Solar Power Will Be Transformational in the Next Decade

by: Jack Yetiv

Many SA contributors and authors in the popular press have weighed in on the prospects for solar energy in the next year, the next decade and beyond. Although I have no formal financial training, I have been a student of this space for many years, and in fact, 3 years ago, I installed a large PV system on my house. I also installed a solar-hot-water system at the same time, rendering the house almost carbon neutral in 2005.

More recently, I have been investing substantial dollars in this space, so I have tried to become informed about it. I have written several solar-related articles in SA over the past few months, and between yesterday and tomorrow, I have submitted a series of 3 articles that discuss various aspects of the solar space. In the first article, published yesterday (link), I presented an argument that solar has already achieved grid parity if we make an apples-to–apples comparison with "conventional" power sources. In this article, I discuss my overall thoughts on macro trends in the solar space, and in the third article, to be published tomorrow, I will compare 11 solar stocks and conclude that Trina Solar (NYSE:TSL) is the best bargain in the group.

In yesterday's article, I reached the conclusion that IF we compare apples-to-apples, solar PV has already achieved "parity" with the three "conventional" sources of electricity—coal, natural gas and nuclear. So the first issue to address here is, ARE utilities and power generators engaging in an apples-to-apples comparison these days when deciding what kind of power plant to build?

Although the evidence is spotty, I think the answer is "Yes." Of course, to be on the leading edge in any investing space, the evidence is often "spotty" at the beginning because by the time everybody knows something, the best potential for investment may well have passed.

The best evidence that utilities are starting to make apples-to-apples comparisons in deciding what kind of power "plant" to build is the decision last month by Southern California Edison to go "solar" for its recent needs for 250 megawatts (see yesterday's article for more details). Although I have no inside knowledge, it certainly seems likely that SCE compared solar to conventional sources of power and decided to go solar. Regardless of its novelty (to my knowledge, no US utility has ever made such a decision), SCE's decision to go solar for such a large amount of solar capacity reflects a definite societal shift away from carbon-fueled electric generation. It is almost impossible to get a coal-fired plant approved today. A major fight has been raging in Kansas (of all places) regarding the construction of a coal-fired power plant. Even in Texas, the epicenter of carbon fuels in the United States, opposition to coal-fired power plants has been growing tremendously.

In addition to growing public opposition, financing carbon-fueled power plants has become more difficult because lenders are themselves being forced to look at ALL the costs of building such generation. One of those costs is addressed by this question that lenders are asking themselves today: Assuming our borrower can even get the coal plant built without CCS (carbon-capture-and-sequestration) equipment, how much will it cost our borrower to retrofit a new coal power plant with CCS equipment if he is forced to do so at a later time? Since nobody really knows the answer to that question (but everybody knows it will be in the hundreds of millions per power plant), that uncertainty is making it difficult to finance these plants.

The general mood in this country is also clearly against carbon-based power generation. Whether one subscribes to global-warming concerns or not, there is no question that this issue has achieved critical mass in the US. Discussions that would have been considered esoteric a few years ago are mainstream today, on TV and in the popular press. One of the reasons for this, of course, is Al Gore's incessant work in this area, but another is the price of oil and gasoline. Whereas one rarely read about energy in the popular press a few years ago, when oil was at $30 and gas just a little over $1, one can scarcely watch TV or pick up a newspaper today and NOT read about energy. And although oil prices technically have very little to do with electricity generation, that truth does not prevent the two from being linked together and repeatedly discussed in stories about the "energy" problem.

The Iraq war has also focused us on what the real cost of oil has been—in terms of American lives—and that has also engendered some of the impetus to solve this "energy" problem. Finally, NIMBYism as to conventional power plants has increased tremendously in the past year, making those kinds of plants harder (and therefore, more expensive) to build.

Against this background, solar as a means of making electricity and as an investment (and most people probably do not differentiate the two) has also hit the mainstream. People who never had a clue about PV (photovoltaic, converting sunlight into electricity) five years ago are actually asking about installing these systems in their house s today. The fact that FSLR was the best-performing stock last year probably introduced a lot of folks to the whole idea of PV. And the Southern Calif Edison decision last month will undoubtedly spur much more interest in this area because the decentralized nature of the installation will expose thousands of people to the idea that electricity can be made from the sun cost-effectively.

With the above background in mind, here are my thoughts and predictions about solar going forward:

1) Primarily because I think we have largely achieved grid parity based on an apples-to-apples comparison that power generators are starting to do today, I believe that annual demand for solar panels will increase more than the 40% number that is widely bandied about. I don't know if the actual number will be 60% CAGR or 80%, but I think that once the "secret" that grid parity has been achieved is out there, I think demand will go up substantially more than 40%.

2) If that prediction turns out to be correct, it will also mean that solar will survive even if incentives are not as robust as I expect them to be. Of course, if incentives are cut, solar penetration will definitely be slowed down, and solar stocks will be substantially hurt, but the solar genie will not go back into the bottle now that we are at, or very close to, grid parity. However, I actually expect collective global incentives to INCREASE over the next few years, rather than stay the same or decrease. Although the US isn't among them, quite a few countries are aiming for the vast majority of their electricity to be renewably-generated, and several countries are well on their way (Germany and Spain come to mind). And although federal incentives in the US won't be as good as those in Europe and elsewhere, the size of our power market is such that even if only ten percent of our electricity is to be PV-generated, that will mean multi-gigawatts-per-year domestic demand for PV. Keep in mind that quite a few states have very nice incentives in place and other states are coming onboard, so total incentives in the US (federal and state) may well be sufficient to generate more total demand for PV than in the very pro-PV countries such as Germany and Spain, which have much smaller power markets than we do.

