It is always useful to invest when you have strong trends as a tailwind. That doesn't solve all your investment problems, but it helps a great deal. We think that with investing in solar energy companies, you'll have strong trends as tailwinds. In essence, solar energy is ready for the big stage and here are some of the trends that are blowing in its favor.
Solar grid parity
It's no secret that solar energy is getting ever cheaper but it's always instructive to show with what kind of speed this is actually happening:
This is simply the combined effect of hundreds, if not thousands, of labs and plants working on, and improving:
- Economies of scale
- Improvements in design, materials, organization
- Increases in cell efficiency
- Lowering cost of mounting
These are the more gradual improvements, although collectively they've produced enormous gains that aren't likely to come to a grinding halt anytime soon. Grid parity is already a reality in some parts of the world, according to Deutsche Bank:
Deutsche Bank said the dramatic fall in the price of solar panels to between $0.60 and $0.70 per watt - lower than thought possible five years ago - has already rendered solar power competitive "without subsidies" in Japan, South Korea, Australia, Italy, Greece, Spain, Israel, South Africa, Chile, Southern California, Hawaii and Chile... These regions could be joined within three years by Thailand, Mexico, Argentina, Turkey and India, among others.
Then there are hundreds of labs working on more radical break-throughs that could produce more sizable (but one-off) improvements (a fraction of these possibilities can be read here and here). Just as an example, many labs are working with materials called perovskits (see here, and here). Other innovations deal with some of solar energy problems:
Los Alamos - home of the Manhattan Project - is working on smart grids and better ways to capture excess electricity produced in peak sunlight hours. The Argonne labs are working on thermal energy storage to overcome "intermittency", the curse of solar and wind. Oak Ridge is testing coatings that increase durability of solar panels eightfold. The National Renewable Energy Laboratory is working on a CO2 power cycle that could achieve 90pc thermal efficiciency and does not require water, transforming the propects of desert solar. [The Telegraph]
Panel costs are often no longer the main cost, and the enormous differences in installation cost (even amongst advanced nations where labor costs are comparable, installation costs in Germany are half those in the US, for instance) suggest there is much room for improvement here as well. Indeed, the US Energy Department expects the cost of solar power (including installation cost) to fall by 75% in this decade to between $1 and $1.50.
Of course, prices are relative and while the most dire predictions about peak oil haven't panned out, what is fairly certain is that extraction costs are ratcheting up. At present we use up cheap oil reserves and replace them with expensive ones while solar energy is getting ever more cheaper.
The achievement of scale economies is largely thanks to early adopter Germany, the first big solar market in the world. Being a first mover can bring disadvantages, and this situation isn't an exception. Basically, by being a first big adopter of solar energy, Germany has suffered two disadvantages:
- High cost of energy
- Intermittency that creates problems for the electricity market
When Germany built large scale solar energy in the first decade of this century, solar panels were at least 4x as expensive as they are today, and generous subsidies were required (via the so-called feed-in tariff or FIT). The result of this situation is that Germany has high electricity rates that alarms industry.
However, because of the collapse of panel prices, this disadvantage isn't likely to repeat itself elsewhere, at least not to anywhere near the same extent, see for instance how the price of FIT contracts have declined:
A key tool in the renewable energy law (Erneuerbare-Energien-Gesetz, or EEG) is the well-known feed-in tariff (FIT),which requires utilities to accept power from independent generators. The price is set by regulators, according to the cost of each renewable technology. This predictability results in low-risk financing, which lowers the cost of capital-intensive renewables. But because the FIT guarantees producers a fixed payment over twenty years, past higher costs for renewables persist -- and add up. A homeowner with a small rooftop solar system who signed a FIT contract in 2009, for example, will be paid 43 cents per kilowatt-hour through 2029. The rate for a similar system installed this past January fell to 13.7 cents. [Greentechmedia]
Unfortunately for Germany, it's stuck with a backlog of these expensive FIT contracts which cannot be unwritten (or even adjusted), but countries only now starting in earnest can easily avoid this.
But there is another problem that is also serious and is produced by the intermittent nature of solar power. In certain situations this can actually be a benefit, producing most energy just when demand is peaking in areas where there is lots of sunshine and heat, and lots of running aircons as a result.
