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Summary

  • The solar industry is entering its next growth phase.
  • This time, growth is healthier.
  • Investor sentiment is changing.

Understanding the solar industry is key to understanding investor sentiment in the sector. This is important because that sentiment causes the high volatility in solar stocks. This article will bring you up-to-date about how we got here and where the market may move in the future, so you'll have the feel of the trend you're investing in.

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Figure 1, above, shows the global cumulative solar (PV=Photovoltaic) installations up to 2008. As is plain to see, the market grew slowly, but exponentially. Figure 2, below, shows the global annual installations up to 2013.

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As you can see, the annual installation suddenly spiked in 2008, 2010, and 2011. In 2012, the market experienced a tough year, which I will explain shortly.

The Chinese Are Coming!

In 2006, the Chinese, after drafting their 11th 5-year plan, decided to tackle the global solar industry. Pouring unimaginable amount of money to the industry, they intelligently built the entire eco-system of the industry domestically, including the Chinese Polysilicon industry. That is relevant to the global market from a price point of view. While the Chinese were busy building massive production capacity and penetrating global solar markets, supply outgrew demand, creating a huge supply glut. That sent solar panel prices diving down. Suddenly, solar started to make more and more sense from an economic standpoint. The EU, led by Germany, pursued aggressive targets to bring renewable energy as a substantial source into the energy mix. Between 2005 and 2010, solar prices were still relatively high, so in order to reach their targets, the EU governments offered bloated subsidies to solar project developers. At the same time, the extreme price reduction presented an attractive investment opportunity to those EU project developers, which caused installations in Europe to skyrocket.

The European Subsidy Shock

Back in the 2011-2012 time frame, the EU countries started to cut subsidies for solar. That was the almost direct result of:

  1. The EU debt crisis, which led many countries to fasten their belt on government spending
  2. The dramatic decrease in panel prices, which brought extraordinary profitability to project developers

The attractive subsidies, especially in Germany, created an artificial and ineffective EU solar industry. The minute subsidies were cut, company after company, the EU solar industry collapsed. Hardly any of the European companies were built to handle the competition from the Chinese industry, which used its economy of scale to offer a much lower price.

The subsidy shock caused demand from Europe to decrease in 2012 and again in 2013. But, as you can see from the chart above, demand from China, the Americas, and Asia more than offset that.

Swanson's Law and Grid Parity

So what's pushing demand for solar panels higher? The answer has two parts. The first is attractive ROI for solar project developers, given the decreasing cost of building such projects. The second is the ability of governments to develop their renewable energy markets without offering huge subsidies.

When producing electricity from solar energy costs the same as producing electricity from other conventional sources, this is called grid parity. Now I'd like to introduce you to a law, or observation, in the solar industry.

Richard Swanson, the founder of SunPower, made an observation which was published a few years ago. His law says that with each doubling of cumulative shipped volume of solar panels, the price decreases by 20%. The next chart illustrates Swanson's law.

At current prices, there are several examples of solar projects around the world able to profitably sell electricity to the grid at market prices.

All of the above lead to a renewed boom in solar installations. But this time, it's not led by artificial subsidies, but from a more economic sense. You might ask why governments support solar energy and how far will they go with doing so. Great question, and I'll answer it with a separate article.

The Future of the Market

Looking into the future, some, such as the IEA (International Energy Association), think that by 2060, 30% of the world electricity generation could be coming from solar energy (including water heaters). That figure came from the most conservative organization out there. According to my research (which I will continue to share with you as we go), the annual installation level could grow 3-4 times in the next few years.

I believe that now, when the market is fueled by real economic incentives and not by artificial subsidies, that future looks very feasible. According to recent reports, today, only 0.6% of global energy is supplied by solar energy. That means almost 60 times more solar energy will be used over the next 45 years. Any way you look at it, the current conditions are set up for massive growth in shipments for decades to come.

Investor Sentiment

Now that you are aware of the key factors in the solar market evolution, you can understand the sentiment of solar investors. Let's take a look at the profitability of different solar manufacturers in recent years.

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Starting in 2011, gross margins started to take a dive. Prices plunged, while cost reductions, although impressive, were not enough to maintain pre-2011 gross margins. That translated into massive losses for the solar companies in 2011-2012, which translated into stock price declines.

Many investors got burned, and the general view about solar turned very negative. When investor sentiment gets that negative, it takes time for it to change. The year 2013 got many investors excited about the industry turning back to profitability, but it was a bit too soon and a bit too fast.

Don't be mistaken, the sentiment will change, and signs show the change is already underway. Think of a big Wall Street institution as a large ship. When Wall Street spots the same changes in the industry as you, it takes them a long time to turn the ship in a new direction. But we, as individual investors, can move as fast as a fly changes his flight path.

This enables us to intelligently invest in solar and beat the street to it. It will take time, but the sentiment is changing and the market is evolving.

Source: The Solar Market Evolution

Additional disclosure: The photos in this article are from the EPIA.