“So Myron, have you installed solar panels on your house?” I asked.
The answer was no: “I have these magnificent redwood trees, so that gives me trouble..”
Indeed, we performed a shading analysis on Myron’s house with Aurora. Shading from the trees prevented his roof from receiving enough irradiance to generate a meaningful amount of energy.
But we weren’t here to try to sell solar to Myron, or to convince him to chop down his magnificent redwoods. We wanted to get some insight into how economists think about buying solar installations for their homes. We were also looking for advice on solar business strategy and key economic indicators we should be following.
So on a sunny Monday morning, we sat down with Myron Scholes for a quick lesson on the macro- and micro- economics of solar.
Myron Scholes was awarded the 1997 Nobel Prize in Economics for "a new method to determine the value of derivatives." His famed Black-Scholes formula is used by investment bankers every day to calculate options pricing around the world. Myron is a lecturer at the Stanford Graduate School of Business and has been a long-time adviser to Aurora.
What is your take on the current US and global economy?
It does appear to me that the risks of inflation have increased, consequently there could be unanticipated surprise on the plus side of inflation, in the US and around the world. We’re seeing that many inflation type assets have tended to increase in price such as oil, or gold, which is an indicator of inflation.
There is a real belief in the markets today, regardless of the party that’s elected to the presidency in the United States, that in 2017, at least in the first months, we will see many bills going through congress that will either increase infrastructure spending in the United States, and/or have some form of tax reduction for the middle class so they can foster consumption.
All of these tend to lead to a stronger US economy in the short run with the proviso that the debt increase necessary to bring this about means that future generations will have to pay it back, other than through the possibility that the projects they invest in will actuate positive present value. If they are positive present value, they’ll be self-sufficient and sustainable, otherwise they won’t.
Given all of this, how would you advise solar installers to position themselves?
Being flexible at this time, especially with decision making. [Solar installers] don’t have large capital costs since they are providing things at the margin.
The question is how do you see [inflation] affecting the prices of the [solar] panels themselves. So they come from foreign countries. If China’s devaluing [their currency] and wanting to encourage their economy then they’re exporting the deflation… this makes the US Dollar stronger, which makes the cost of panels less. So it actually helps the importers more. If the US has the inflation to counter the deflation in China, Japan, then the benefit is to the solar panel installer.
Any other suggestions on how to manage a solar business today?
Through the power of technology, you can’t just say one shoe fits all. You have to figure out how to handle a whole cross-section of different clients and their needs, and be efficient in doing that.
Technology always moves down to the individual and away from the total. When [the solar installation industry] first started, there was just one panel, and now you’re getting more differentiation and that’s a force that will continue. Installers will have to really be aware of that force and realize you need different types of panels, different configurations, different ways in which you address the clientele.
And speed. Clients like things to be done quickly. The question is how do you create a business that allows you not only to quote bids but to also satisfy and fulfill them.
The whole technology world is moving away from a product-focused to a solutions focus in the true sense of the word. That’s something they will have to be aware off. We’re getting closer and closer to a bespoke world and away from a product world.
The business person always wants to think of it as one product. But the individual wants something that works for them, so there’s this fight: take this product it’s good for you.
In economics, it’s what [the customers] want that counts, not what they supply for you.
What does it take to sell solar to an economist?
The way I look at any installation is that it’s somewhat akin to buying a new car. It’s not whether you replace it, it’s when: should it be now or should it be next year?
And the way you think about that decision is that if the marginal cost of holding your car, holding your old power for one additional year is greater than the time-weighted cost of replacing, then you should replace.
There’s the cost of installing my solar panels, which is the fixed cost. I have the cost of the power itself plus the amortization of the cost of the panels over the expected life of the panel. You have to discount the same way that you do the mortgage on your house.
Each year you pay a mortgage, principal plus interest. You do the same with solar. You pay it down, period, such that at the end of its expected life, you’ve paid it off. And that’s the comparison of your marginal cost each year compared to the marginal cost of staying as you are.
So you can build a model very easily of which would show that. What’s the cost of your current power? What’s the cost of your solar power? And how would I amortize the cost of the panels over time such that at the end of the life of the panel I’ve paid it off and I can start over again. (Exactly how Aurora does it)
What have you been up to nowadays?
I’m teaching a class at the GSB called The Evolution of Finance.
Additionally, I’m building a new investment business where I am concentrating on how to increase the value of your terminal wealth conditional on wanting to have a limited drawdown, or how much drawdown risk one is willing to take. So it’s a whole different focus from the current focus of the industry.
The current debate is between passive-active, should you invest passively in ETFs or index funds or active in active managers. That’s completely the wrong analogy.
Everything is relative. Everyone likes: “How am I doing relative to everyone else in the investment world?” I remember the titanic and everyone on the top level of the Titanic drinking champagne, while people below were drowning, trying to get to the lifeboats.
Absolutes are more important in life, not relatives.
Any highlights of your career or what are you particularly proud of?
It might sound trite, but it’s true: I’ve always tried to give to students and others through what I know. That, I’m really proud of. It’s transferring my thinking either through research and papers and also transferring my thinking to students or others to whom I can transfer knowledge.
As you get older, you don’t only have theory, but you also have experience. The combo of theory and experience is very rich rather than either on its own. So I have a lot of theory and ways in which I think about a problem because I’ve studied them for a myriad of years. And on the other hand I’ve had a lot of experience and understand how things work and through that combination of experience I think I’m getting smarter and smarter over time. As I get smarter and smarter, it allows me to transfer that knowledge to others.
So I enjoy giving and that’s an important part of life.
Not the Nobel Prize?
I mean obviously if you get awarded the Nobel Prize don’t turn it down- it’s a wonderful thing. But sometimes what you do in life is in part luck, if you’re in the right time right place and obviously having the vision to see things that others didn’t see for a long time.
There’s two parts to life: one part of life is what happens all time and how you see this and what you do with all the mystery around you and how you add value.
The other part is the tails of the distribution. Go for the tails, don’t go for the middle.
Obviously not the bad tail. Avoid the bad go for the good. So many people in life just stay in the middle.