Real Demand Shock
The big news I'm digesting is China's recent policy announcement about PV power in which it is halting new PV power plant construction needing any state subsidy, decreasing feed-in tariffs, and increasing market mechanisms. Here's the translated document.
The important thing to notice is that the beginning of the document has the feel of an emergency halt. This is not anything gradual or pre-scheduled. It's a real, substantial shock in demand for PV systems and components. This is confirmed by the resulting heavy adjustments in outlook by experts, who drastically lowered their forecasts. After a booming year of 53GW of Chinese PV installments in a 98GW global market in 2017, these experts are cutting Chinese installment estimates from ~45GW to ~30GW for 2018, and it could even be worse next year, as one adviser estimates only 20-25GW of installments for 2019 and 2020. In other words, we are looking at roughly a demand shock of roughly 20% in a highly competitive global market. Spot markets have started reacting immediately, as pvinsights reports PV components mostly falling 3% to 8% and polysilicon prices tanking 10%, and Bloomberg predicts a 35% crash in prices by year-end.
Other countries will inevitably have to help soak up the supply glut, but we are definitely looking at consolidation and bankruptcies among PV component makers.
Attempting to Understand Energy in China
But what's really going on in this policy move, and will this demand shock really last through 2020?
When trying to understand China, we should keep in mind that China generally governs for state interests, including interests of both domestic consumers and domestic producers, and also to some extent creating a good national image/brand/reputation in light of international concerns. But China probably has little international concern operating here since its renewable energy production has literally exploded.
The general tenor of China's energy policy decisions recently have been to move toward increasing competitive market mechanisms (since this seems to be a useful economic framework), and to move toward reducing energy subsidies in general (I'll discuss coal subsidies below), in part with the aim of de-incentivizing energy usage in general and lowering pollution. Meanwhile, recently, renewable subsidies have risen far beyond what was budgeted largely because of the solar explosion. However, if I were China, I wouldn't issue an emergency halt to a flourishing market (especially one which combats pollution) due to such a budgetary issue; I would lower subsidies, not halt them. So, I want to look for a deeper reason for the severe halt.
Consider the Chinese grid. There is rising evidence that the rapid change in the supply of renewables in the last few years has resulted in grid troubles and curtailment. This issue was raised by Greenpeace last year and China justified its update on its wind policy last month by citing grid concerns. Additionally, the IEA's discussion of China's solar growth states "Two important challenges in China - the growing cost of renewable subsidies and grid integration - limit [PV] growth."
The challenges brought to the grid by a rapid influx in solar are not unique to China (e.g., see here, here, and here). There is the problem of how to upgrade grids to become compatible not just with current drastic changes in distributed energy generation, but how to upgrade them to become compatible with an uncertain future with unknown energy weights coming from various sources at various times; and who to stick with the bill for such costly upgrades and strategically manage various incentives. It's not as straightforward as, say, building a few more gigafactories; there is not the same exponential dynamic as solar component manufacturing. It seems that no one has a great comprehensive solution to these problems, though of course utilities, relevant equipment makers (e.g., battery makers), and governmental agencies are grappling with these problems and making progress. Sometimes naive policies hinder progress on these problems, such as, in my opinion, California's recent policy to require solar panels on all new homes (starting 2020).
So here's my conclusion: the limitations of China's grid are the biggest reason behind the new policy. For all the language of making solar growth more orderly and more optimized, it would not make sense to reign in the growth of solar installations so dramatically unless there were some real problem - some substantial problem - behind the words "orderly" and "optimize." I think that substantial problem is that grid development has fallen far behind the exuberant pace of solar installations. I'm guessing that the reason the document doesn't openly address the scope of the grid problem is basically to save face - to prevent drawing international attention to that problem. (Just now I see SA author Energy Solutions Partners agrees.)
