Profound Implications Of Solar's Exponential Growth

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Includes: FSLR, SPWR, TSLA, VSLR, XOM
by: Simple Investment Ideas

Summary

If the solar industry continues to grow at its historic exponential pace, solar will become the predominant source of energy generation within a few decades.

The solar industry has the potential to disrupt markets on an unprecedented scale.

A few of the leading solar companies such as SolarCity, First Solar, and SunPower will gain disproportionately from solar's growth.

Despite the inherent risks associated with a young industry like solar, its future is extremely bright.

The solar industry has been experiencing a smooth exponential growth rate for the past 30 years. This growth is reminiscent of Moore's law, which observes that for every 2 years, the number of transistors in an integrated circuit approximately doubles. This is hardly surprising though, as solar panels use essentially the same technology as semiconductors. While the underlying mechanics of these two industries are the similar, this has much bigger implications for the solar industry.

Solar's equivalent version of Moore's law is called Swanson's law, which observes that photovoltaic modules drop 20% in price for every doubling of shipped volume. Solar panels, unlike conventional fossil fuel, are essentially based upon nanotechnology, which is subject to exponential improvements. Whereas fossil fuel based energies will inevitably rise in price due to their nonrenewable nature, solar will only get cheaper in time.

Swanson's law in effect

Source: Economist

The big question among industry experts is whether or not this type of exponential growth will be sustainable going into the future. While many argue that solar will eventually follow a S shaped growth curve, there is no reason to think that this will happen before solar is able to beat out nonrenewables in the majority of the world. For nearly half a century, people have been arguing the same exact thing for semiconductors, yet Moore's law still holds today.

Interestingly, solar will only need to grow at its current rate for about 16 more years to meet all of today's energy needs. Solar has been growing at this rate for about 30 years already, and there is no physical barrier/limitation to suggest that this growth will stop or slow down within the next 20 years. In fact, famed futurist and Google's (NASDAQ:GOOG) director of engineer Ray Kurzweil, who is known for his accurate predictions, has even stated back in 2013 that

"Larry Page and I are convinced that within five years we will reach a tipping point where energy from solar will be less expensive per watt from coal and oil. We also see an exponential progression in the use of solar energy. It is doubling now every two years. Doubling every two years means multiplying by 1,000 in 20 yeas. At that rate, we'll meet 100% of our energy needs in 20 years.

Note: He adds a couple of years to account for increased energy usage in the future.

Industry Implications

If solar continues to grow at its historical rate, there are some huge implications across the entire energy sector. The solar industry would become one of the largest industries in the world, as the world consumes approximately $2 trillion worth of electricity every year. This would also imply that virtually every solar stock today is undervalued based upon future potential. Because of these enormous implications, many find it hard to believe that such a disruption will take place in spite of all the evidence.

Graphical representation of solar's exponential growth path

Source: Solarfinancing

The fossil fuels industry, on the other hand, would very likely die out, as it would have an inverse relationship with solar. Although there might still be some niche roles for fossil fuels, these nonrenewable sources of energy will very likely fade away. With the exception of oil, which is largely used for transportation, fossil fuels such as natural gas or coal have an extremely limited lifespan. Again, people find it extremely hard to believe that something so present in human life will vanish within a decade or two. This natural human disinclination to believe such radical change will offer a great opportunity for astute investors.

While the entire solar industry would indeed benefit immensely from this exponential growth, a few companies stand to gain disproportionately. On the manufacturing side, First Solar (NASDAQ:FSLR) and SunPower (NASDAQ:SPWR) are likely to benefit the most from the solar boon. Both of these companies are the leading U.S. solar manufacturers with a huge global presence. SunPower boasts the highest efficiency panels, and will keep pushing the technological frontier of solar. Although First Solar's panel efficiencies are found to be wanting, the company is quickly improving on this front.

On the downstream side of solar, SolarCity (SCTY) and Vivint Solar (NYSE:VSLR) stand the most to gain from solar's growth. The downstream industry is becoming increasingly consolidated, with these two companies leading the market shares by a massive edge. SolarCity accounts for about 40% of U.S. residential market share, while Vivint Solar accounts for around 15%. With distributed energy becoming ever more popular, SolarCity may stand the most to gain out of all solar companies. In fact, on top of its downstream business, the company is making a huge move into manufacturing, which will make it the most vertically integrated solar company on the planet.

Obstacles Facing the Solar Industry

While the breakneck pace of solar adoption is undeniable, there are still many potential risks facing the industry. A large concern is an intensification of the trade wars playing out between the U.S. and China. Although many argue that the trade war is a detriment to everyone involved, it may actually be a boon for the industry in the long run. By putting tariffs on Chinese panel manufacturers, the U.S. solar industry will have a greater chance of success. This is extremely important as U.S. companies generally focus more on pushing the technological barriers, which is great for the entire industry.

Another obvious risk is that the future growth of solar ends up following more of a linear path rather than an exponential path. While this scenario is highly unlikely, the implications are devastating for the industry, as many solar company valuations are already levered with the expectation of large future growth. Despite this concern, there is really no evidence to suggest that solar will stop growing at its current 40% CAGR, or that growth will follow an S curve anytime soon.

Conclusion

The solar industry is one of the most exciting spaces in the 21st century. The disruptive potential of solar is absolutely mind-boggling. While the current solar industry is valued with the expectation of high future growth, it is not valued nearly high enough. If solar's historical growth rate plays out for 10-20 more years, solar could potentially be one of the largest markets in the world.

Fossil fuels have dominated the energy industry and acted as the engine of prosperity since the 19th century industrial revolution. Therefore, it is understandable why investors doubt that this mainstay industry could vanish within a few decades to an energy source barely registering on the scale today. This skepticism is clearly reflected in the markets, as large fossil fuel corporations such as Exxon Mobil Corporation (NYSE:XOM) are valued as if nonrenewable's dominance will never end. On the other hand, solar companies such as SolarCity, SunPower, or First Solar enjoy relatively tepid valuations in comparison to their future potentials. In the face of such massive promise, the leading solar companies are definitely undervalued at their current prices.

Disclosure: The author is long SCTY.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.