The Solar Revolution: Part 2

by: Jonathan Fishman

If you haven't read part 1, please click here.

In this part of "The Solar Revolution" series I'll address the solar subsidy climate around the world, solar panels' cost-reduction road map, major solar players' financial stability, and a touch about residential solar.

Subsidies: A Thing of the Past

Click here for an interactive map of current FiT programs around the world.

In the past decade or so, many countries around the world have decided to "push" solar energy as a sustainable source of energy. There are numerous reasons to do so. First, to reduce the share of electricity generated in dangerous nuclear power plants. One of the reasons that Japan is now massively growing the rate of PV installation is the horrible Fukushima disaster that happened in March of 2011. Another reason is the externalities of burning fossil fuel are very heavy. These include pollution treatment, massive amounts of energy to extract the fuels from the earth's crust and ship it to the power plant, and health problems caused by polluted air. A thorough Harvard Medical School study examined the external costs of coal. So if you take the externalities of fossil fuels into account and the fact that (if you are a U.S. resident) you hiddenly pay about 9-27 cents per coal-generated KWh you consume. I suspect that externalities around the world are about the same. So the case for governments "pushing" solar to be a greater share of their country's electricity source is clear. Oh, and of course there is the following (and terrifying) countdown (scroll down to the energy section). In about 42 years, we will run out of oil. Yes, there is plenty of gas for the next 164 years, but in my view, trying to solve the oil problem with natural gas, is just postponing the end. With the severe externalities, it's hard to say if our world will be livable by the time we finish consuming all of the gas in the world. The world can free itself from the dependency on fossil fuels by tapping (a tiny fraction) of the huge amount of energy that the sun releases. Every second in the sun's core, 620 metric tons of hydrogen are fused into helium, as the result of nuclear fusion that happens 149,600,000 km from us. My view is that if we will generate most of the electricity we consume from renewable energy, we can:

  • free ourselves from the dependency on finite resources for energy (except the sun itself, but when the sun will die, we will die with it);
  • increase the standard of living for many humans as we improve our environmental situation and release the tremendous amount of effort that now goes into extracting fossil fuels and apply it to other areas, such as education and technological developments; and
  • turn to solving other pressing issues of mankind.

Going back to subsidies. Recently, more and more countries reduce solar subsidies. Europe, the pioneer in solar energy, apparently has better thing to do with its money right now than to enable generous subsidies. Germany, until recently the world's top PV market, is struggling to maintain their subsidy program. Other countries are choosing to go that way as well. Why do I think it's good that countries cut subsidies? I think that as the industry grows to be more mature, profitability can be sustained in non-subsidized markets. That means that a downstream developer can invest in a solar project, sign a PPA with the power company, and sell the electricity to make a profit with no subsidies. The same developer can get a FiT for 20 years at the price of retail electricity, thus costing the country nothing but encouraging solar development. This is made possible by the fact that the cost of solar panels has dropped to be competitive at today's retail electricity prices (or close to that) in many countries. The non-subsidized market will develop in a more "healthy" manner, and a real, economic incentive will drive demand instead of artificial subsidies, thus focusing solar companies on better markets.

Swanson's Law or: Moore's Law for Solar

Richard Swanson, founder of SunPower (NASDAQ:SPWR), published the paper, "A vision for crystalline silicon photovoltaics," in 2006. Swanson's Law resembles Moore's Law. Both are observations, both made by industry leaders (Gordon E. Moore is Intel (NASDAQ:INTC) co-founder). Swanson observed the prices of modules and claimed that they decrease 20% every doubling of shipped cumulative volume. Here is the original graph from the paper:

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As you see, the DOE projections from 1977 were way off so we can ignore them for now. Swanson's projections are a bit more conservative as prices are about $0.70/watt right now and hit $0.65$ about a year ago. Swanson projected that we will hit $0.65 in 2013. Another useful work included in Swanson's paper is the subsidy required to maintain the solar industry until costs are competitive.

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This figure sits well with the recent subsidy cuts we are seeing around the world. The actual required subsidy these days, as I already mentioned, is $0. Module costs are low enough to be profitable at today's electricity retail price in many regions.

It's useful to look at Swanson's cost projections as well as we are today well ahead of his projections at about $0.55/watt costs.