Furthermore, I wish to draw attention to a missing piece of the situation: Chinese coal subsidies (and other energy subsidies). Coal is the main competitor to solar in China, and in all the commentary I've seen discussing this policy move, I have yet to see any discussion of the state of state coal subsidies. After reviewing a very limited set of documents about China's coal subsidy situation, including this, I have reached several conclusions: China's coal subsidies are substantial, diverse, difficult to measure, and on the decline. If China has the motive to decrease solar subsidies at this moment, it is more clear that China has a sustained long-term interest in decreasing its coal subsidies. In other words, the current solar cut in subsidies is not the end of the story. Sooner or later, it's more than likely that China will make a move to decisively reduce its coal subsidies. My guess based on the emergency-halt-language of the new solar policy is that a major coal subsidy reduction will not be immediately released (as in "oh by the way we are doing the same thing to coal that we did to solar"); it might be months or years out, and it might be more gradual. But it's not hard to imagine that on the day a coal subsidy reduction is announced, solar stocks will not be doing so bad.
China's move against solar growth should not be read as a permanent policy change. They still care about pollution-reduction and moving toward renewables, not to mention their large domestic solar industry. In the medium term and long term, these concerns will be re-asserted.
Collateral Damage and Opportunities
With this new perspective on the short run vs. the long run, and the hypothesized grid problem, we can speculate not just about directly affected markets but also about secondary and tertiary effects of China's new policy. A market shock of this scope will have ripples.
Directly, PV components producers will suffer since the components market is global. Even a producer who only sells in the U.S. with Trump-tariff protection will feel the pain, since other companies who sell both in the U.S. and abroad will feel the effects of the oversupplied international market and will transfer some of that pricing pressure into the U.S. market. Also, Chinese solar installers (e.g., EPC) will suffer dramatically, but other installers' fate will be linked to their distance from the Chinese installation market, as the installation market is not globally commodified. The utility installation market is more global and will face pricing pressures, but residential/retail installers outside of China (e.g., Sunrun (RUN)) should benefit. Global EPC Solar installation contracts will come under pressure and some will probably be reneged, and others renegotiated. Hence, the immediate worry about the security of First Solar's (FSLR) contracts (for instance), which do have some security because of the required deposits. Generally, I fear that Invesco Solar Portfolio ETF (TAN) will feel more pain.
The most immediately connected competing markets are the international coal market (and perhaps other energy sources) and Chinese power plant construction markets. China will be needing to generate more energy from somewhere. Actually, you might think that wind would do rather favorably (contrary to the immediate market response). However, if you buy my story about the grid's trouble with solar, then you might also have worries about the grid's capacity for wind, a worry which the Chinese government already explicitly raised. Meanwhile, the global coal market is too gigantic to be affected much - coal futures have ticked up only a few percent after the announcement. Although the global coal market dwarfs the global solar market, the market for new installations is a different creature, so any company involved with coal plant construction in China should be looking rosy (for now).
Some markets and companies are connected, to some extent, to what happens with solar, and to the rate at which solar is adapted. These include utilities, battery makers, lithium miners (Global X Lithium & Battery Tech ETF (LIT)), and grid tech companies (e.g., ABB Ltd. (ABB)). If you buy my analysis in the last section, then we have to differentiate between the short or mid term (before an inevitable change in Chinese policy) and the long term, not to mention a negative solar component R&D adjustment now having effects later. Short term, solar becomes attractive outside of China, and with it battery makers and grid tech companies. Short term, I expect lithium to struggle. But since these are secondary or tertiary effects in addition to being temporary, they shouldn't be given much weight.
On the other side of the supply chain, the polysilicon producers will be in rough shape (for now), especially as polysilicon prices tend to move more dramatically than PV component prices.
In the short-to-medium term, the solar market is in real trouble, and there will be reverberations in various connected markets. However, the length and depth of this trouble are closely tied to Chinese government policy moves going forward, and in particular, when and to what extent they crack down on coal subsidies. Additionally, China's navigation of this whole energy situation is probably tied to the development of its grid and its current inability to cope with exponentially rising levels of solar. Long term, there will be better and better grid solutions, and solar will do just fine - at least those solar companies that survive the ride.
Disclosure: I am/we are long ABB, FSLR.
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.