Solar investors have been loving life the last few months. Worldwide demand for clean energy has never been stronger, especially in Asia, already the biggest solar customer. In the U.S., the potential for the Suniva trade case to put a crimp on imports may have modestly boosted prospects for domestic U.S. companies like First Solar (FSLR) and SunPower (SPWR) - even though the tariffs would hurt domestic PV demand.
As usual, however, the real driver for solar company financials and long-term profits lies in the global supply-demand balance that drives pricing. The past few months have had some fantastic news on that score from China, the world's largest solar market, which installed a whopping 25 gigawatts (GW) of PV capacity in the first half of 2017. There was a rush to install solar before a cliff in the country's feed-in tariff, which declined roughly 13%-19% for systems installed after June. China has now become the first country with over 100 GW of solar PV installed.
China annual solar PV installations (GW)
Source: China National Energy Administration
China cumulative installed PV capacity (GW)
Source: China National Energy Administration
Such boom-and-bust cycles are not uncommon around the world, and especially in China, as the solar market is still largely policy- and subsidy-driven. Yes, solar is increasingly reaching parity with retail or even wholesale power prices in some markets such as the Middle East or Australia.
That's not the case yet in China, however, where wholesale power prices for coal power are set at fairly low levels by the government and where renewable energy facilities suffer financially from delayed subsidy payments and from curtailment. (Curtailment, or wasted energy, is when state-owned coal plants are dispatched instead of renewable energy, even when the sun is shining or wind is blowing.)
A perspective on China's new solar targets
China's 2016 solar installations wowed investors at the tail end of 2016: China installed 34 GW of solar, boosting its installed capacity by 80% to 77 GW. The country accounted for an astonishing 45% of the 75 GW world solar market in 2016. For perspective, the second largest solar market, the U.S., installed "only" 13 GW, and China's 34 GW is more PV than existed in the entire world in 2009.
China's 13th Five-Year Plan for solar energy, issued December 2016, put a damper on this euphoria. Whereas investors had hoped to see a 2020 solar target of 150 GW, or even higher, the actual PV target was set at "at least 105 GW," plus 5 GW for solar thermal. That implied a worst-case scenario where China might need to install just 7-8 GW of new solar PV each year - and the global PV market would be flooded by cheap panels.
However, the NEA is moving away from guiding the markets via targets, and emphasized that these figures truly are minimum levels. Indeed, NEA's targets for individual provinces even omitted key provinces, such as Xinjiang, that have overcapacity. Adding up the provincial targets, and accounting for capacity already installed in provinces not mentioned, the 13th FYP target came out considerably higher.
My view at the time was that the national 2020 PV target could be ignored. 24 GW of installations in 1H appears to confirm that assumption. China has likely already exceeded 105 GW as you read this. Would anyone conclude that all China PV installations will cease for the next 3.5 years? Of course not.
China's past solar targets have lagged actual solar additions
Source: China National Energy Administration and media reports
In response to the surge, NEA on July 27-28 released a new Guiding Opinion regarding solar installations through 2020. The document appears to boost the target for 2020 PV to at least 190 GW. Noted solar analyst Frank Haugwitz has a new forecast suggesting China could hit 230 GW by 2020.
This is all fantastic news for global PV supply and demand, right? Sort of, but it's important to put things in perspective. Journalists and market watchers have tended to put far too much weight on the targets set by China's NEA. Again and again, these targets have been lagging indicators of what the market is up to - see the chart above.
There is a simple reason why the NEA's solar targets seem to lack predictive power: The China solar market is not determined by targets set by the remote hand of the NEA in Beijing, but rather by subsidy levels, payments, and other policies. These are set by other branches of the NDRC, and only loosely coordinated with NEA.
Three China solar trends to watch
So if targets aren't such a bright and shiny object, what things should we be watching in China? I suggest looking at three trends: 1) China renewable energy certificates and other market mechanisms launching in 2017, 2) upgrading of China domestic manufacturing capacity, and 3) exports to countries in the One Belt One Road initiative, known as OBOR.
Renewable energy certificates (also called "green-e certificates" or lvzheng in Chinese) are the government's solution to an old problem: delayed payment of the subsidies under the feed-in tariff scheme. (For an analysis of the policy, see here.) The government plans to eventually scale down and eliminate the FITs, but doesn't want to completely tank the PV market. The solution is to transfer the subsidies to other parties, namely to the provinces and state-owned power companies. Increasingly, these entities will be subjected to renewable quotas that can only be met by purchasing certificates.
Trading these certificates differs from similar programs in the U.S. Under the law, renewable plants are already guaranteed the FIT payment, so they won't sell certificates for less than the subsidy. On the day the certificate program officially launched, I went online (with the assistance of a friend with a Chinese ID) and bought a certificate from a Chinese wind farm. The price per kWh was exactly the same as the difference between the local power price and the FIT level in that wind farm's location. Instead of feeling virtuous, I knew my hard-earned cash had just gone to pay for the government's subsidy obligation.
So, what does it mean for investors? We need to watch to see whether the government expands renewable quotas for state-owned companies and provinces. If they do, it would bolster prices for RECs and speed the retirement of FITs. In the next year, such quota developments (provided they are mandatory) will be more important than other targets from NEA.
Then there's upgrading capacity. If the China domestic solar market had truly collapsed this year, as some feared, this would have not only flooded the market with cheap panels, but reduced capital for upgrading production lines. Now, with demand running at high levels, big Chinese panel makers have the confidence to invest in leading technologies such as PERC (passivated emitter rear contact) lines. These PERC cells can have efficiency up to 1% higher than the competition.
We are even seeing some investments, such as recently by Jinko (JKS), in early-stage technology like perovskites, a low-cost solar cell material that could boost solar conversion efficiency by acting as a tandem layer on top of conventional silicon cells. PERC upgrading has already boosted demand for solar tools from companies like Meyer Berger, and it poses a potential market threat for more efficient players outside China such as SunPower and First Solar. (See Finlay Colville's alternative view on this topic here - he argues that a shakeout in China would encourage more upgrading.)
This May, China held a celebratory diplomatic gala for its OBOR project, a $1.3 trillion investment extravaganza designed to create energy and transport infrastructure all over Asia and Africa to recreate the old Silk Road routes while boosting China's soft power abroad. Future Chinese infrastructure investments in these countries will come with a halo of central government support and diplomatic hand-holding.
China Development Bank and the Asia Infrastructure Investment Bank are eager to bolster their green credentials by boosting solar and grid investments. This should help financing and exports of solar to Southeast Asia, Latin America, Central Asia, and Africa. Cheap financing from China for Chinese-made panels could further constrain these markets for First Solar and SunPower, while boosting exports from the big Chinese players.
Treat the new China NEA solar guidance with caution and focus on developments concerning solar subsidy/certificate reforms, manufacturing equipment upgrades, and solar exports outside of China. These have much more potential to affect global solar prices and demand for panels from competing U.S. solar manufacturers.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.