We have lowered our fair values across the solar sector in response to our growing belief that the industry is about to enter into a period of significant oversupply. In our view, solar faces two serious problems in slowing near-term demand growth and overly aggressive expansion of production capacity. Our current projections forecast module pricing declines of 30-40% (depending on the specific company) during the next two years, and we expect growth and profitability to compress across the space. Though cost reductions will continue and somewhat limit the damage, both First Solar (FSLR) and the leading crystalline silicon players (Trina TSL, Yingli YGE, etc.) cannot cut their costs this quickly. Presently, we think the biggest opportunity is indentifying overvalued companies, as shares have yet to price in either significant pricing declines or an industry downturn. In fact, solar stocks have rallied strongly in recent weeks due to the nuclear backlash resulting from Fukushima.
Shrinking European Markets Will Not be Offset by Growth Elsewhere
Recently, the solar industry has seemingly been in trouble a couple of times, only to see sufficient demand surface solve its problems. After Spain dramatically reduced its solar subsidies (~40% of global demand in 2008), it seemed fanciful to think the global solar market could grow in 2009. But the German market doubled, fuelling 20% global growth. The next scare was from Germany itself, when it announced its solar subsidies would be cut in mid-2010. Many expected a strong first half of 2010 would be followed by a sharp decline in the second half. Instead, demand in Germany remained strong and Italy’s solar market grew by more than 400% for the year. These two countries together combined to install 11.4 gigawatts (GW) of solar last year, good for 63% of the 18.2 GW installed worldwide.
Now, developments in many of the world’s major solar markets again are raising concerns that an industry slowdown could be forthcoming. Below is a summary of recent policy developments:
- Germany’s solar feed-in-tariff was reduced by another 15% at the beginning of 2011, and we’ve heard project economics there are now much more challenging than at any point during the last few years. Further cuts will occur on July 1 if more than 3.5 GW are installed on an annualised basis between March and May. The government has stated it wants to limit annual solar installations to 3-4 GW beyond 2011. We are projecting installations of 5.5 GW in 2011 and 4 GW in 2012, down from 7.6 GW in 2010.
- Italy will draft a new solar subsidy framework soon, and it is widely expected the government will enact a 1-2 GW effective annual cap. Installations in 2011 still seem destined to be above 2.0 GW, given (a) January and February were strong and (b) the government seems likely to soften the blow from a future cap by allowing a grace period for projects that were already in the planning/permitting stages to still receive a subsidy. We project 3.7 GW in 2011 and 2.0 GW in 2012, down from 3.8 GW in 2010.
- The Czech Republic (third largest market in 2010) saw its government kill its solar programme after installations surpassed 1 GW in 2010. This market for all intents and purposes is dormant.
- France (sixth largest market in 2010) has unveiled a 500 MW annual cap on the amount of solar power it will subsidise. Similar to Italy, however, 2011 will be above this cap as projects approved before the cap was legislated will be eligible for the 2011 feed-in-tariff. We project 1.0 GW in 2011 and 500 MW in 2012, compared to 720 MW in 2010.
Optimists point to the recent examples of the industry defying the odds to downplay the risk of slowing demand. In our opinion though, this time things will turn out worse. Germany and Italy have propped up solar for two years, and the reality that both will be shrinking (or at best, stabilising) leaves a large void to be filled elsewhere.
Unfortunately, no other country has the subsidy framework in place that can generate multiple gigawatts of demand in 2011-12. Based on these considerations, we are projecting solar installation growth in Europe to shrink by 19% in 2011 and 32% in 2012. This will be somewhat offset by emerging solar markets, as the US, Canada, China, and India are all expected to rapidly expand. But given our expectations that 65% of 2011 worldwide demand will come from Europe, we are forecasting global installations to shrink by 2% in 2011 and 9% in 2012.
There is a chance that demand in 2011 could surprise enough to the upside to delay trouble (from either strong US growth or an Italian cap not coming online until 2012). But in our view, a major downturn in 2012 is unavoidable. Solar power growth from here clearly lies outside of Europe, but the markets of the future (China, the US, and India) are not ready to put the industry on its shoulders quite yet. We are projecting solar installations in US/China/India will increase to 4.7 GW in 2012 from 1.4 GW in 2010. Impressive growth to be sure, but still a fraction of the 11.4 GW installed in Germany/Italy during 2010.
Capacity Additions Have Been Far Too Aggressive
Periods of negative growth are challenging enough, but solar manufacturers have compounded the issue by aggressively expanding production capacity. We have compiled a table (see above) to show the planned 2011 capacity expansions of the industry’s 13 largest solar cell manufacturers. The results are troubling. First, these companies as a group expect to grow their shipments this year to 18.8 GW, or 58% year-over-year. These companies make up only 55-65% of global production capacity, however, implying the industry is planning on shipping 30+ GW in 2011. With this being the case, we believe production will soon be overshooting demand. If our demand projections are even close to accurate, solar is rapidly approaching oversupply.
In our opinion, the market has not realised the magnitude of pricing pressure that is likely to ensue very soon. We are forecasting module pricing declines of 30-40% from current levels by the end of 2012, and expect growth and profitability to compress across the space. With all of the risks facing the industry, we think near-term solar fundamentals are too weak to warrant investment at present.
Boost From Nuclear Backlash Will Not Solve Solar’s Near-Term Issues
It appears likely that the world’s future energy mix will include less nuclear power than expected prior to the March 11 disaster in Japan. The resulting backlash could plausibly result in both existing nuclear plants being taken offline and fewer new ones being built. Many have taken this to equate to a large future boost for renewables, and has led to a rally in solar stocks during the past few weeks.
It is true that what is bad for nuclear is good for solar. Still, any shift away from nuclear represents more of a long-term positive and cannot solve solar’s looming supply/demand problems. Nuclear is a baseload power source, which solar and wind are not. Since both solar and wind generate intermittent output (i.e. solar doesn't generate electricity when it is cloudy), they cannot be used as the core of a generation portfolio. Should any existing nuclear plants be decommissioned permanently, natural gas (the cleanest of the “dirty” generation sources) would likely be the near-term replacement for the majority of this capacity.
Further, solar remains an artificial industry where all demand is driven by government subsidies. The reason cloudy Germany is the world’s largest solar market is it has had the most expansive subsidy programme. The cost of solar power is still far too expensive to generate new demand without the introduction of new subsidies or improvements to current ones. The one country where policy adjustments could occur because of Fukushima is Germany. The country has already taken seven of its aging nuclear plants offline and a large portion of its electorate is decidedly anti-nuclear. If Germany were to move toward retiring its entire nuclear fleet, approximately 20 gigawatts of capacity would need to be replaced in the coming years. Given nuclear power’s high load factors relative to solar, it would take more than 70 GW of solar installations to replace the lost nuclear generation. Still, even if Germany decides to raise its annual solar target from the current 3-4 GW, it would doubtless be at subsidy rates below the EUR 0.21-EUR 0.25/KWh that solar now receives, meaning this incremental demand would not help stop module prices from declining. We think a plausible scenario is Germany increases its target solar growth to 5-6 GW per annum. An expanded solar market is certainly a positive, but Fukushima does not appear to be a watershed moment that will save solar from its deteriorating near-term fundamentals.
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