Read report in PDF with graphs: MAC-Solar-Sector-Update-Dec-2017
Solar Index Performance
The MAC Solar Index, the tracking index for the Guggenheim Solar ETF (NYSE ARCA: TAN), has rallied sharply since May and is up +45% year-to-date.
Recent bullish factors for solar stocks include (1) a surge in Chinese solar installs in 2017 and broadening solar strength coming from India, Latin America, the Middle East, and Southeast Asia (see page 5 for the world solar growth outlook), (2) stronger demand for solar power due to the increasingly competitive price of solar versus alternatives as countries seek to meet their carbon-reduction targets under the Paris COP21 global climate agreement, and (3) continued low valuation levels that indicate that solar stocks are conservatively priced even after the recent rally.
Bearish factors for solar stocks include (1) uncertainty about whether the Republicans’ U.S. tax reform plan will hurt the availability of tax equity financing for the U.S. solar industry, (2) uncertainty about whether the Trump administration in January will impose U.S. import tariffs on solar cells and panels as a remedy for Suniva’s Section 201 trade complaint, (3) continued downward pressure on solar pricing caused by ample global production capacity, (4) uncertainty about the strength of global climate policy after the Trump administration earlier this year withdrew from the Paris climate agreement, and (5) ongoing solar trade disputes that have resulted in tariffs and various market dislocations.
Solar stocks are still trading at low valuation levels compared with the broad market even after the recent rally in solar stocks. The median forward P/E of companies in the MAC Solar Index is currently 13.9, which is well below the forward P/E of 19.8 for the S&P 500 index. In addition, the median price-to-book ratio of 1.30 for the companies in the MAC Solar Index is well below the 3.27 ratio for the S&P 500. The median price-to-sales ratio of 1.55 for the MAC Solar Index is well below the 2.22 ratio for the S&P 500.
Solar stocks see a sharp recovery rally
Solar stocks have rallied sharply since May on signs of improved solar industry fundamentals and reduced concerns about Trump administration policies. The oversupply of panels that plagued the market in late 2016 has eased and company profit fundamentals are improving. In addition, the market was very encouraged to see a surge of about +45% in Chinese solar demand installs in 2017.
Solar stocks have also been boosted by the stabilization of solar cell and panel prices, which has helped company profit results. Part of the reason for the recovery in U.S. solar panel prices, however, is stockpiling and strong demand ahead of a decision in January on Suniva’s trade complaint, which could result in tariffs or import curbs (see discussion on page 2).
Regarding U.S. politics, the solar market has already absorbed the negative moves that President Trump took earlier this year, including his intention to exit the Paris climate agreement and to rescind the EPA’s Clean Power Plan. There was relief, however, that the Trump administration did not go so far as to pull the U.S. out of the entire UN climate treaty framework nor to rescind the EPA’s legal obligation to regulate CO2 emissions.
Chinese PV growth surges
Forecasts for 2017 global solar installs have risen substantially because of a surge in Chinese installs. The China PV Industry Association (CPIA) reported that Chinese PV installs in the first half of 2017 were stronger than expected at 24.4 GW, up +19% year-on-year. The unexpected strength is mainly coming from distributed solar as opposed to utility solar.
CPIA said that Chinese solar installs for 2017 will likely reach 50 GW, which would be up by a blistering +45% from the 2016 install amount of 34.5 GW. In response to the first-half strength, Bloomberg New Energy Finance (BNEF) raised its 2017 Chinese solar forecast to 54 GW from its July forecast of 30 GW. IHS Markit is forecasting 45 GW of Chinese solar installs in 2017.
In July, China met the government’s 13th Five-Year-Plan (2016-2020) target for cumulative solar installations of 105 GW. As a result, the government raised its target to 150 GW. However, total Chinese installs are likely to be significantly higher than the target since the target does not include rooftop solar, which is booming.
Utility solar costs are now comparable to natural gas and have fallen below coal and nuclear
The levelized-cost-of-energy (LCOE) for utility-scale solar PV has dropped by -86% over the last eight years, by -36% over the last four years, and by -9% in 2017, according to Lazard’s latest LCOE report (link). Lazard’s report is the most comprehensive LCOE analysis available for alternative and conventional energy sources.
The latest Lazard report found that unsubsidized utility solar PV costs now have fallen by so much that solar is now competitive with new natural gas plants and is cheaper than new coal or nuclear plants.
Specifically, Lazard pegs the unsubsidized utility solar LCOE cost of 4.6-5.3 cents per kWh as comparable to the 4.2-7.8 cent cost of natural gas (combined cycle) and lower than cost of 6.0-14.3 cents for coal and 11.2-18.3 cents for nuclear.
