unfold much more slowly than the revolution in the telecommunications industry that now has millions of consumers cutting off completely from landlines and relying exclusively on mobile devices.

But electric utilities generate revenue by selling power. And demand growth is slowing at the same time options for consumers appear to finally be multiplying. The impact of even a relative few migrations to PV solar will be felt by ratepayers who must bear a greater burden to support capital investment necessary for capacity upgrades and grid improvements.

For his part, at least in his statements to the WSJ, AEP CEO Nick Akins is evaluating the challenge presented by distributed energy not as the beginning of the end of the US electric utility industry as we know it: “On its face you would look at it and say distributed generation is a threat. But on the other hand we see it as an opportunity because our business is changing. There’s no getting around it.”

AEP’s Ohio subsidiary has a 20-year power purchase agreement for solar energy with Turning Point Solar LLC, a joint venture of Agile Energy Inc and New Harvest Power.

Southern Company CEO Tom Fanning was similarly solution-oriented in his interview with the WSJ: “I think we should find a way to come to ‘yes.’ If this is a thing that customers want, we’ve got to find a way to meet their need.”

In November 2012 UF Growth Portfolio Holding Dominion Resources Inc (NYSE: D) operating unit Dominion Virginia Power received approval from Virginia’s State Corporation Commission (SCC) to build and operate a solar power demonstration project.

A total of 30 megawatts of solar capacity will be installed at different locations by leasing rooftops of commercial, industrial and public government buildings. Each installation will have a generating capacity of 500 kilowatts to 2 megawatts and will span a roof area of 75,000 square feet or more. The first, announced in early May, will be at Old Dominion University.

Dominion will spend about $80 million over 2013 and 2014 on 20 small-scale rooftop solar plants that will be able to power around 6,000 homes during peak daylight hours. The company will file a request with the SCC to charge its entire customer base for the cost of purchasing and installing the solar equipment as well as the leases it pays on the rooftop solar systems, plus a rate of return.

Management is of the mind that the proposal will save money for its Dominion Virginia Power unit because the extra power will reduce the need to pay for upgrades to its distribution system.

The future may not be now. But it is coming. And the survival of existing US electric utilities depends on their ability to adapt out of system that’s now nearly a century old.