Read report in PDF with graphs: MAC-Solar-Sector-Update-Sep-2016
Solar Index Performance
The MAC Solar Index, the tracking index for the Guggenheim Solar ETF (NYSE ARCA: TAN), has sold off sharply this year and is currently down -37% year-to-date. The MAC index in 2015 closed -15% lower after the -2% decline seen in 2014 and the +127% gain seen in 2013.
Solar stocks have recently seen weakness due to (1) downward pressure on solar pricing and panel oversupply caused largely by a hangover from solar install spikes seen in 1H-2016 in China and the U.S., (2) uncertainty about whether the EPA’s Clean Power Plan will ultimately survive the presidential election and its court challenge, (3) uncertainty for the U.S. residential solar market amidst a shift to purchase/loans from leases and cutbacks in net metering in some states, (4) concern about the outcome of the Nov 8 U.S. presidential election and the post-election political climate for alternative energy, and (5) ongoing trade disputes that have resulted in tariffs and various market dislocations.
Recent bullish factors for solar stocks include (1) strong overall world demand for solar with the sector set to grow by at least 20% this year (see page 4 for the world solar growth outlook), (2) the strong prospects for U.S. solar in coming years after Congress in December 2015 approved a 5-year extension of the U.S. solar investment tax credit (ITC), (3) strong demand for solar power worldwide due to the increasingly competitive price of solar versus alternatives and as countries seek to meet their carbon-reduction targets under December’s Paris COP21 global climate agreement, (4) the partial recovery in oil and natural gas prices from the early-2016 lows, (5) M&A activity in the solar sector after Tesla (TSLA) offered to buy SolarCity (SCTY) and Trina Solar (TSL) received a management go-private buyout offer, and (6) low valuation levels that indicate that solar stocks are very conservatively priced.
Solar stocks are currently trading at very low valuation levels compared with the broad market. The median forward P/E of companies in the MAC Solar Index is currently 8.7, which is well below the forward P/E of 18.6 for the S&P 500 index. In addition, the median price-to-book ratio of 0.86 for the companies in the MAC Solar Index is well below the 2.87 ratio for the S&P 500 and the median price-to-sales ratio of 0.83 for the MAC Solar Index is well below the 1.95 ratio for the S&P 500.
Solar stocks are on the defensive due to falling solar pricing and overcapacity concerns
Solar stocks have recently been on the defensive mainly because of concerns about module oversupply and falling solar pricing, which has pressured the profit margins of polysilicon, cell, and module producers. So far this year, average polysilicon solar module prices have fallen by -26% to a record low of 41 cents/watt (according to PV Insights) and solar cell prices have fallen by -38% to a record low of 21 cents/watt (according to Bloomberg New Energy Finance). Polysilicon prices posted a record low of $13.08/kg in February but have since recovered a bit and are +11% above that low at $14.52/kg and are up +6.5% on a year-to-date basis (see pricing commentary and charts on page 8).
In a diversified solar stock index such as the MAC Solar Index, the downward pressure on solar pricing has a mixed effect. Lower solar pricing is (1) negative for polysilicon, cell, and module producers, (2) positive for utility, commercial, and residential solar developers who pay lower module input prices and should be able to boost sales with a more price-competitive product compared with alternatives, (3) moderately negative for the large vertically integrated solar companies that manufacture modules and also install solar plants, and (4) slightly positive for yieldcos in that more solar projects should become available as solar falls to more competitive pricing levels versus alternatives such as wind and natural gas.
For the short-term, the decline in module pricing is clearly negative for solar manufacturers because of the downward pressure on margins. However, there is a benefit that emerges over time in that lower solar pricing should stimulate demand and eventually result in higher unit sales. The problem for the solar industry thus becomes cutting costs and waiting for increased demand to emerge from lower pricing.
In the bigger picture, the solar industry has no choice but for pricing to drop further so that it becomes the cheapest source of new electricity generation and easily beats its alternatives on an unsubsidized basis. There is clearly short-term pain involved with that downward pricing process but huge upside potential over the long-run as solar gets closer to becoming the cheapest source of electricity generation. In addition, once solar is cheap enough that subsidies disappear, then demand growth will be much more natural and the boom-bust days caused by the ups and downs of subsidies will be over.
