Seeking Alpha
Long/short equity, small-cap, tech, solar
Profile| Send Message|
( followers)  

In the next three articles, I will try to give you an introduction to the solar industry from both macro and micro points of view, as well as predict how the solar industry will look in the next few decades. I think the solar industry is in the midst of a historical turnaround, and market dynamics are changing fast. In late 2010, the solar industry tumbled into a chasm, and now it is climbing out. I think that in the mid- to long term, the solar industry will grow tremendously.

In this article, I will provide a brief introduction to the basics of solar technology. I will then describe the supply chain. Finally, I will discuss the supply and demand sides of the market.

Solar Companies' Gross Margins, 2010-2013 "The Chasm"

Source: SEC Filings.

As solar companies climb out of the above-mentioned chasm, they will meet a different solar market than the pre-2010 market. But before we get to the complicated task of thinking about the future, I would like to make you more familiar with the solar industry.

The Technology

Solar technology, also referred to as solar photovoltaic (PV) technology, requires the use of solar panels-but what are solar panels, anyway? You may have seen solar panels on houses or buildings over the past few years, as the global rate of installing solar panels has been growing at a steady pace.

Solar panels capture sunlight and transform it into electricity. They are made mainly out of polysilicon (I will not discuss CdTe solar technology in this article).

The process of manufacturing solar photovoltaic panels

Polysilicon is made from sand. Silicon is the second most abundant resource in the Earth's crust (after oxygen). In the Czochralski process, polysilicon ingots are grown.

Wafers are made by sawing the polysilicon ingot with a wire saw. In most cases, wafer thickness is 140-160 microns.

Cells are constructed by placing several layers on top of one another. P-type silicon is silicon with a positive charge (extra holes). N-type silicon is silicon with a negative charge (extra electrons). The process of altering silicon to be N/P type is called doping.

Modules are assembled by soldering cells together into strings. The strings are then connected to create a module.

Next, the modules are shipped to customers. The customers are usually rooftop/utility project developers, such as SunEdison (NYSE:SUNE).

Inverters are a very important part of any solar system. Inverters simply invert DC currents to AC currents, which can then be used for everyday purposes.

Efficiency

Although the Sun "washes" the earth with about 617,000 TWh of energy every day, we are only able to capture a fraction of it. To get the right perspective, I will tell you that over the entire year of 2008, the world consumed about 138,000 TWh. The electricity generated from solar energy in 2012 was about 123 TWh. If we could collect that energy and store it, we could solve most of the world's energy problems. (However, solar irradiation changes from place to place.)

(click to enlarge)

Today's technology enables us to use 20%-25% of the energy trapped in sunlight. R&D labs around the globe reached efficiencies of more than 40%. Unfortunately, commercial modules are still in the low- to mid-20s in terms of efficiency.

Important Metrics

Watt Peak (Wp) - Wp is the nominal power of a solar cell/module. This means that if a module rated as 120Wp is exposed to one hour of sunlight, it will generate about 120 Wh (watt hours) of electricity.

LCOE (Levelized Cost of Electricity) - This is the cost (usually per KWh) of electricity generated by different sources. It takes into account the useful life of a system, capital investment, operating expenses, fuel expenses, and more.

Conversions

1000 Watt = 1 Kilowatt

1000 Kilowatts = 1 Megawatt

1000MW = 1 Gigawatt

1000GW = 1 Terawatt

The Value Chain

Upstream and Midstream

The value chain in the solar industry is quite short. Polysilicon suppliers are at the top of the chain. Module manufacturers become mostly vertically integrated as they grow their own ingots, cut them into wafers, build cells, and assemble them into modules. A few companies purchase ready-made cells or wafers. The following list is not complete; it mentions only major companies. These are the major players in today's solar industry:

Company

What the Company Produces

GCL-Poly

Polysilicon and Wafers

Daqo (NYSE:DQ)

Polysilicon and Wafers

LDK (NYSE:LDK)

