Solar Energy is in Deep Shade

The solar energy sector is in ‘deep shade’ right now, struggling with serious business problems that threaten the survival of many firms that looked so promising only recently.  All eyes are watching the quarterly earnings reports from several of the leading publicly traded players to assess just how bad this situation is for the industry and its investors.  A stumble by any significant player will further weaken confidence in the sector, risk a serious sunburn for many investors suddenly overexposed in a falling market, and invite the vultures to pick the carcasses clean. This is not just a problem in the United States, but a worldwide phenomenon.

Emissions Allowances will Encourage Renewable Energy Growth

It was not supposed to be this way.  The frantic beating of chests over global warming and the imperative to do something bold to reverse it was a key driver in the rapid growth potential of renewable energy from many sources.  Except for the US skunk at the Kyoto Protocol lawn party, nations were expected to rise to the challenge and act.  Many did, and in the EU there was such a flurry of activity that the desire for emissions allowances reached a fever pitch.  Politicians being, well politicians, sought to pander to the voters today and defer any price to pay until tomorrow—beyond their watch—so to many allowances were issued.  The result was that allowances prices were so low that the prudent business decision was clear—buy allowances and avoid taking any other action to actually reduce emissions if it cost more than buying the allowances.

The price of emissions allowances has fallen along with the prospects for explosive growth brought on by a convergence of forces that include the recession depressing demand and tightening access to credit, ambitious growth plans and expanding production suddenly stranded in a sea of excess capacity, and too many players with pockets not quite deep enough to withstand the market volatility.  EU carbon emissions allowances (EUA) futures prices, for example, fell below14 euros/tonne July 28 2009 because the glut of allowances available for sale is driving down the prices and forcing banks who held them to dump them.  EUA’s trade like other commodities based upon supply and demand, and recently there is much more supply than demand.  Traders said that the lack of compliance buyers such as utilities or large industrials in the market was depressing prices.

Feed-In-Tariffs will Save Clean Energy

The response from renewable advocates, industry players suddenly worried, and politicians’ facing a day of reckoning too close to the next by-election was to further muddle the market.  Feed-In-Tariffs were used in Germany and popularized in Spain as a way to more rapidly scale the renewable energy industry.  A feed-in-tariff is a subsidy that requires the utility buyer of renewable energy to pay higher than market prices on a long term contract for the clean energy output in order to jump start more renewable production.  But in Spain today, the government realizes it can not continue its subsidizing ways in the current recession and has delivered a cruel lesson to all who live on such subsidies.  What the government gives it can take away.

In 2007, Spain set a national cap of 400 megawatts under its feed-in-tariff and expected that to be sufficient through 2010. By September, 2007 solar installations reached 344 megawatts and solar installers started lobbying the Government to raise the cap and adjust the solar electricity rates.  But in a rare show of common sense, the Spanish Government set a 500-megawatt cap for 2009 and cut the solar electricity rates for both roof-top and ground installations by as much as 29 percent.  The problem was solar developers rushed to complete as many projects as possible while the government debated the new rules and purchased about 1.7 gigawatts of solar panels but were able to install only 800 megawatts of them before the new rules took effect.   The result was falling prices for panels as developers unloaded them at fire sale prices adding downward pricing pressure for the entire industry.

California has had a feed in tariff program for renewable generation since 1969[1], but restricts it seven jurisdictional utilities. The California feed-in-tariff was designed to require the utilities to buy renewable energy produced my water and wastewater treatment utilities mostly municipal but it has expanded over time.  Critics say the California feed-in-tariff isn’t priced right because it is based on the cost of building and operating a combined cycle gas power plant considered the marginal power plant choice in a typical least cost, best fit integrated resource power portfolio by the CPUC.[2]

Since those who do not study history are doomed to repeat it, feed-in-tariff advocates in some more progressive places are encouraging their adoption in a desperate attempt to recover the momentum for the struggling industry segments.  Gainesville, Florida’s municipal electric utility adopted a 4 megawatts per year capped feed-in-tariff earlier this year, Vermont imposed a similar 50 megawatt capped measure by legislative fiat[3], and the Sacramento Municipal Utility District (SMUD) plans a feed-in tariff program next January to encourage solar energy system owners to sell excess electricity to the utility.

SMUD’s action is part remorse and more politics since it recently pulled out of a large electric transmission project designed to bring more renewable energy resources from across Northern California and Northwest Nevada to California’s Central Valley and San Francisco Bay area.  By withdrawing its support in the face of NIMBY pressure from landowners opposed to a transmission line across their property, SMUD sabotaged its own business model of relying heavily on renewable energy sources to meet the electric demand of its customers.  But to execute that strategy, SMUD must have access to more transmission to bring those clean energy resources to market.

