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Last year Barron's warned silicon producers would take a hit as a supply glut hit the market, but predicted thin film solar panels produced by First Solar (NASDAQ:FSLR) and Energy Conversion Devices (NASDAQ:ENER) - which use 97% less silicon - would remain solid.

Not any longer, author Bill Alpert says. The glut is far worse than most anyone expected, driving silicon prices from $450/kilo one year ago to about $100.

First Solar panels convert 11% of the sun's energy to electricity, vs. 20% for comparable non-thin panels. But the firm admits that its competitive advantage evaporates the closer silicon feedstock drops toward $50/kilo. FSLR will also have to bear the loss of a massive Spanish subsidy under which it was able to install 2.4 gigawatts at a 75% markup. A subsidy plan announced last week by China won't fill the gap, Alpert says. Some analysts say shares ($147) should rebound to at least $175, but this may prove too optimistic if the silicon glut continues to eat away at its margins.

Energy Conversion is even less fit than FSLR to deal with cheap silicon; its $3/watt electricity seemed cheap when the rest of the industry was at $3.50 - but now they're at $2.80. Two weeks ago, ENER shocked investors by pulling its guidance and suspending production expansion. Another factor impacting profits is ENER's liberal policy of recognizing sales as soon as panels are ready to be shipped - in an environment where contracts and price agreements are under heavy barrage.

The good news? Supply may outstrip demand by 50% this year and 75% in 2010 - which will help bring solar prices in line with fossil-fuel powered electricity. What's bad for the solar firms may be a coup for the environment.

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Zachary Scheidt thinks the markets underestimated last week's China announcement:

When you begin to understand the magnitude of this announcement, its actually only surprising that these solar companies didn’t jump more than 45%. In the coming weeks I expect that markets will continue to absorb this news and as a result solar stocks will move higher... much higher!

Meanwhile WSJ's Heard on the Street says the short-term excitement belies some key long-term risks:

The rush of companies entering panel production is reminiscent of the now oversupplied flat-panel and semiconductor markets. Companies in those sectors are losing money faster than they can raise it.

Source: Even Thin Solar Can't Weather Silicon Glut - Barron's