Many US listed Chinese companies have been under pressure during the past year due to accounting irregularities and corporate fraud among a group of smaller capitalized Chinese companies. Additionally, many solar companies have been under pressure since the start of 2011, due to declines in average selling prices (ASP) for solar products. As a result, it is not surprising investor sentiment for US listed Chinese solar companies has taken a negative double whammy, which has caused multiple compression to as low as two times trailing earnings in extreme cases. However, recent reports should remind investors in Chinese solar companies of forgotten advantages inherent in being based in China. According to reports, China’s NDRC has set a unified feed-in-tariff (FIT) for solar projects approved before July 1 or completed in 2011, at RMB 1.15/kwh (USD $0.179/kwh), which will be reduced to RMB 1.00/kwh (USD $0.155/kwh) in 2012.
Large scale and supply chain advantages have already allowed top Chinese module producers Suntech Power (STP), Yingli Green Energy (YGE), and Trina Solar (TSL) to gain tremendous global market share. Unlike many global peers struggling to stay in business in an extremely competitive solar industry, low production costs have yielded growing profits for most US listed Chinese solar companies. Direct evidence is seen in trailing price to earnings (PE) ratios, which range from the mid-single digits to even low-single digits. Trina Solar, which posted almost 72% compound annual growth rate (CAGR) in its four years as a US listed public company, trades at only 4.4x trailing earnings currently. In more extreme cases, Renesola (SOL), LDK Solar (LDK), JA Solar (JASO) currently trade at 2x, 2.2x, and 2.6x trailing earnings, respectively. Other large US listed Chinese solar companies include Canadian Solar (CSIQ), Hanwha Solarone (HSOL), China Sunergy (CSUN), and Daqo New Energy (DQ).
Cost advantages have allowed large Chinese solar companies to gain market share away from higher cost competition all around the world. It is the same cost advantages that give Chinese solar companies a huge edge in gaining market share in China’s large electricity power generation sector. This factor as evidence by low valuations has been forgotten amongst investors in Chinese solar companies. Yet it is a factor significant enough to singularly justify owning leading low-cost Chinese solar companies.
Needless to say, China is a large country with a very large population. As more of its population migrates from rural to urban environments, electricity demands have skyrocketed. To meet growing demand, China has added huge power generation capacity annually. In 2009, China grew its electricity power generation capacity by 10% to 874GW. For 2010, power capacity was set to increase by 85GW to over 950GW. Yet despite incredible capacity additions, the country still experiences electricity shortages notably during summer months. Described in China’s recently unveiled 12th five year plan (2011-2015), total power generation is set to increase by almost 100GW annually to 1440GW in 2015.
Solar’s market share in China’s power generation market has been small if not insignificant. At the end of 2010, total solar power capacity stood at only 0.8GW out of over 950GW in nationwide capacity. Last year China only added approximately 0.5GW of solar capacity whereas wind capacity has been added at a clip of around 15GW annually in recent years. Most of China’s annual power generation growth has been thermal based with coal grabbing the vast majority of the market share due to cost. For the same reason, higher costs have restricted solar usage in China in past years. Given recent declines in total installed cost for solar energy, China’s solar future may have reached an inflection point.
Much of China’s previous attempts in stimulating the solar sector have been limited in scale and more test in nature. The first major announcement came with a rooftop subsidy in March of 2009, which was later followed by its “Golden Sun” program in the following July. Unlike FIT programs deployed in most of Europe including Germany, the world’s largest solar market, these initial Chinese programs capped targets due to its high level of subsidies involving rebates. Golden Sun for example rebates up to half the installed costs for solar projects, but in the most recent round of approvals only 272MW, or 0.27GW, were granted.
China’s first attempt at initiating a national wide FIT was in 2009 when it announced an open bidding process for a 10MW Dunhuang photovoltaic project. Most bids were below RMB 2.00/kwh with the lowest at RMB 0.69/kwh by Yingli. That bid was ultimately not used since it was considered an unrealistic publicity attempt by the company, and the final FIT rate was set at RMB 1.09/kwh (USD $0.16/kwh). More than anything else, Dunhuang was the testing grounds for the government to get feedback from its large domestic solar industry on what FIT rate was economically acceptable.
China’s further attempts at implementing solar FIT came in 2010 with two batches of projects of increasing magnitude. The first came in April of last year when a total of 40MW was announced for four Ningxia projects at a FIT rate of RMB 1.15/kwh. In August of 2010, China opened another round of FIT bidding for 13 projects totaling 280MW. Due to decreased installed costs combined with high solar insolation in the project regions, around 50 companies submitted bids with the winning bids ranging between RMB 0.7288-.9907/kwh which were much lower than 2009’s RMB 1.09/kwh Dunhuang FIT rate.
While the FIT rates witnessed in China are much lower than rates in other regions of the world, it may not be as negative as initially perceived. Current FIT rates in Germany range from USD $0.32-0.40/kwh compared with China’s range of USD $0.11-0.18/kwh. However due to geography, solar insolation in Germany is much lower at around 800-1000kwh/y compared with over 2000kwh/y experienced in China’s inland desert regions where many of these projects reside. Geography combined with lower installation costs due to labor and supply chain advantages could make FIT rates not justifiable in other regions of the world acceptable in China.