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More conclusions that Swanson gets to are:

  1. Cost reductions will come mostly from thinner wafers, more efficient manufacturing processes, and better lamination materials.
  2. Wafered PV technology will control the market up to about 2016. Future manufacturing technologies might take over after that.

So, what can we take from Swanson's Law? It doesn't seem to be accurate anymore as the cost, price, and cumulative production are all very well ahead of Swanson's projections. There is a clear trend that can be used to further project cost, price, and production levels. I think Swanson's work is quite remarkable; the power of well-made observations can't be undermined. Every model, whatsoever, has to keep evolving and improving. I believe it is time to take Swanson's Law and update it to reflect the next 10-20 years. I will try to do exactly that in part 3.

Financial Stability in the Solar Industry

After falling into the "chasm" in 2010, a lot of companies got tangled up in financial mayhem. A lot of Tier 2-3 companies didn't have a chance to access the required capital to operate during this rough period. Two Tier-1 companies went practically bankrupt. These are LDK Solar (NYSE:LDK) and Suntech (NYSE:STP). Both companies are in various stages of going bankrupt. Suntech is trying to fight the petition for a Chapter 7 involuntary filing. Suntech have some restructuring and recapitalization plans, but for now, it seems that until things clear up at Suntech, investors should stay away from the company. LDK's financials look like a mess. I don't believe that at the current rate LDK will stay solvent for much longer. LDK entered into a new forbearance agreement with noteholders, which will expire on November 26th.

After discussing the casualties of the 2000-2012 oversupply, we have to take a look at the other companies' financials. There are a lot of companies that aren't out of the mud yet.

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Source: Companies' SEC filings. Numbers are in 000's USD.

I ranked the companies by applying about the same weight to all the above metrics (except price-to-book ratio, which is a valuation ratio). The results are as follows:

Company Financial Rank
First Solar (NASDAQ:FSLR) 1
Sun Power 2
Trina Solar (NYSE:TSL) 3
Yingli Green Energy (NYSE:YGE) 4
Canadian Solar (NASDAQ:CSIQ) 5
JinkoSolar (NYSE:JKS) 6
ReneSola (NYSE:SOL) 8
Hanwha Solar (HSOL) 9
LDK Solar 10
SunTech 11

The ranking above is my own analysis. Every investor should do his own thinking about which metric he thinks matters the most. I believe that the top 5-6 companies will survive and thrive. I think that companies 7-9 will survive and become acquisition targets in a few years. It's easy to see that Yingli, ReneSola, and JinkoSolar need to finance their working capital going forward. I believe that all three won't have a problem doing so as the CDB (China Development Bank) supported them in recent years by signing various agreements (Yingli agreement, ReneSola agreement, JinkoSolar agreement). The dependency on the CDB is one of the major risks going forward for those companies. If the CDB decided to cut off access to capital for a particular company, the company could default on its liabilities almost immediately. I think that the CDB's very clear vote of confidence in the Chinese solar industry "winners" says it all. Over the next few years, the winners can take advantage of their improved profitability status and growing revenues, to de-leverage and become a more sound investment. It will take time, but as the CDB has these companies' back, I'm a lot more comfortable with their future.

Although the industry is still young, I suspect it will take a few more years (for the winners to be better off financially) before we see large-scale consolidation. Until then, each company that survived 2010-2012 will return to healthy profitability very soon.

Back to Profitability: It's Not If, but When

To determine when solar companies will return to profitability, I will use Trina Solar and Yingli Green Energy as a benchmark. Let's see what the revenue breakeven point is for each company, assuming current business models and expense levels. I think that gross margins at the 20%-30% level are achievable by next year. This assumes the $0.70 ASP level will hold up and costs will keep going down at the same rate it has up until now. According to my analysis these are Yingli and Trina's revenue breakeven points, with different gross margin scenarios.

Gross Margin Scenario 11% 15% 20% 25%
Trina Solar $850 $630 $490 $370
Yingli Green Energy $1,100 $800 $600 $480

All Numbers are in millions of USD, revenue is stated on a quarterly basis.

Given that Trina finished the last quarter with $440.7M and Yingli finished it with $550M, I think that assuming a 30% increase in shipment in 2014 paired with 20% in gross margins can bring both companies to show substantial profits by mid-2014. This will allow both companies to enjoy positive working capital by year-end 2014, which will allow them to be less dependent on the CDB for everyday operation financing.