However in more temperate climates, where the sun can disappear for days, the intermittancy really is a problem. SA contributor John Petersen has summed it up:
The costs utilities pay to smooth and stabilize the filthy electric current from residential PV solar and provide standby facilities for the inevitable cloudy, rainy, gloomy days are huge. Sadly, the residential PV system owners who created the instability in the first place do not pay the costs of intermittency abatement. Instead, those costs are simply folded into the rate base and paid by the utility's other customers. It's a great deal for the PV solar system owner and abusive for all other users of electric power.
In Germany, where distributed energy (from solar and wind) comprises 20% of electricity production, this can lead to serious problems for utilities:
It is not uncommon for electricity prices to drop to zero on days where solar energy production is high and consumption is low. [Hydrogenfuelnews]
The business model of utilities can become problematic as a result, here is Barclays:
Electric utilities… are seen by many investors as a sturdy and defensive subset of the investment grade universe. Over the next few years, however, we believe that a confluence of declining cost trends in distributed solar photovoltaic (PV) power generation and residential-scale power storage is likely to disrupt the status quo. Based on our analysis, the cost of solar + storage for residential consumers of electricity is already competitive with the price of utility grid power in Hawaii. Of the other major markets, California could follow in 2017, New York and Arizona in 2018, and many other states soon after. In the 100+ year history of the electric utility industry, there has never before been a truly cost-competitive substitute available for grid power. We believe that solar + storage could reconfigure the organization and regulation of the electric power business over the coming decade.
Petersen (in the article cited above) goes as far as to call solar energy a scam and he lists four ways in which it is used to game the system, dumping its costs on others. This might have been true before, but with falling costs this is getting much less serious. Here is Markus Hoehner, CEO of Hoehner Research and Consulting Group:
As Hoehner put it, while the solar industry in the era of high feed-in tariffs was "all about making money," the new era of falling feed-in tariffs and falling solar panel prices has shifted the emphasis: "It's all about saving money," he said. [Greentechmedia]
Petersen himself has to admit that energy storage can resolve this issue:
With a stunning record of four abject failures on four tests of fundamental fairness, there's a very good argument that residential PV solar is more trouble than it's worth, unless the owner acts responsibly and adds enough storage to abate his intermittency.
So energy storage could take away most of the solar problems and Petersen argues that energy storage is destined to become an investment mega-trend that will "endure for decades." He simply thinks batteries are not ready yet. Others disagree, like Barclays (see quote above).
In fact, Barclays is not the only institute which argues we're on the edge of storage grid parity. Analyzing the German market, the observation from Germany Trade and Invest:
Electricity prices are rising and solar PV prices are falling, which means that if battery storage falls to around €0.20 per kilowatt-hour (U.S. $0.27), parity will be achieved.
We reproduce the graph below:
Australian investment firm Morgans, in an assessment of Brisbane-based battery storage developer Redflow, suggests that company's zinc-bromine flow battery may already be commercially economic in Germany, the country that leads the world in terms of household adoption and government support for renewables.
If it's competitive in Germany, it should be competitive elsewhere as Germany isn't exactly the sunniest country that comes to mind (although they do have high electricity rates, setting a low bar for solar to jump over to become competitive).
And once again Germany takes the lead in moving forward with solar + storage, although so far with limited success. In part this is due to the complexity of the subsidy system set in place last year. Morgan Stanley also argues solar + storage is on the brink of breaking through:
Morgan Stanley projects that an average residential utility customer in California would be paying $.26/kWh for electricity in 2020. But, says Morgan Stanley, by 2020 Californians should be able to go completely off-grid with a solar/storage system for 10 to 12 cents per kilowatt hour. And the off-grid solution has the added benefit that when the grid goes down, your home or business won't. [Cleanegroup]
So solar + storage could become competitive fairly soon in some parts of the world, but this depends also on progress in energy storage. Once again, capitalism enlists the distributed intelligence of many players seeing a market opportunity and trying to push the envelope. Already at the 2012 Intersolar conference:
Energy storage solutions were on display from 140 companies [Greentechmedia]
And there are many more. Who wants to bet against somebody somewhere figuring it out and producing a storage solution that is significantly cheaper than those available today? Actually, Petersen is one who doesn't believe in energy storage breakthroughs:
We can expect slow incremental progress, but the game changing "Moore's Law" advances we enjoyed in information and communications technology are not going to happen in energy storage.