For instance, data on China’s first large scale FIT project at Dunhuang was released earlier this year. For the period between December 28, 2010, and May 16, 2011, Dunhuang’s 20MW project generated 1.06KW for each installed watt of capacity. This translates to approximately 2700kwh/y solar insolation despite using data annualized over winter operating conditions. At an installed cost of almost $2.9/watt with the assumption of 85% average operational yield over the 25 year FIT period, Dunhuang’s raw electricity power generation costs roughly totals USD $0.05/kwh. At its FIT rate of RMB 1.09/kwh, the project would yield an IRR over 10% over 25 years.
Thus, it is not entirely surprising then when China’s latest round of FIT bids involved numerous participants and ranged from RMB 0.7288-0.9907/kwh. Even at the lowest RMB 0.7288/kwh rate, the Dunhuang project under the same operating metrics would yield over $6.3/watt over 25 years, much higher than its $2.9/watt cost. Yingli’s RMB 0.69/kwh bid may not have been entirely unrealistic after all, although after proper discount rates are applied YGE’s bid would have been at best a break-even proposal.
In the two years after Dunhuang’s FIT rate was announced, the cost for solar energy has declined considerably. Module ASPs for most large Chinese solar companies have declined from over $2.00/watt to around $1.40/watt. Module pricing may continue to decline toward $1.25/watt next year if upstream component costs trend as expected. With some companies such as LDK and SOL indicating system costs could decline to $0.75/watt for large scale Chinese based installations, total photovoltaic system costs in China could drop to and below $2.00/watt within a year. This compares with a global average of around $1.80/watt for wind power installations during the past couple of years.
Metrics, which supported Dunhuang’s RMB 1.09/kwh FIT rate could support a FIT rate around RMB 0.70-0.75/kwh within a year. This compares with China’s wind FIT rate, which tops out at RMB 0.61/kwh. While this rate is still well above China’s residential grid rate of approximately USD $0.05/kwh, it is much closer to industrial rates paid by many manufacturers including Chinese solar companies. In its annual reports, Jinko Solar (JKS) reported it paid RMB 0.678/kwh (pdf) for electricity while LDK’s electricity rate stood at RMB 0.659/kwh. Ironically and opposite of popular belief, Chinese manufacturers actually pay more for electricity than Chinese consumers, which is the mirror opposite of the Western world where residential consumers typically pay higher rates than commercial counterparts.
Without more detailed information regarding China's new solar FIT policy, it is impossible to analyze its potential effect. The stated FIT rate of RMB 1.15/kwh for 2011 and RMB 1.00/kwh for 2012 appear higher than necessary. One possible reason could be China wanting to extend photovoltaic installations beyond isolated inland desert locations where much lower FIT rates could be supported. Eastern costal regions yield up to a third less solar insolation than the Dunhuang project described above and thus would require a higher FIT rate; China's wind FIT announced in 2009 grouped rates by four separate regions. Another possible explanation for the higher initial FIT rates could be capped capacity targets much like how China’s previous solar subsidies have been limited in scope. If the actual FIT rate of RMB 1.15/kwh is uncapped or restricted by geography in any form, it could lead to a huge boon for solar installations in China due to the extremely high returns that could be generated in western desert regions in China.
Thus until exact details are revealed with complete transparency, it is too early to pass a final judgment. Regardless, investors in leading US listed Chinese solar companies should keep in mind the forward trends regarding China’s solar industry.
China is a very large and still growing power generation market. Due to cost constraints, solar deployment in China up until a couple of years ago has been near nonexistent. The economics of varying power generation alternatives have been changing rapidly however and solar power is close to rivaling industrial as well as wind power grid pricing. China’s annual wind market alone is double Germany’s record solar market in 2010. Thus it would not be unreasonable to assume China’s solar demand could reach similar levels once the cost economics converge. Outside of large scale thin film producers such as First Solar (FSLR), very few global solar companies outside of China could compete with leading Chinese solar companies in meeting the country’s cost requirements. As a result, top tier Chinese manufacturers would most likely be the first to benefit from any expansion in China’s solar demand.
How much market share the solar industry can take from other competing power generation sources will ultimately depend on how each country weighs all factors into consideration. The nuclear disaster in Japan in March 2011, has already changed the nuclear direction in several countries such as Germany, Italy, and of course Japan itself. While it is unlikely China will alter any current nuclear projects, future plans may be reconsidered especially as the cost of alternatives such as solar energy continue to drop. Other considerations involve pollution effects caused by fossil fuels. However, China’s annual growth demands are so great at nearly 100GW, it would almost be impossible to alter capacity addition ratios too greatly. The solar industry's record levels of installations achieved in 2010 at 17.5GW would barely dent China's annual demands alone.
For well positioned solar investors, macro economic factors should clearly be in their favor as the cost disparity between solar energy and other alternatives converge. Details of China’s upcoming solar FIT would only change the timing of events, not the certainty because forward costs for solar energy in China can be derived to intersect key benchmarks such as grid pricing at certain levels as well as wind pricing. LDK Solar, China’s most integrated large scale solar company based on 2011 target capacity, anticipates its levelized cost of electricity (pdf) to fall below average grid levels in China to USD $0.07/kwh in 2012. Granted, actual costs would be higher in this example after wholesale mark up, but nevertheless it is further confirmation by an industry participant indicating how close the industry’s cost levels are in relation to grid levels. If fossil fuel power generation costs were to be equalized for less analytical effects such as pollution, the cost for solar power could even rival coal in the near future.
With the market potential so large, and with current valuations for many US listed Chinese solar companies so low, long-term investors could be big beneficiaries of these macro trends once recent Wall Street negativity over Chinese and solar companies reverses.