Because solar panels are almost entirely unable to compete with cost of traditional electricity production (it depends on local electricity tariffs and hours of sunshine), the industry hinges on subsidies for its uptake, offering an object lesson in industrial policy.
We have three main players, the US, Europe, and China (Japan also traditionally has a significant solar sector, but these are losing market share). Each of these players have chosen a different industrial policy to get solar energy off the ground:
- European countries (Germany pioneered the approach and is still the dominant market) have concentrated on stimulating solar panel installments through so-called feed-in tariffs
- The US has concentrated on getting seed capital for innovative approaches and new companies
- China has mainly provided cheap bank financing for its solar players to expand capacity and profit from demand created elsewhere
Europe and the US (we'll talk about China a little later) are each doing something that is essential to develop a solar industry.
By stimulating demand with feed-in tariffs, it's stimulating demand for solar energy. Indeed, European markets like Germany, Spain, and Italy are amongst the biggest solar markets in the world. A feed-in tariff offers long-term contract to solar energy producers where consumers (or the government, that is, tax payers) subsidize the difference between the existing tariffs and the feed-in tariff from their electricity bills.
The feed-in tariff is usually declining over time to maximize incentives for efficiency improvements. This policy is not without problems, though, as first Spain and then Italy -- both countries with lots of sunshine, so good markets for solar energy -- testify. Both countries set rather generous feed-in tariffs, then were swamped by the results and had to back-track.
Without these European policies, demand would be much lower and there would be little incentives for producers to invest billions of dollars to improve technologies and production efficiencies.
Apart from economies of scale (efficiency advantages of larger-scale production), economists will be well aware of "economies of learning," which show that just by producing, one gets to be better and more efficient at production. Production routines are practiced and become ingrained; errors and inefficiencies are weeded out; improvements are introduced.
And indeed, solar energy is the only energy source that is becoming ever cheaper. In the 1980s, one watt of solar-cell power cost upwards of $25; today that is around $1 or less.
There is no reason to believe that this progress is coming to an end any time soon. However, apart from incentives for these steady efficiency increases through economies of scale and learning, the solar sector needs something more. Something at which the Americans excel.
The solar industry is still in its early phase, not unlike were the car industry was before Ford (NYSE:F) established the assembly line and Model T. Although polysilicon cells dominate, there are still many other approaches and technologies, and literally hundreds of companies trying to develop these. So there is no (what economists like to call) dominant design yet, or one type of solar-cell technology sweeping all.
Instead, there are a host of technologies and approaches, each battling it out in a race to become that dominant design. The production of new designs and approaches to capture solar energy hasn't come to a halt either, but it needs early capital, and this is where the US excels.
One has to realize that this is quite a risky affair. Generating new designs is a necessary process, but there are few guarantees for any individual design, as the Solyndra debacle testifies. Still, it's useful that as many technological avenues are explored as possible.
To a considerable extent, China has been sitting on the fence. Perhaps they're waiting for that dominant design to emerge, but a better explanation is that they didn't really have to do a lot, as they could ride on the US, and especially the European, efforts.
A cynic would argue that the Chinese solar industry rose to market dominance on the back of European subsidies. Europe provided the market for Chinese solars to drive production scale and economies of learning, helped by cheap labor and credit, and the rest is history.
In 2010, solar cell production from China (including Taiwan) increased a whopping 152%, and the Chinese/Taiwanese increased their global market share from 50% to 59%. To appreciate the Chinese dominance, see the figure below:
Source: Greentech Media Research. Click to enlarge.
And Chinese companies top the list of big solar producers:
Source: Greentech Media Research. Click to enlarge.
Global Market Perspective
So the Chinese let others do the hard work, driving the scale and efficiency of their solar sector. Now that these are approaching attractive levels, could they embark in earnest in developing their domestic market for solar energy and move the industry forward?
The market is a little in the doldrums right now. Reduction in German and Italian feed-in tariffs (and the uncertainty over the direction of Italian policy until recently) have slowed demand just when a whole lot of capacity has come online.
The result has been overcapacity, resulting in steep price falls for cells and modules. What the sector needs is another big market to develop, and it seems the Chinese are finally ready to take their domestic market seriously (after numerous previous announcements that did not result in any big take-off).
The New York Times wrote yesterday:
Since last month, project developers here can sell electricity generated from the sun to utilities at a price of about 15 cents per kilowatt-hour, a result of China's first nationwide feed-in tariff scheme for solar energy.
The article even suggests this change from announcements to actual policy implementation is given at least in part to offer their solar producers a new market.
China will cross surpass 1 gigawatt of annual installed solar by the end of this year, but Suntech's (NYSE:STP) chief commercial officer, Andrew Beebe, said he expects China to be a "multi-gigawatt market" in 2012. In an article in the Financial Times, Yingli Solar's (NYSE:YGE) chairman and CEO, Liansheng Miao, was quoted as saying, “We strongly believe that China will quickly evolve into one of the largest and most important solar markets in the world."
It is, of course, no surprise that China has an interest in developing its domestic market. Its energy needs are rising fast. Coal is by far the most dominant source for domestic electricity production, but coal pollutes its cities, emits lots of greenhouse gasses, and China has recently become an importer of coal.
Solar Sector Stocks
The sector, including the Chinese producers, has been slaughtered on the markets as a result of big price falls in cells and modules. A somewhat better second half of the year is expected, but the market could rebound strongly should these new Chinese initiatives bear fruit.
The Chinese domestic market is still small compared to the likes of Germany, but we know things can develop rapidly in China once they're fully behind it.
We think it's still a little early, but we're watching the situation closely, and one can only say that the sector trades at very low multiples -- some, like JK Solar (NYSE:JKS), below 2. A shake-down of epic proportions seems to have been baked into the share valuations already, and the shares could turn on a dime.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JKS over the next 72 hours.