A Solar Industry Shift Born of Necessity

by: Proactive Investor

The renewable energy industry has always been one stooped in controversy; a sector led as much by political factors as it is from the econmic effects of demand and supply. The ever increasing global taste for low carbon energy sources and fears surrounding damage to the environment caused by the consumption of fossil fuels, has led governments in the developed nations of the world to make proactive efforts on behalf of the renewable energy industry, perhaps most notably in solar power and photovoltaic (PV) energy.

Never was this more so than in Europe, where historically left-leaning, liberal bias, meant governments were very keen to subsidize the sector, based on political and ideological beliefs, in hopes of underpinning a fundamental shift into renewable energy sources. At the same time, a more conservative and oil-based economy in the US, meant that comparatively less effort was made in the country to push towards renewable energy sources and solar power. Two significant shifts have happened in recent times however, that have now begun to filter through to the solar energy sector; firstly, a Democratic President came to power in the US, bringing with him a more liberal agenda which very much included strong efforts to support renewable energy sources. Secondly, in Europe particularly, problems surrounding sovereign debt and budget deficits this year, have spurred the need for renewed efforts by governments to cut down on spending, and adhere to fiscal austerity measures.

These two shifts have now began to show in the photovoltaic industry, with Spain and Germany both recently announcing a reduction in subsidies to the sector, while at the same time in the US, several loan guarantees have recently been put in place to benefit fledgling solar energy companies, not just via efforts to boost renewable energy sources but also thanks to funds set up to provide economic stimulus. But do these moves really represent a philosophical change in attitudes from Europe and the US towards the solar energy industry; or rather are they born of necessity, where political beliefs inevitably had to give way to basic economics in times of financial turmoil and uncertainty?

For some quick background, solar energy comes in two main ways; direct thermal energy, where the light or heat of the sun is used to warm a house for example, and indirectly via solar panels, or photovoltaic cells, where technology converts the light into electricity, which is then used in the same way as any other form of electricity.

Naturally one of the main requirements for solar power is a fairly good supply of sun, and although this doesn’t necessarily mean as many would expect, a clear bright sunshine day, it has still been a prohibitive factor in the uptake of solar energy. Even in Europe for example, where renewable energy has been actively promoted, solar power (thermal and photovoltaic combined) still only accounts for less than 1% of energy produced.

The main hurdle facing the solar industry however has not been lack of sunlight, but the comparatively high costs of solar power and photovoltaic energy conversion, even compared with other renewable energy sources. In Europe, this has led to the subsidising of solar power through the use of feed-in tariffs, which guarantee that producers receive fixed wholesale prices for their output, typically for 20-year periods.

As highlighted, however, the need for European countries to reduce budget deficits and undertake fiscal austerity measures has now brought this subsidy under review. This has most notably been the case with Spain, one of the European ‘peripheral’ countries that have been most susceptible to concerns surrounding sovereign debt in recent months. Since 2008 for example, Spain has invested an estimated €23bn in the PV sector, a quarter of that in 2008 alone. The annual cost of subsidies for all renewable energy sources in Spain is estimated to have reached €5bn last year and could hit €6.3bn this year. It has, therefore, comes as no surprise that the Spanish government intends to cut subsidies for new solar energy projects, in order to make up some of the €18 billion deficit for the Spanish electricity industry (brought about by the subsidised costs compared to low end prices in recent years). What has come as a shock in recent weeks however is the government’s intention to retroactively reduce subsidies in the sector by 30%, either by directly cutting the feed-in tariff, or by capping the number of production hours receiving the subsidy.

Although not yet enacted, expectations are that the law may come to pass in the next few weeks, and if so, the industry is likely to see a massive impact in the Iberian Peninsula. This is particularly the case as the photovoltaic sector is usually highly leveraged, around 85% of financing coming from bank loans. Naturally it would hit the profitability of the company’s hard, reducing their value significantly along with equity prices. This in turn would impact investor sentiment in the sector, particularly renewable energy and ‘clean power’ funds, which have seen a lot of interest in recent years. On top of this, their would undoubtedly be a knock-on effect for those financial institutions which have provided financing for the companies, increasing the likelihood that some may default on their debt.