Polysilicon, Wafers, Cells, and Modules

OCI

Polysilicon

Hemlock

Polysilicon

Yingli Green Energy (NYSE:YGE)

Wafers, Cells, and Modules

Trina Solar (NYSE:TSL)

Wafers, Cells, and Modules

ReneSola (NYSE:SOL)

Polysilicon, Wafers, Cells, and Modules

Canadian Solar (NASDAQ:CSIQ)

Wafers, Cells, and Modules

First Solar (NASDAQ:FSLR)

Thin Film

JinkoSolar (NYSE:JKS)

Wafers, Cells, and Modules

Suntech (NYSE:STP)

Wafers, Cells, and Modules

SunPower (NASDAQ:SPWR)

Cells and Modules

JA Solar (NASDAQ:JASO)

Wafers, Cells, and Modules

Hanwha (NASDAQ:HSOL)

Polysilicon, Wafers, Cells, and Modules

Downstream

Company

Produce

SolarCity (NASDAQ:SCTY)

Distributed Energy

SunEdison

Developer

The downstream side of the solar value chain is divided into two groups: utility scale projects and rooftop projects. SolarCity pioneered a new segment in the solar industry called distributed energy. Instead of just selling and installing modules, SolarCity offers to install rooftop solar panel systems for its customers. The installation is free of charge, but the customer must sign a power purchase agreement (in short, PPA) with SolarCity.

Recently, more and more module manufacturers have been entering the downstream side of the industry. China's recent policy guarantees a feed-in tariff (FiT) for utility scale projects for a period of 20 years, thus making them a sound investment.

Utility Scale Solar Project.

The Supply Side

In 2010-2011, severe over-capacity in the industry caused module prices to plunge, thus pushing solar companies into financial chaos.

The polysilicon market is extremely oversupplied. According to SolarPVInvestor.com, the world has the capacity to produce about 550,000 metric tons of polysilicon, which translates into just over 100GW of module production per year. With polysilicon costs now above cash costs for many producers, I expect some Tier 2 and Tier 3 producers to exit the business in the coming years. Tier 1 producers like OCI, GCL-Poly, Hemlock, and others will be better positioned to take the market as demand continues to increase. I see just a modest opportunity for polysilicon capacity to expand in the coming years, and I expect most of the CapEx to go toward equipment upgrades, which will ultimately enhance profitability for the companies that will be able to afford them.

With the global demand for solar panels on the rise, the PV industry recently returned to profitability and a few companies have even shown double-digit gross margins. To determine which company is best positioned to capture value going forward, let's look at the industry's production capacity.

Company Rank

Company Name

Annual Capacity in MW

Capacity Share

1

Yingli Green Energy

2,450

3.61%

2

Trina Solar

2,400

3.54%

3

Canadian Solar

2,400

3.54%

4

JA Solar

1,800

2.65%

5

Hanwha

1,680

2.48%

6

LDK

1,500

2.21%

7

JinkoSolar

1,200

1.77%

8

ReneSola

1,200

1.77%

9

SunPower

1,200

1.77%

25

Suntech

600

0.88%

Rest of Market

51,455

75.79%

Total Supply

67,875

100%

Capacity data is module capacity. Source: Solarpvinvestor.com.

As we can see, the solar industry is highly competitive. Several companies have failed to cross the chasm and have gone bankrupt. The future of Tier 2 and Tier 3 companies is in question. The Chinese government has recently banned the expansion of capacity, thus limiting the industry to M&A. Some claim that Tier 2 and Tier 3 companies will become a "virtual fab." This means that market leaders will start OEM businesses, selling modules made by lower tier companies. The industry is still oversupplied, but demand is catching up, so a decision must be made soon.

The Demand Side

Demand has been increasing in recent quarters. After a rough 2012, demand is now expected to reach ~40GW this year, up from 32GW last year.

Source: EPIA Global Market Outlook for Photovoltaics, 2013-2017.

