The intent of the original California Net Energy Metering (NEM) legislation (SB 656) was to compensate customer-generators for electricity generated by installed solar that "offset part or all of the customer's own electrical requirements." In other words, the legislation did not intend for utilities to compensate customers for electricity generated in excess of the customer's electricity needs.
At each annual settlement date, customers would "use or lose" any Net Surplus Electricity (NSE) generated during the previous year.
In 2009, additional legislation was passed (AB 920) requiring utilities to compensate customer-generators for NSE, either by paying customers for NSE at a rate – called the Net Surplus Electricity (NSE) compensation rate – that is just and reasonable for the net surplus customer-generator but that does not create a cost for other bundled service customers, or by applying a kilowatt-hour credit that is rolled forward to the next year for that customer.
The Net Energy Metering cap
NEM was developed to encourage private investment in renewable energy resources. Palo Alto's original NEM program compensates solar customers for export electricity at retail rates. When customers are compensated for export electricity at retail rates, over the course of one year they may pay zero for the electric portion of their utility bills — even while using the grid — if the total amount of electricity that they import from the grid during the year is matched by the amount of electricity that they generate and export to the grid. In this scenario, a solar customer is using the grid as free electricity storage, and the cost of maintaining the grid is borne by nonsolar customers. For this reason, state law requires each electric utility to offer this original type of NEM only up to a certain amount of installed solar generating capacity (a NEM cap) within the utility's service territory. The NEM cap was set by California legislation (AB 510) to be “5 percent of the electric utility's aggregate customer peak demand.” The Palo Alto City Council determined the cap for Palo Alto to be 10.8 MW of installed solar capacity (Staff Report #7346).
As Palo Alto approached its NEM cap in November 2016, the City opened a NEM Reservation program to enable customers to sign up on a first-come-first-served basis (as outlined in CA legislation) for the City's original NEM (also called NEM 1) program. At the end of 2017, Palo Alto reached its NEM 1 cap. Starting January 1, 2018, new solar customers are served by the City's NEM 2 program.