Depending on the banks’ exposure to debt from the solar energy sector, this could take a cut out of profits in an industry that is itself, under pressure. This already has the banking sector worried. The Financial Times for example, recently published comments from a letter from the Spanish Banking Association to Miguel Sebastián, the Spanish banking industry minister, saying: “Any alteration to the tariff would be damaging to the sector and its financiers, and set a precedent which would end up seriously complicating Spain's ability to attract investors and financial institutions.”

On top of this, investment in the sector is already beginning to suffer from the proposals. The Barcelona based construction company Fomento de Construcciones y Contratas (FCC) for example, has recently announced it will be freezing €600 million worth of investments in two thermo-solar plants that were due to come onstream in 2012 and 2013. The news also brought about a delay in at least two IPO’s in renewable energy companies, due mainly to the uncertainty surrounding price subsidies in the sector; Grupo T-Solar Global shelved a €250 million offer it was going to undertake, while Renovalia pulled its intended IPO, in which it hoped to raise €153 million.

It is not just Spain, however, which is undertaking these stringent measures. Just last week a bill passed the German Bundesrat (upper house of parliament), backing reductions in solar power subsidies but offering the industry an extra three months to adjust to the cuts. The measure reduces feed in tariffs for solar power fed into Germany’s electricity grid by 16% for rooftop equipment, 15% for farmland and 11% for spaces such as former industrial or military sites, all effective as of July 1st. Germany looks set to suffer an additional hit from the contraction the industry is expected to see, not just from solar energy producers, but also from the manufacture of photovoltaic cells, of which Germany is the world’s biggest maker.

While in Europe, austerity measures are making the solar energy sector a prime target for cut backs, in the US, which is seeing comparatively little fear surrounding their sovereign debt, the political agenda led by the Democrat and pro-environmental President Obama, is leading to a move in exactly the opposite direction.

President Obama promised during his election campaign for the White House, to create manufacturing and construction jobs in the green power industry, a move that not only benefits the environmental cause, but also one that will supposedly help the economy by stimulating job growth. Although one could argue this was merely a way of "selling" the idea to American voters, and the true value of economic stimulus coming from increased government spending is one which has been argued by economists for centuries, the move still comes on the back of effectively the same reasoning behind the opposite move in Europe, i.e. improving the economy.

Whereas in Europe the need to reduce fiscal deficits is paramount, in the US President Obama has been able to increase government spending in the renewable energy sector not only to stimulate the economy but also, had previously been the case in Europe, to back the sector on ideological beliefs in Environmental conservation and carbon reduction. Earlier this month, President Obama began the move, announcing that nearly $2 billion in loan guarantees will be given to two solar energy companies in a move which he hopes will kick start the industry in the US. He said the money will come from government stimulus funds designed to boost the economy during the recession, and expects the move to create 5,000 new jobs. Although President Obama did acknowledge the move is simply a first step, his future plans were clear, saying: “we're going to keep competing aggressively to make sure the jobs and industries of the future are taking root right here in America.”

It is a paradoxical situation, therefore, that Europe and the US are undertaking two totally opposite measures in the solar energy industry, with the hopes of effectively achieving the same (or at least a very similar) goal. In Europe, the need to reduce fiscal deficits has become the main priority for governments in recent months, and is seen as key by the market and economists alike, to stabilizing their economies and paving the road towards a full economic recovery. One of the key areas which are seen as easy to cut has been the solar energy sector, which has traditionally benefited from subsidies, one could argue to the detriment of becoming cost effective and efficient.

In the US, attempts to stimulate the economy by increased government spending have combined with the environmentally friendly political agenda of the Democratic party and President Obama, in increasing subsidies to the solar energy sector; hoping to both stimulate jobs and promote carbon free energy sources. One could argue that in both cases, the moves have been born of necessity from the economic recession in recent times. Although undoubtedly both moves also have a political agenda, hopes of stimulating or stabilizing their respective economies has to be the key aim for both governments.

To see the effectiveness of these moves, we will just have to watch this space.

Disclosure: no position