China's Subsidy Cut Puts Grid Parity In Reach

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Includes: CSIQ, DQ, FSLR, HQCL, JASO, JKS, TSL, WKCMF, WKCMY
by: Growth And Value

Summary

Two weeks ago, the National Development and Reform Commission and the National Energy Administration announced to focus on quality over scale by cutting subsidies.

About half of last year’s demand for PV modules came from China.

Industry analysts have lowered their expectations for demand and prices, while solar stocks are trading sharply lower.

In China, the cost of solar is edging close to grid parity.

China announces a new direction

An announcement (in Mandarin) was published on May 31 by the National Development and Reform Commission and the National Energy Administration that declares that there will be no plans for new ground-mounted projects in 2018. Local entities may not start building power plants that require state subsidies in any form.

As for distributed photovoltaic projects, this year, there will be a quota of 10GW. Any project connected to the grid within May 31 will be counted as being part of this quota.

Support for PV projects aimed at fighting poverty (the "Poverty Alleviation Program") remains in place. The announcement also states that the "Top-Runner Program" is being re-evaluated. This program incentivizes the use of more efficient solar modules. In addition, all feed-in tariffs are lowered by CNY 0.05 starting from June 1, a month earlier than expected.

During a press conference (in Mandarin) held the following day, the NDRC stressed that the government is shifting its focus from scaling up the PV industry to making it profitable on its own. It also wants to a curb industry overheating because, in some parts of the country, power supply has outgrown grid capacity.

On May 6, executives and representatives of most of the industry's players, such as Trina Solar (TSL), Sungrow, Tongwei, LONGi, CSI, and JinkoSolar (JKS) met in Beijing with the director of China's New Energy Department. But the government didn't change its position.

The China Photovoltaic Industry Association commented that, under the new policy, current growth rates are not sustainable. An employee from Trina Solar said to reporters that the impact of the policy change is still hard to evaluate.

Expectations on demand and price

Industry players expected that subsidies for the solar industry would eventually decline, but the sudden and harsh action taken by the Chinese government came as a surprise to many. In 2017, the global demand for solar modules was 105GW, of which 53GW came from China. Most analysts had higher numbers in mind for global demand in 2018. During the last week, they revised their forecasts downward.

The Asia Europe Clean Energy Advisory (AECEA) revised its deployment forecast for China from 40-45GW to 30-35GW. IHS Markit forecasts 38GW.

Goldman Sachs expects a 40% drop in demand in China. As a result, Goldman expects a supply glut across all components with solar cells being affected the most.

Bloomberg's BNEF predicted in a note that multi-crystalline module prices will fall by around 34% from $0.37/Watt to $0.24Watt. In 2016, module prices declined by a similar rate, while in 2011, prices fell by 40%.

Impact across the supply the chain

In 2017, polysilicon manufacturers, such as GCL-Poly Energy, Wacker Chemie (OTC:WKCMF) (OTC:WKCMY), OCI and Daqo (DQ) enjoyed high margins because the production process of silicon doesn't allow for quick changes in output. This inflexibility is currently causing oversupply, which in turn leads to a strong decline in the price of polysilicon worldwide.

The companies most affected by China's change in policy are Chinese second-tier module manufacturers. They have difficulties selling abroad. Furthermore, they often can't benefit from the Top Runner Program because keeping up with innovation has become costly. Also, financing is increasingly difficult because of China's ongoing deleveraging campaign. As a result, the demand for wafers and cells has dried up. Module manufacturers are rushing to clear their inventories by offering prices as low as $0.26/Watt. According to data from PV Insights, they are also dumping their products on the Indian market for prices in the range of $.27/Watt.

The members of the Silicone Module Super League (the six biggest crystalline silicon module suppliers Canadian Solar (CSIQ), Hanwha Q Cells (HQCL), JA Solar (JASO), JinkoSolar, Trina Solar, LONGi, and GCL) generate a large of revenues abroad where module prices are higher than in China. Most of these companies suffered from lower margins in 2017 because of high polysilicon prices. During the last two weeks, prices for polysilicon, wafers, and cells have been falling faster than module prices, but there is no guarantee that it will stay that way.

The age of subsidies is ending

China's decision to scale back its support to the domestic solar energy is likely driving some second-tier manufacturers out of business. Module prices will be considerably lower in 2018, and most investors fear a supply glut similar to the ones that occurred in 2011 and 2016.

In a Caixin article, Seeking Alpha contributor Doug Young discussed the importance of being wary of subsidies when doing business in China. Financial support from the government can cease with almost no warning. The lesson investors can draw from this is that they should avoid Chinese companies whose profitability depends on government support.

On the bright side, the days in which solar depends on subsidies are coming to an end. The current decline in module prices means that solar will become the cheapest source of energy in more regions around the world. After several countries in Arabia and South America have reached grid parity last year, Southern Europe will be next. SolarPower Europe, the European solar industry association, just estimated that the European market will grow on average by more than 50% percent over the next two years.

At the SNEC in Shanghai last month, several panelists, among which IHS Markit senior analyst Holly Hu, claimed China's leading power producers can produce solar energy at a cost as low as CNY 0.30/kWh in some places. This is below the price of coal power, China's cheapest source of energy. It suggests that the decline in module prices puts grid parity in reach. It is likely that the Chinese solar industry will emerge stronger than ever once it has overcome the current turmoil.

It's too early for picking winners

It is hard to say whether today is a good buying opportunity. Industry leader JinkoSolar currently sells two-thirds of its products abroad. Jinko also uses cells it buys from OEM producers in its products. So, the company is experiencing a drop in input costs, but it is not clear whether this is enough to compensate for lower selling prices. Jinko has recently secured selling agreements with NextEra Energy (NEE) and sPower that include downpayments. Next Era has quietly become the world largest operator of wind and solar farms. It also plans to expand its renewable energy business by building solar parks for large corporations, such as Google (GOOG) (GOOGL).

On the other hand, we don't know how these transactions have impacted the Jinko's balance sheet and whether Jinko needs more capital to get through potential difficulties ahead. Besides declining average selling prices, it is possible that China cuts back the Top Runner program which is responsible for a large part of Jinko's revenues in China.

Some value investors have argued that Canadian Solar's (NASDAQ:CSIQ) market cap is lower than the overall value of solar projects it currently owns and it is trying to sell. In December 2017, Canadian Solar's management published a non-binding going private proposal at $18.47 a share. There is a chance that management renegotiates the deal which would erase any upside potential for investors.

First Solar (FSLR) performed well in 2017. It has high reserves in cash and a full order book for the coming two years. First Solar's stock price benefited from the US imposing import tariffs on PV products last year. But the tariffs have also led Jinko Solar to start building an assembly plant in the US. Also, the current decline in prices likely erases the effect of these trade barriers. Solar cells and modules from China are a target of president Trump's efforts to reduce America's trade deficit, but it remains to be seen whether tariffs aimed at Chinese products have much impact. Most first-tier manufacturers have production facilities in other parts of Asia to circumvent tariffs. Ultimately, First Solar's success depends whether it will be able to decrease production costs of its thin-film modules faster than crystalline silicon module prices decline. Betting against China's module manufacturing giants has proven to be risky in the past.

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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.

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