Solar has already made dramatic progress in competing with alternatives such as wind and natural gas in some areas. According to Bloomberg New Energy Finance, coal plants generate electricity for about 3.4 cents per kilowatt-hour (kWh) and natural gas for 4.7 cents/kWh. However, there are a growing number of examples of solar projects that are being offered near, or even below, those coal and natural gas figures.
For example, a new record solar power purchase agreement (PPA) low was recently established when an Asian consortium that included JinkoSolar (JKS) bid 2.42 cents/kWh for a 350 MW solar plant to be built in Sweihan, Abu Dhabi. That beat the previous record low of 2.91 cents/kWh offered by Solarpack in Chile in August. Earlier this year, Enel agreed to provide electricity for only 3.5 cents/kWh on a solar PPA in Mexico totaling 1 GW. Most large solar PPA contracts are currently being bid in the area of 4-5 cents/watt.
The good news for the solar industry is that the industry has already proved over the course of its multi-decade history that it can drive down costs on a sustained basis, thus preserving profit margins even as solar pricing declines. The solar industry has driven solar costs lower through (1) technology innovation that allows manufacturers to produce higher-efficiency panels at lower costs, (2) lower manufacturing costs stemming from economies of scale and taking advantage of the manufacturing learning curve, (3) lower balance of system costs that involve lower costs for inverters, tracking systems, permitting, and installation, and (4) reduced financing costs as solar financing techniques mature and investors gain confidence about the safety of returns from solar plants with guaranteed PPA revenue.
As an example of how solar companies are reducing costs based on technology, First Solar (FSLR) with its latest S6 module technology will be able to reduce its module cost by about -37% to 25 cents/watt from the recent company average of about 40 cents/watt, according to analysts at Cowen and Company. Meanwhile, Daqo New Energy (DQ) with its latest technology and cost reduction efforts has cut its current polysilicon cost structure by -27% yr/yr to $9.43/kg in total cost and to $7.42/kg in cash cost, according to figures provided by the company.
In addition to progressively cutting production costs through technology, most large solar companies are responding to the latest drop in solar prices by cutting SG&A expenses (Selling, General and Administration Expenses), reducing employee head-counts, and shutting down older and higher-cost production lines.
The sharp decline in solar pricing seen so far this year is due to several factors: (1) an overhang of module supply in 2H-2016 since demand dried up in China after the June 2016 step-down in China’s FIT and since the 2016 U.S. utility solar surge is dissipating (that surge was caused by the former ITC expiration date at the end of 2016) (see page 4 for a more complete discussion of the solar growth outlook), (2) production increases and capacity expansion announcements from existing players and new entrants, particularly in China and India, (3) the reduced effect of trade tariffs in supporting solar pricing as producers implement work-arounds to move production away from high-tariff production locations, and (4) lower manufacturing costs that allow manufacturers to naturally reduce prices.
Solar pricing is likely to see continued downward pressure until inventory levels are brought down to normal levels and companies dial back on production and capacity additions to better match demand. The current downtrend in pricing is likely to cause somewhat of a shake-out among the smaller and weaker solar players that cannot cut production costs and are too small to compete. Meanwhile, some of the large solar companies have already cut back on their capacity expansion plans and are redoubling their efforts to cut costs to sustain profit margins even as pricing falls.
Florida voters show support for solar by approving a solar tax break for businesses
Florida voters on Aug 30 approved a solar tax break by the wide margin of 73% in favor, showing that public support for solar remains strong almost aside from political affiliation. Voters approved Amendment 4, which allows the Florida legislature to exempt solar installments from property tax for 20 years for businesses. Homeowners are already exempt from paying property tax on solar equipment. The measure is not a done deal, however, because the Florida legislature in 2017 needs to approve legislation to implement the measure.
Despite the good news for solar on Amendment 4, Florida continues to be a tough place for solar to flourish due to anti-solar regulation and the lack of a renewable portfolio standard (RPS) for utilities. Florida ranks only 14th in installed solar capacity among U.S. states despite having the 3rd best solar potential in the nation, according to the Solar Energy Industries Association (SEIA).
Pro-solar advocates are currently worried about the upcoming Florida vote on November 8 on Amendment 1. Voter approval of Amendment 1 would outlaw third-party ownership of solar in Florida, which would significantly damage solar potential in Florida by not allowing leasing of solar equipment to homeowners, businesses, or government entities.