3) If the above two projections turn out to be correct, and demand will be higher than most experts expect, the fall in ASP's will be slower than many anticipate. I have read various doomsday projections that argue that there will be an oversupply of panels by the end of 2008 (and that panel prices will crash), but none of the solar companies that I am aware of seem to agree with that prognostication. On the contrary, most solar companies have already pre-sold their 2008 production and some have sold a significant amount of their 2009 production. In addition, ASP's in the 4th qtr of 2007 and so far in 2008 have actually been slightly higher than earlier in 2007, and most companies have estimated that ASP's will only drop a few percent by the end of this year, and somewhere around 10% next year. Obviously, the end users that are buying 2009 panel production today are not convinced that the panel prices are going to decrease tremendously in 2009.

4) Again, in contrast to some doomsday scenarios projecting a glut of poly by the end of this year, I believe that while poly prices will certainly decrease, and will do so more rapidly than ASP's, the increased demand for PV panels will soak up much of the poly, preventing a crash in its price. Therefore, I believe gross and net margins achieved by panel manufacturers will largely stay intact for the next 18-24 months (gross margins will be company-specific rather than undergo a secular industry-wide crash). If demand ramps as I have projected, and assuming no disruptive technologies, margins for the leading solar-panel manufacturers might remain intact for longer than that.

5) However, by 2011 or so, and again assuming no disruptive technology has yet reached mass commercialization, making panels will largely be a commodity business where most of the products (with certain exceptions) will be essentially fungible with very little to distinguish one panel from another. There will be exceptions, such as patent-protected design features or other proprietary aspects of the PV business, but these will be the exception rather than the rule. Of course, if a disruptive technology is proven and can achieve significant cost savings or much higher efficiencies, that certainly could invalidate this prediction.

6) Within 3-4 years, the leaders will be selling panels approaching 25% efficiency, and almost everyone will be making panels with efficiencies over 20%, except for the thin-film products (eg, FSLR's) which will be in the 12-13% range (I have read reports that some CIGS panels have reached 19% efficiency in the lab, but I have no ability to verify this or to evaluate the likelihood of thin-film reaching this level of efficiency in commercial production in the next couple of years). Within 3 years, poly-panel makers will be using half as much silicon per watt as they used in 2006, as wafer thicknesses decrease and as cell efficiencies increase.

7) To decrease fabrication and installation costs (decreased fab costs=increased margins), the standard panel will go from the current 150-200 watts to 225-400 watts, resulting both from an increase in physical panel size and an increase in the efficiencies of the cells (SPWR already sells commercially a 315-watt panel at 19.3% efficiency; even without any change in panel size, that panel at 24% efficiency will generate 392 watts).

8) This year, expect 2 or 3 more announcements similar to the 250-MW announcement made by Southern California Edison in which solar will be chosen over "conventional" electrical power generation sources.

9) Also within the next year—maybe two years if the economy takes a while to recover—expect to see PV products sold at select Costco, Home Depot or Lowe's stores in locations that have a significant sun resource, and therefore, a better payback. Expect to see several "kits" offered, ranging from 2KW to maybe 7KW. You will have the choice of installing the modular kit yourself or pay an extra fee to get it installed (or do most of the installation yourself and then have an electrician or solar installer do the final connections). It will probably be financeable—with your electric savings each month just about covering your monthly payment on the PV system. Expect price targets of about $10,000 for a 2KW system installed, up to $30,000 for a 7 KW system, installed. Assuming electricity cost of 13 cents per KWH (that's what I pay here in Texas today), expect 12-15 year paybacks in sunny locales in the US. Of course, as costs of these systems continue to drop, more big-box stores will carry these systems because even places with a less-than-perfect sun resource will be able to achieve reasonable paybacks.

10) Also within the next year, maybe two (again, based on how the economy is doing), expect a new business model to be floated in which a company will install a PV array on your roof at no cost to you. In exchange, you will enter an agreement to pay the company for electricity that you use at the existing rate you are already paying, plus 2-3% annual escalators for 30 years. The company will be responsible for all maintenance, and will receive any market incentives that are available. At any time during the 30-year agreement, you will be able to purchase the system at a pre-arranged price.

11) Finally, expect a much larger percentage of new construction—whether it's residential or commercial—to incorporate energy-saving features, demand-response capabilities and active electric generation via solar power. Expect homebuilders (once they recover from their current predicament—or maybe as a means to distinguish themselves even now) to offer homebuyers the choice of an "energy-efficiency" upgrade which will include an active solar component. By installing a PV system as part of the home's construction, one can lower its cost substantially (versus a retrofit) and once that cost is rolled into a 30-year loan, the electric savings will actually exceed the increase in the loan payment that is due to the "energy-efficiency" upgrade option.

Obviously, as I suggested in the title, I expect solar to be "transformational" in the next decade and beyond. I believe the trends I have predicted above will be self-reinforcing (ie, as PV becomes cheaper, increased demand will make it even cheaper), and thus will accelerate. One can only hope so because going to a renewable-energy-based economy is our (Baby Boomers') only chance to maybe leave the earth in better shape than it is now for our children and grandchildren.

DISCLOSURE: I own a large position in TSL, and a decent-sized position in STP. My CSIQ shares were called away from me over this weekend since I sold $25 calls against my position about 3 weeks ago, but I may buy more CSIQ on a dip. I am not short or long any other stock.