Solar Panel Investing: Don't Fly Too Close To The Sun

 |  Includes: CSIQ, FSLR, HQCL, JASO, TSL
by: Dividend Dog

Solar panels have dropped in price over the past decade, and are now price between one and two dollars per watt. First Solar (NASDAQ:FSLR) has announced that its manufacturing costs have reached one dollar per one watt cell.

At what price do solar panels become recommendable investments for homeowners? How do photovoltaic solar systems stack up as investments?

The Basics of Installing a Photovoltaic Solar System

Today the cost of a solar system runs roughly $7 per watt, with roughly $2 per watt attributable to the solar panel itself. The remaining costs are labor for installation, the cost of wiring, and the cost of an inverter. Even if retail prices do drop to $1 per watt for photovoltaic modules, retail solar investors will still pay about $6 per watt.

Depending on your geography, solar panels receive 6 to 3.5 hour equivalents of sunlight per day. This means that on average a 1 watt cell will produce 6 watt-hours per day to 3.5 watt-hours per day. This is a problem for consumers who pay an average of $0.12 per kilowatt-hour. (Since there are 1000 watts in a kilowatt, the cost per watt-hour is $0.00012 per watt-hour.) It is very hard to reap meaningful savings for such a cheap commodity: a 1 watt solar cell saves $0.263 per year, in the best conditions. The output of a solar cell is subject to degradation. Photovoltaic output is expected to drop 0.5% to 1.0% per year (expect higher drops from thin-film solar systems).

The Finance of Photovoltaics

I am located in Bakersfield, California which endures 6 full hour equivalents of sunlight per year, prime real estate for solar. At $7 per watt installation cost and $0.12 per kilowatt-hour price, this is a 3.82% after-tax return in the first year (assuming a 99% efficiency after 1% degradation in the first year and a 2.5% annual increase in electricity prices). For subsequent years, the payoff of the investment depends on electric rates and the decline of the solar cell's output over time. After 25 years, the $7 solar panel has paid back only $8.00. These solar panels have a terrible internal rate of return of 0.99%.

These cash flows are horrible for a risky investment, and yes, solar cells are a risky investment. Solar cell payoffs can be interrupted by acts of God, theft, the vacancy of their installed property, or many other causes that are not covered by a manufacturer warranty. SunPower (SPWRB) found many unforeseeable causes for power interruptions in their test fleet of solar cells, including ant infestations of inverters and bullet holes.

Many solar cells are guaranteed by their manufacturers to maintain 80% of their quoted output for 25 years. This might serve as an assurance against randomly damaged units. However, if there is a systematic degradation that triggers warranties in large numbers of solar systems, this becomes a question of solvency. A company which has made promises it cannot keep could go bankrupt, and consumers with excessively degraded solar cells might find that bankrupt firms might not make good on their promises.

The myriad destructive forces which confront residential solar installations are similar to those which face residential real estate, and for that reason it is sensible to compare the returns of solar systems to real estate. A low-end return in a survey of real estate investment trust (REIT returns) was found to be about 3% in a prior article comparing real estate and REIT returns. If 3% is used as a (generously low) required rate of return, NPV (net present value) of installing a 1 watt solar cell is -$2.16. The investment is clearly not worth the risk.

At what electric rates and installation prices would solar installation make sense as an investment? The assumptions about required return, degradation and electricity price inflation were used to generate a graph which shows maximum installation price per watt and minimum electricity prices needed for an investment to have a positive NPV. These boundary conditions were plotted for the extreme environments found in the continental United States: 6 equivalent hours of production and 3.5 equivalent hours of production.

Graph which plots a maximum installation price vs. electricity rates for risk-adjusted returns.Click to enlarge

You can use this graph to determine what prices make sense in your geography.

Conclusions for Investors

Retail solar installations require more strategy to be sensible investments to offset standard power bills. Investors might consider strategies which incorporate do-it-yourself installation to reduce costs, exploiting subsidies, or sizing solar systems to match peak power rates which would effectively increase per kilowatt-hour savings. However, earning an economic return on a residential solar installation would be the exception, not the rule.

Conclusions for Solar Companies, Governments, and Environmentalists

Residential solar installations are not compelling investments in most areas and would not be even if the cost of each photovoltaic cell goes to zero.

Solar companies should be focusing on slashing other costs: wiring, labor for installation, and inverters. In particular, solar systems should be repositioned as plug-and-play kits for unskilled do-it-yourself homeowners, which would slash installation costs. The total cost of installing a 1-watt solar cell needs to drop to about $5.00 per watt before it becomes a sensible investment even in the best geographies.

Investors should scrutinize solar industry firms which cannot produce cost-saving products for retail customers. Solar companies like First Solar, Sun Power, Canadian Solar Inc. (NASDAQ:CSIQ), JA Solar Holdings (NASDAQ:JASO), Hanwha SolarOne Co., Ltd (HSOL), and Trina Solar Limited (NYSE:TSL) all jumped more than 5% on Friday and made dramatic gains in the current rally. Investors should be careful if they are considering these companies as long-term investments.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.