Florida is already one of the very few states in the country that makes third-party leasing effectively impossible because the solar owner/lessor would need to register as a utility. Pro-solar advocates are worried that Amendment 1 might pass because it is intentionally couched in language that makes it look to the voter as if he or she is voting in favor of solar when in fact a vote in favor of the measure would significantly damage solar potential in Florida.
The Amendment 1 measure is formally called “Rights of Electricity Consumers Regarding Solar Energy Choice,” which on its face sounds like a good thing for solar, when in fact the opposite is true. The fact that anti-solar utility interests need to use a deceptive title to try to get their anti-solar measure passed shows they know they are on the wrong side of the public on solar.
Nevada PUC bows to pressure and allows net metering grandfathering
In a boost for the U.S. residential solar sector, the Nevada Public Utilities Commission (PUC) earlier this month issued a ruling that solar customers who had already-installed solar systems or had active applications before Jan 1, 2016 will be grandfathered in to the original net energy metering program (NEM) that existed prior to a recent cut in the NEM program. Customers were outraged when the Nevada PUC unilaterally cut their NEM rates and hurt the economics upon which their system purchase was based. Large solar companies were also outraged and some withdrew altogether from the Nevada solar install market in protest.
The good news for the residential solar industry is that the pressure on Nevada’s PUC was so strong that it was forced to relent and grandfather in existing solar customers. That will act as a warning to public utility commissions in other states that they are likely to face some serious backlash if they try to cut NEM rates on existing solar customers.
Clean Power Plan oral arguments will be heard on Sep 27
Oral arguments on the case about whether the EPA overstepped its authority with the Clean Power Plan (CPP) are scheduled to be heard on Sep 27 by the Court of Appeals for the District of Columbia Circuit Court. Of the nine judges on that court who will hear the CPP case, five were appointed by Democratic presidents and four were appointed by Republican presidents, possibly giving the CPP the upper hand with a 5-4 decision if the case is decided along partisan lines. Based on the current time line, a decision by the Court of Appeals for the DC Circuit could come by late 2016 or early 2017. The case would then likely be heard by the U.S. Supreme Court on appeal by spring or fall 2017.
However, the fate of the CPP also depends on the outcome of the presidential election on November 8. If Donald Trump wins the White House and takes over as President in January, then all the court challenges would likely become moot because the Trump campaign has said he would rescind the EPA’s CPP.
On the other hand, if Hillary Clinton wins the White House, then the ultimate fate of the CPP would likely depend on the makeup of the U.S. Supreme Court at the time of a CPP decision. Ms. Clinton has already said that she strongly supports the CPP and would press for its implementation.
The presumption is that the U.S. Supreme Court at present is tied 4-4 on CPP since opponents to the CPP lost their 5-4 advantage on the Court when Antonin Scalia died in February 2016. If Ms. Clinton can get a new Supreme Court justice through the Senate in time for a CPP ruling and that judge supports CPP, then the chances would appear to be good for a 5-4 vote in favor of CPP.
On the other hand, if Ms. Clinton wins the White House but cannot get a new justice on to the Supreme Court bench in time for a CPP ruling, then the Supreme Court could end up deadlocked 4-4 on the CPP. In the case of a Supreme Court deadlock, the decision of the Court of Appeals of the DC Circuit would become the final ruling on the CPP case, illustrating the importance of the Court of Appeals decision.
The CPP is currently in a state of suspended animation since the U.S. Supreme Court on February 9, 2016, granted a stay for the states on complying with the EPA’s CPP until the merits of the plan are litigated in court. The Supreme Court’s stay means that states, if they wish, can stop the planning process on how they would comply with the CPP.
The CPP is not scheduled to come into effect in any case until 2022. Before the Supreme Court issued its stay, the states were required to submit their plans by 2018 on how they would comply with the CPP. If the EPA ultimately wins the CPP case, it not clear whether the EPA will give the states additional time to submit their plans since states that oppose CPP have stopped work on their plans. However, states that favor the plan have continued their work on adopting their plan to meet the requirements of the CPP.
The goal of the EPA’s CPP is to reduce national greenhouse gas emissions by 32% from 2005 through 2030 and for the U.S. to get 28% of its electricity from renewable energy sources by 2030, more than double the 2014 level of 13%. The CPP is the centerpiece of the Obama administration’s plan on how to comply with the Paris COP21 global climate agreement. If the CPP ultimately does come into effect, it would provide a big boost for solar power after the current solar Investment Tax Credit (ITC) largely expires in 2022.