U.S. is now the lone holdout from the Paris climate agreement
The U.S. is now the only country in the world that has refused to abide by the Paris COP 21 global climate accord. The only other holdouts, Syria and Nicaragua, recently acceded to the agreement. Nicaragua signed the Paris climate agreement in October and Syria in November announced its intention to sign the agreement.
The rest of the world is continuing with the Paris climate agreement without the United States. China and Europe have flatly rejected the Trump administration’s request for a renegotiation of the agreement. It makes little sense to renegotiate the agreement since the emission reduction targets are voluntary, which means that any country including the U.S. can simply change their goals if they wish.
Even though President Trump on June 1 announced that the U.S. plans to leave the Paris climate agreement, the U.S. exit will not actually occur until the end of President Trump’s term. The Paris agreement is binding on the U.S. for the next three years and then requires a 1-year notice to withdraw. The earliest date for a U.S. exit is November 4, 2020, one day after the next presidential election. At any time during that period, the U.S. could drop the exit process and recommit to the Paris agreement. The U.S. could also recommit to the agreement at any time in the future if desired by a new president.
The Obama administration originally signed the Paris climate agreement with a voluntary goal of reducing U.S. carbon emissions by 17% by 2020, by 26%-28% by 2025, and an intent to reduce emissions by 80% by 2050. Most climate experts believe the Paris agreement was not tough enough in the first place to meet its goal of limiting global warning to two degrees Celsius (3.6 degrees Fahrenheit) from pre-industrial levels.
Trump administration’s Section 201 trade remedy decision is due by January
The U.S. solar industry is on edge as it waits for the Trump administration’s decision on the remedy, if any, to the decision by the U.S. International Trade Commission (ITC) that U.S. solar cell and panel manufacturers have been harmed by foreign competition.
The Section 201 solar trade case began in spring 2017 after two foreign-owned solar manufacturing companies based in the U.S., Suniva and Solarworld, pursued a Section 201 trade case with the ITC. The companies alleged that they had been driven into bankruptcy by foreign competition. Section 201 is a little-used U.S. trade complaint that was last used by the steel industry in 2001.
ITC commissioners on Sep 22 ruled by a vote of 4-0 that American solar manufacturers were in fact harmed by foreign competition. The ITC on Oct 31 then released its remedy recommendations, which were less severe than the markets had feared. The ITC recommended tariffs of 30-35% on imported cells and panels and a possible import quantity limit. The tariff recommendation was substantially weaker than Suniva’s request for an import duty of 40 cents per watt and a minimum price of 78 cents per watt. Suniva’s requested remedy would have more than doubled the cost of imported panels from the current price of about 32 cents per watt.
The Trump administration currently faces a deadline of January 26, 2018 to announce its decision on remedies, although that deadline could slip. The Trump administration is not bound by the ITC’s recommendations and is free to choose whatever remedy it wishes, or even decline to apply any remedy at all. The Trump administration has given no indication of what remedy it might choose.
If the Trump administration does impose tariffs under Section 201, there is a chance that those tariffs will eventually be struck down by the World Trade Organization (WTO). President Trump’s U.S. Trade Representative Robert Lighthizer recently asked the ITC to identify any “unforeseen developments” that might come from tariffs, such as the impact on the solar install industry or a challenge to the tariffs at the WTO.
Section 201 solar import tariffs would be negative overall for the U.S. solar industry, which is heavily dependent on imported solar panels to support the rapid installation of solar in the U.S. Indeed, U.S. factories manufactured fewer than 10% of the solar panels that were installed in the U.S. in 2016, according to Bloomberg New Energy Finance. In fact, U.S. installers in 2016 heavily relied on imported panels for more than 90% of their U.S. solar installs.
Any increase in the after-tariff price of imported panels would make U.S. solar projects less economical in the U.S. and would therefore hurt the U.S. solar install growth rate. GTM Research estimates that U.S. solar installs would be cut by -9% from what they would otherwise be if the Trump administration levies a tariff of 10 cents per watt, which would be close to the ITC’s recommendation of a 30-35% tariff.
The problem for the Trump administration is that any tariff on imported solar panels will likely result in a net reduction of U.S. solar jobs. Of the 260,000 solar jobs in the U.S., 85% are in installation and only 15% are in manufacturing, according to the Solar Energy Industry Association (SEIA). Import tariffs might give a small boost to U.S. solar manufacturing jobs, but that small boost would be swamped by the number of jobs that could be lost in the solar install industry. For that reason, the Solar Energy Industry Association (SEIA) strongly opposes any tariff or trade restrictions on imported cells and panels.