Who knows? There are indeed certain chemical laws that make breakthroughs in storage less likely, but there are hundreds of labs nevertheless trying to produce meaningful gains. Tesla (NASDAQ:TSLA) argues that significantly lower costs simply come from producing on a vastly bigger scale.
Moreover, few argue that solar costs won't keep falling for the foreseeable future and we should stress that it's the combination of solar and storage that is relevant here, not just storage cost alone.
Perhaps it's useful to be reminded how far lithium-ion batteries have come already:
lithium-ion batteries have a fifteen year history of exponential price reduction. Between 1991 and 2005, the capacity that could be bought with $100 went up by a factor of 11. The trend continues through to the present day. [Nextbigfuture]
While perhaps not quite a Moore's Law improvement, it's still mightily impressive. Tesla's batteries have decreased in price from $500/KWh in 2008 to $250/KWh for the Model S to potentially $125/KWh at the gigafactory. And there is plenty of promising stuff going on in labs around the world improving energy storage (see here for a small selection), things like:
Cheap energy storage from flow-batteries (a Harvard research project funded by the US Advanced Research Projects Agency) will soon overcome the curse of intermittency, letting us absorb the sun's rays by day and release them again as heating and light overnight. [The Telegraph]
A new nanotechnology that doubles the life of smartphone, laptop and electric-vehicle batteries even after being charged and discharged more than 1,000 times has been developed by researchers at the University of Limerick. The breakthrough means the research team could be tapping into a market estimated to be worth US$53.7bn by 2020. [Siliconrepublic]
These are just a few examples out of many. Lest we forget, energy storage offers another advantage, cutting grid dependence entirely.
Needless to say, most of the investment implications are longer term, but we see five categories of companies affected by the trends:
- Solar panel makers and installers
- Smart grid companies
- Battery makers
- Fossil fuel companies
Not surprisingly, if storage takes away the main disadvantage of solar panels and prices keep on falling as they have done, we haven't seen anything yet. Demand for solar panels will simply keep expanding and this expansion could very well accelerate. At present, a tiny fraction of world energy production comes from solar (0.3% or so). This is a bit higher for electricity generation, but the scope for growth is enormous.
Investors should keep a keen eye on the supply/demand balance, as capacity has a habit of getting ahead of itself, producing downturns and rationalization. We just experienced a rather epic episode of this in the last three years.
Because of the near commodity nature of solar panels, we prefer to go with either well capitalized tier-one players that can survive such a slump and/or cost leaders, or panel makers having some competitive advantage through differentiation.
On these grounds we argued in previous articles in favor of SunPower (NASDAQ:SPWR) and Jinko Solar (NYSE:JKS). The first produces more durable and efficient panels and has the backing of energy giant Total (NYSE:TOT); the latter is the Chinese market and cost leader.
These are just our favorites, there are quite a few other good choices, like First Solar (NASDAQ:FSLR) and Yingli Green (NYSE:YGE). Or one might want to go with a solar ETF, plenty of choice here as well, such as Guggenheim Solar ETF (NYSEARCA:TAN) and Market Vectors Solar Energy ETF (NYSEARCA:KWT).
Also keep an eye out for innovations from labs and new players, if they succeed in significantly more efficient and/or cheaper panels or cheaper production methods, the incumbents could have a problem.
We have already discussed the problems that utilities in Germany are struggling under distributed energy production, which accounts for up to 20% of electricity production (versus 1% in the US).
The dash for renewables there has strained the power network and made life hard for utilities. This week one of the country's largest, RWE, announced that it made a net loss of €2.8 billion ($3.8 billion) in 2013, its first annual loss in more than 60 years, as the rising supply of electricity from (subsidised) renewable sources undercut its prices. [The Economist]
While some of this stems from German idiosyncrasies (for instance, power from renewables is prioritized on the German grid by law), it is hard to escape the fact that economics for utilities changes for the worse, the bigger the share of intermittent renewables is in electricity generation. Here are some possible adverse effects:
- Supply and demand for electricity are often out of synch
- Prices are driven lower, often at peak demand
- Utilities cannot cut investing in the backbone supply and the network, due to the fact that alternative electricity might fall away completely for considerable lengths of time (gloomy winters, etc.)