Most demand today comes from utility scale projects. Different countries around the world have various renewable energy policies in place. In the past, companies looked for subsidized markets, as the cost of generating solar power was higher than the local selling price of electricity. Today, in most parts of the world, solar power has a lower LCOE than local electricity prices. The situation in the U.S. is such that in most states, a solar project can be implemented and generate power in a lower cost than the retail price of electricity. It is true that coal and natural gas have a slightly cheaper LCOE than solar power, but if the externalities are taken into account (coal is estimated to cost the U.S. an additional 9-27 cents of external costs), it is clear that solar power is a favorable source of electricity.

The Case for a Utility Scale Project

I will focus on the U.S. market. Several solar projects have been built around the world, costing $1.20-$2.00 per watt. Every project cost per KWh varies depending on how many hours of sunlight the project gets. The lowest cost per KWh is about 5.8 cents (assuming $1.20 project cost per watt, and 5.5 sun hours per day). The highest cost per KWh is 11.4 cents (assuming $2 project cost per watt and 4.2 sun hours per day). Let us look at electricity retail prices around the U.S.:

Area

Retail Price

New England

13.97¢

Middle Atlantic

13.30¢

East North Central

9.46¢

West North Central

9.45¢

South Atlantic

10.02¢

East South Central

8.92¢

West South Central

8.49¢

Mountain

9.54¢

Pacific Contiguous

12.96¢

Pacific Noncontiguous

27.27¢

U.S. Total

10.34¢

Source: EIA Electric Power Monthly, August 2013 report. All prices are averages of residential, commercial, industrial, and transportation prices.

It is easy to see that there is a business case for building solar plants and selling the electricity back to the grid, even with no subsidies. With more countries offering convenient 20-year FiT plans, these projects get more visibility, making them easier to finance. A solar project with a 20-year locked FiT is a very predictable asset, delivering very predictable cash flows. With more module manufacturers getting into the downstream side of the market, they can see project costs in the $1.20-$1.30 (per watt) range, resulting in a KWh cost of 6¢-6.50¢. This can result in attractive Internal Rates of Return (IRRs).

In China, the leading country in terms of global demand for solar panels, a new policy was recently introduced. Under this policy, a FiT of 0.90-1 RMB (about 14¢-17¢) is offered to utility scale project owners. JinkoSolar and Yingli Green Energy have already taken advantage of this lucrative offer. Yingli recently demonstrated the IRRs it can achieve in China.

Source: Yingli Green Energy 2013 Analyst Conference.

To conclude, the demand side is characterized by a "push" strategy in which manufacturers push the end demand for their products, mainly by building and owning solar power plants themselves. Manufacturers can choose to sell projects to investors, but in the long run, it is more profitable for them to keep projects and sell the electricity they generate. Both residential and commercial customers have yet to "pull" solar panels in massive numbers. SolarCity is active in this area, and I think that if the value proposition is attractive enough, it will start seeing a greater number of homeowners demand rooftop solar systems, thereby freeing homeowners from the shackles of big electricity companies. Large utility projects should continue to perform as long as attractive returns are present. Countries around the world that want to reduce their dependence on fossil fuels-and their external costs-should continue to support FiT programs for solar project developers.

To Be Continued...

This article was aimed at making you familiar with the solar industry, the different players in the industry, and the current situation. The important points and questions you should take away from this article are:

  1. Polysilicon over-supply
  2. The value chain: Who are the players?
  3. What is the global supply situation?
  4. Where is demand coming from?

In the next article, I will discuss the future of solar module manufacturing, costs, and ASP trends, and where the industry is going. I will analyze solar companies' financial stability and try to determine who will show profits starting in 2014. Finally, the last article will be about my prediction for the next 10-20 years and why I think this is the time to get on board the "solar train" before it departs the station.

All investors should be familiar with the risks, and I will touch on these in Part 2.

Source: The Solar Revolution: Part 1