Will a feed-in-tariff save SMUD from its own self inflicted wounds?  Probably not, since few others have incentives to build transmission when SMUD is unwilling to pay its fair share of the costs for such a project.

In a further sign of just how desperate solar developers are, their lobbyists succeeded in inserting into H.B. 3039 approved in Oregon providing for a pilot program for small-scale solar projects a provision giving utilities in that state a two-for-one credit toward their 25% of retail energy sales renewable portfolio standard (RPS) goals for solar energy purchased from large projects, up to a total of 20 MW.  This sleight of hand infuriated state officials and environmental advocates who saw it as a crass political move by the solar industry that had the perverse effect of diluting the state’s 25% overall RPS goal for 2025.

Competition is a Cruel Mistress

The solar sector is undergoing a consolidation and shake-out as a result of the convergence of structural, economic and market problems facing the industry.  Just like the wind industry before it, smaller weaker players are being forced out or bought up by stronger players.  While this is good for the industry over the long term, it causes many promising developers of new technology heartburn and sometimes failure.

At the heart of the problem, the solar industry is not just an energy play it is a technology play and competes for materials with silicon chip makers and IT giants bringing innovative new products to market across the cleantech space.  Private equity is heavily involved in the IT space and as solar players stumble, it is taking control of struggling companies and imposing financial discipline.

The structural problems facing the solar industry include:

  1. Disruptive Technology.  There is a race to market and scale with the goal of reducing the overall cost of solar technology to grid parity—the holy grail for acceptance of solar as a mainstream clean energy resource like wind.  Solar developers have sought private equity funding, in large part, on the basis that fast growth in market share will drive down costs of panel production and make [ insert favorite solar stock here] the industry leader. Any slow down in market share growth or scalability dooms many of the smaller players by undercutting their value proposition in the eyes of investors.
  2. Falling Commodity Prices Put Downward Pressure on Solar Prices.  The recession has tanked IT sales and created a short-term glut of raw materials.  Solar energy competes with chip makers for its raw semiconducting materials.  When raw materials prices fall, it puts pressure on solar developers to lower the price of their finished products which eats into cash flow and creates going-concern problems for undercapitalized businesses.
  3. Energy Price Competition.  Solar is in a tough position because of the widespread success of wind energy in becoming an accepted mainstream resource.  At the same time, the generally accepted standard for grid parity requires solar to bring down its levelized cost of electricity to match essentially a combined cycle gas fired turbine in order to compete.  At today’s production costs solar is not economic.
  4. Demand for Renewable Energy is Subsidized. While customers surveyed uniformly favor renewable energy from clean sources, when asked whether they will pay more for clean energy most still say no.  The government has manipulated the market to require utilities to purchase a certain amount of renewable energy and, in some cases, as I wrote earlier has used feed-in-tariffs and other subsidies to scale the market share of renewables in an effort to reduce emissions of greenhouse gases.  But unless solar and other renewable energy sources can reach grid parity and compete without subsidies they risk changes in government policy such as recently seen in Spain which pulls the rug out from under the market participants.   This is a fundamental structural risk to the sector.

Wall Street Wants to See the Money!

Investors want to see signs of a recovery in solar panel demand as earnings reports from developers and manufacturers are released over the next few weeks.  But most investors know that today’s quarterly earnings reports are not nearly as important long term as the prospect for continued falling prices for solar panels.

The consensus seems to be that Q2 solar results should be better than Q1 which were horrible. But it is the guidance and outlook from those reporting about demand and average selling prices that will offer the best clued about whether confidence of better times is growing.

But there are plenty of downside risks.  Many had hoped that government stimulus money would jumpstart falling demand and thus raises prices.  But the slow action by US DOE in releasing money means that it will be well into 2010 before any significant help arrives from the government.  That may be too late for some players.  And, meanwhile, prices on solar panels are still falling.

Steven Milunovich, Bank of America/Merrill Lynch analyst, said he expected Q2 earnings to be disappointing and that the solar rally was over for 2009.  He recently downgraded the solar sector to “underweight,” because of the risk that demand will not recover as much as expected.   Now we wait to see if Steven is correct and whether solar investors will get sunburned.


[1] http://www.cpuc.ca.gov/PUC/energy/Renewables/feedintariffssum.htm

[2] http://www.greentechmedia.com/articles/read/california-feed-in-tariffs-the-price-isnt-right-6000/

[3] http://www.renewableenergyworld.com/rea/news/article/2009/06/vermont-fits-become-law-the-mouse-that-roared