- Distributed alternative electricity generation usually doesn't pay for these costs.
While some of these adverse effects can be countered by smarter design of markets (for instance, where solar is at or even below grid parity, it could, at least in principle, contribute to network and backbone cost), much of it seems like an unavoidable byproduct of the relentless cost decrease of solar and its intermittent nature.
However, not all of the burden falls on utilities, depending on the institutional setup:
Twenty power companies including Germany's biggest utilities, EON SE and RWE AG, now get fees for pledging to add or cut electricity within seconds to keep the power system stable, double the number in September, according to data from the nation's four grid operators. Utilities that sign up to the 800 million-euro ($1.1 billion) balancing market can be paid as much as 400 times wholesale electricity prices, the data show. [Bloomberg]
So some of the burden falls on the grid companies, at least in Germany where these are separate from the utilities. In fact, this balancing market has developed into a significant opportunity for the utilities, but overall, the effect of alternatives having priority on the German grid is still likely to be a negative for these companies.
So apart from a rapidly rising share of alternative electricity generation, one should familiarize oneself with the institutional particulars of specific markets before one starts shorting utilities outright.
Of course, storage will ameliorate the problems for utilities as it smoothes out supply, but one has to keep in mind that during winter, it's not uncommon for German solar power to generate very little for weeks on end. Whether storage can deal with that anytime soon remains very much to be seen.
Smart grid companies
Demand for so called smart grids (the use of ICT to increase the efficiency and reliability of the electricity net) is likely to get a boost from the increase in distributed energy production (mostly, but not necessarily all from alternatives). Companies such as GE (NYSE:GE), Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Cisco (NASDAQ:CSCO), Control4 (NASDAQ:CTRL) or EnerNOC (NASDAQ:ENOC) - and there is even an smart grid ETF (NASDAQ:GRID).
No doubt that if solar (and wind) + energy storage takes off, this sector will be perhaps the main beneficiary and early investors could make a killing. However, it's really way too soon to argue with any precision who will win here, perhaps with one exception, Tesla, which is making a difference through some bold steps:
What's new about this is the recent announcement by Tesla that it plans to build a $5 billion "gigawatt scale" battery manufacturing plant somewhere in the southwestern U.S., a plant that the company projects will produce more lithium-ion batteries than the entire global supply for 2013, while halving per-unit costs. Already, SolarCity and Tesla have teamed up to offer a solar/storage package to residential and commercial customers. [Cleanegroup]
But we wouldn't really go overboard here. It's early days, there are tens, if not hundreds, of labs working on energy storage concepts and significant breakthroughs that could undercut lithium-ion batteries in general or Tesla's in particular. This is well within the realm of possibilities here.
The best one could argue for Tesla's case is that it has a headstart, and will reap economies of scale, while new concepts first have to prove whether they're able to scale, that is, whether the advantages from prototypes can be mass manufactured cheaply enough.
There are plenty of companies, like China BAK (NASDAQ:CBAK), BYD (OTCPK:BYDDY), EnerSys (NYSE:ENS), and Johnson Controls (NYSE:JCI). The non-specialist investor is perhaps better served by a sector ETF. There is a lithium ETF (NYSEARCA:LIT) which has half its assets in lithium mining and the other half in lithium battery companies.
Fossil fuel companies
The proposition is rather straightforward here, sooner or later solar + storage will become a competitive threat, simply by the fact that solar + storage continues to fall in price and fossil fuels have a tendency to rise in price, as the cheap resources are being replaced by more expensive ones.
Solar + storage does have other advantages, it's cleaner and doesn't need the grid. We wouldn't divest your fossil fuel portfolios just yet though, there is a great deal of inertia in these markets, switching costs are often high and fossil fuels will be around for decades to come.
Disclosure: The author is long SPWR, JKS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.