"Sunset in Italy" sounds romantic, but in this case, it's not. The Italian ministers for environment and industry have signed a much-awaited decree which reduces the country's generous solar incentives. The document is long overdue. but came with the surprise of deeper cuts than in previous drafts. More importantly, the decree does not respect investments under way (any installations not complete and connected to the grid by the end of June 2011 are no longer eligible) and continues the uncertainty with a new registry mechanism for big plants which does not guarantee the subsidies.
The kneejerk reaction by analysts and investors is that the actions in Italy will kill the solar market. This is mostly the same crowd that was trumpeting unrealistically high forecasts for the Italian market not so long ago. We begged to differ then and we beg to differ now.
First of all, nothing is simple in Italian politics. The decree first has to be published in the "Official Gazette" to become law, and could still be vetoed by the president. As you would expect, the Italian solar industry is outraged and investors in the Italian solar power market have already filed lawsuits against the Italian state to cover damages expected from the regulatory changes. The decree as signed last week is highly unlikely to get implemented in its current version.
A little history will help understand all the hoopla surrounding the Italian solar regulations. As recently as 2008, Italy was not a large solar market and did not rank among the top five. While large European solar markets like Spain and Germany collapsed in 2008, hit by a combination of over-capacity, reduced government incentives and the onset of the worst global recession in a century, Italy was busy enacting favorable solar subsidies which triggered a rush to build large power plants. The incentives propelled Italy to become the second-largest solar market in a little over two years.
Just in January of this year, the Italian Energy Agency was crowing about new solar capacity added during 2010 reaching 1.850 MWs (up 62% from 1142 MWs at the end of 2009). There have been some wild forecasts for the Italian solar market in 2011, all the way to some 6,000 MWs, but we tend to side with more conservative estimates, such as Ardour Capital Investments', which places Italy at some 11.8% of the world market, or about 2,000 GWs.
Italy appears to be late to the party. Spain, which used to have outrageous incentives and had become the largest solar market in the world, totally mismanaged its incentive plans and killed off the local solar market. France had embarked on incentive plans which rapidly became over-subscribed and had to be curbed. Germany, still the world's largest solar market (and it's not because of the abundance of sunshine), appears to be managing its solar incentives reductions the best, gradually and without destroying its industry.
Italy still has the option to follow either scenario, but even if the Italian ministers' ruling withstands the legal, industrial and political challenges it faces, it will not affect feed-in tariffs for rooftop installations under 1 MW or ground installations smaller than 200 kilowatts. It would certainly reduce the number of large utility-scale installations, but in most European markets much of the growth is expected to come from smaller distributed installations.
Another way of looking at what the market is actually doing is through earnings reports from solar companies. Of the major solar panel manufacturers, Trina Solar (TSL) is the only one so far to revise its outlook downward for the quarter ended in March directly as a result of Italy's solar regulatory revisions. But it reaffirmed its 2011 view. Another company with an important presence in Italy, First Solar (FSLR), reported solid results that beat expectations last week and reiterated its 2011 guidance.
As it supplies most solar panel manufacturers with encapsulants, the film that protects the semiconductor material in solar cells and panels, STR Holdings (STRI) can be seen as something of a bellwether for the solar industry. Just last week, STR reported sales and earnings for the first quarter which exceeded analyst expectations, and the company reaffirmed its full-year 2011 guidance.
In conclusion, the sky is not falling. Yes, ill-conceived government subsidies have created a series of bubbles and bust cycles in several countries, but overall, solar energy costs have been falling much faster than subsidies. We expect the global market to adapt well to changes in individual markets and for other countries to mostly pick up the Italian slack. For example, after a disastrous 2010, the U.S. is set to double new solar installed capacity this year, without any feed-in tariffs. Asian markets have been booming, with China, India and Japan all expected to have record year.
We believe that winning solar companies in our Green Portfolio like the ones above have been diversifying geographically to insulate themselves from issues in any one market and will continue to deliver superior revenue and earnings growth.
The solar industry, with an average P/E of 11.4 (and an even lower 4.9% average for Chinese solar stocks), is near record low valuation levels and offers many bargains we cannot ignore.