Distributed Solar Energy: Solar's Killer App

Solar distributed energy is just starting to appear on the surface of the industry. What is distributed solar energy? It is generating solar electricity at the point of consumption, the opposite from generating it in a PV power plant miles away and delivering electricity over the grid. The point of consumption can be your house, an office, a factory, a school, and so on. Today you can buy a solar system from your local installer, pay in advance a substantial amount of capital, and enjoy your solar electricity most of your day. I claim the value proposition from doing so is not sufficient, thus limiting demand for distributed solar energy. SolarCity (SCTY) is trying to change all of that. SolarCity offers customers to install a solar system on their roof, with no capital investment. That's right, zero capital investment. SolarCity will then charge the customer a monthly payment that is a bit lower than the local electricity retail price. This is a far better value proposition as the customer doesn't need to pay a big amount upfront and change his spending habits and even creates some saving from the difference in SolarCity's monthly billings and the utility company's ones.

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Source: SolarCity website.

There is still a missing part. It's called electricity storage. Customers that install a solar system can enjoy the solar electricity during the day but at night, or when the sun doesn't shine, the system electricity output is zero. If consumers had a way to store electricity, they could generate enough electricity during the day, to keep them running during the night or when the sun doesn't shine. Unfortunately, electricity storage is an unanswered problem the world has not yet solved. Current solutions are far from being economical.

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One solution for that problem today is "net-metering."

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Source: Wikipedia

Net-metering is an electricity policy for consumers that enables them to pump the extra electricity they generate back to the grid and use the grid when their system is off. At the end of the month, the utility company calculates how much electricity was consumed (from the grid) and how much excess electricity was generated (and delivered back to the grid) by the consumer. The consumer then pays the difference between the amount he consumed from the grid and the amount he supplied to it. If the consumer supplied more electricity to the grid than he consumed from it, he is actually getting paid for it. How many of you got money from your utility company recently? Distributed solar energy could be the "killer app" for the industry, changing the dynamics in the market from a "push" strategy" to a "pull" strategy where consumers will rush to install systems on their roofs, with no initial capital required, to free themselves in the longer term from their dependency on utility companies and the world from the dependency on fossil fuels.

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Net-metering is a good solution for the midterm. As the grid is a closed system, with no good methods for storing electricity somewhere in the system, net-metering has a limit. If more than 50% of electricity consumers will generate their electricity from solar, the excess electricity is lost. Consider the following closed grid system:

  1. Fifty percent of consumers generate their own electricity needs during the day. To enjoy the benefits of net-metering, they generate excess electricity so they will be able to "pull" electricity from the grid at night, with no charge.
  2. The excess electricity generated during the day is going back to the grid, finding consumers who don't generate their own electricity, and serving their needs.
  3. At day, almost all the consumers are using solar electricity. At night, the electricity demand is met by conventional power plants.
  4. If more consumers will generate excess solar electricity, there will be no one left to consume it during the day. Thus, the excess will be lost and the net-metering system will exhaust its full potential.

Utility companies argue that net-metering without a fee paid to the utility companies themselves for maintaining the grid is in fact unsustainable.

I think that net-metering is an excellent method of "bridging" the gap that the lack in electricity storage has created in the midterm. Net-metering will be limited after massive adoption of distributed solar systems will take place, and this method will have to be replaced by electricity storage. More and more technologies are trying to solve the electricity storage problem and I expect that this problem will be solved in the not-so-far future. When I discuss my predictions for the solar industry in part 3, I'll go through existing and future technologies for storage. There are some exciting ideas for storing electricity out there.

To conclude, the points I want you to take from part 2 are:

  1. Subsidies for solar are a thing of the past.
  2. Swanson's Law is a proof that solar cost and price has a clear trend going forward. While we need to update Swanson's model, we can use it to make our projections for the future.
  3. Solar companies are starting to go back to profitability, enjoying a lot more demand than the last time they were profitable.
  4. Distributed solar energy could be the "killer app" for solar. While it has a few hurdles to pass, it could drive massive adoption of solar through residential, commercial, and industrial applications.

In part 3, I'll discuss future technologies for PV manufacturing and electricity storage. After that I'll finish with my predictions for the solar industry for the coming decades.

Looking forward to your feedback.

Disclosure: I am long YGE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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