The Section 201 trade case has been a positive factor for First Solar (FSLR) because the ITC decision exempted thin-film manufacturers from any trade remedies or tariffs. The ITC decision also exempted manufacturers from Canada and Singapore. By contrast, the ITC decision was negative for Chinese and other global solar manufacturers because they could see a tariff slapped on the solar panels that they export to the U.S. The decision was also negative for U.S. companies that specialize in installing solar panels, such as SunRun (RUN) and Vivent (VSLR), since they would face higher prices for imported solar panels.
The Section 201 trade case has already hurt the U.S. solar install industry by pushing solar panel prices as high as 52 cents per watt since installers are hoarding what panels they can find. In addition, many solar projects have been delayed, waiting for the remedy decision and to see how solar pricing shakes out in 2018.
While the Section 201 trade case has been a negative factor for the U.S. solar industry, the industry will nevertheless survive what would be the latest example of governmental trade interference in the solar industry. A 30-35% tariff on imported panels would push up the price of imported solar panels to the 43-44 cent per watt area from the current 32 cent level, but many solar projects can still be economical at that level. In addition, installers would try to adapt to the tariff by buying domestically-produced panels or otherwise exempted panels. Moreover, some Chinese solar manufacturers are already talking about setting up solar panel factories in the U.S. to avoid the tariffs.
Regarding the impact of the Section 201 trade case on the global solar industry, it is worth remembering that the U.S. market in 2016 accounted for only 18% of global solar installs, according to BNEF. That means that a drop in U.S. installs from tariffs would have a limited effect on the overall global solar market. For example, if the U.S. solar installs suffered a -10% hit from Section 201 remedies, that would translate to a decline of only about -2% in worldwide installs (i.e., a -10% U.S. decline multiplied by the 18% U.S. market share).
Trump administration moves to rescind Clean Power Plan
The EPA on October 10 took formal steps to repeal the Obama administration’s Clean Power Plan (CPP), which was designed to cut CO2 emissions from U.S. power plants. That action, however, was in line with the Trump administration’s well-known intentions and had little stock market impact.
When President Trump was elected in November 2016, the markets were already aware that the CPP would not go into effect during the Trump administration’s watch. The CPP, in any case, was already bottled up with a legal challenge at the U.S. Supreme Court when Mr. Trump took office. There was a chance that the Supreme Court would have struck down the plan anyway as an overreach of regulatory authority even if Hillary Clinton had been elected as president.
Nevertheless, the loss of the CPP is a blow for U.S. efforts to reduce its carbon emissions. Without the CPP, the U.S. is unlikely to meet the Obama administration’s former goal under the Paris climate agreement of reducing U.S. carbon emissions by 17% by 2020, by 26-28% by 2025, and by 80% by 2050.
The EPA’s repeal of the CPP will be a long and torturous process since the repeal must go through the EPA’s regular rule-making procedures from scratch. The repeal is then likely to be challenged by environmental supporters in court. That whole process is likely to extend well past the end of the Trump administration’s first term. In the meantime, the CPP will not be implemented and will have no effect.
The good news for the solar industry is that the EPA is still under a legal requirement to regulate CO2. The EPA’s obligation to regulate CO2 emissions has already been litigated all the way up to the U.S. Supreme Court and would be extremely difficult to reverse. The Trump administration has already decided not to challenge President Obama’s 2009 CO2 endangerment finding, which established the legal structure by which the EPA is legally obligated to regulate CO2 emissions.
The EPA said it plans to issue a replacement rule for the CPP in order to meet its legal obligation to regulate CO2 emissions. The EPA has requested ideas from stakeholders about the content of a replacement rule. However, few believe that a significant CO2 emission reduction rule is likely to emerge during the Trump administration.
Republicans’ tax reform plan may have negative implications for tax equity financing
The Republicans have not yet finalized their tax reform plan, which means the implications of the plan for solar are not yet clear.
In a very positive development for solar, Republicans appear to be headed towards leaving intact the existing solar investment tax credit (ITC) provisions through 2021, which is an important support measure for the U.S. solar industry. The solar ITC is currently set at 30% through 2019 and is set to step down to 26% in 2020 and 22% in 2021.
The ITC in 2022 will expire entirely for direct-owned residential projects, but will permanently remain at 10% for utility PV projects, non-residential, and third-party-owned residential solar installations. The Republican tax bill, however, may end that permanent tax credit at some date in the future such as 2027. The elimination of the permanent tax credit would be mildly negative for the U.S. solar industry, but would only take effect far out into the future.
The solar industry’s main area of concern about the Republicans’ tax bill is the impact on tax equity, which is an important source for financing for solar projects. Tax equity accounted for about 21% of the $58.5 billion of U.S. renewable energy investment in 2016, according to BNEF.
Through tax equity, an investor can take passive partial ownership of a solar project to capture the tax benefits, which might not otherwise be available to the developer. Tax equity helps reduce the overall financing costs of a solar project.
The Republican tax bill aims to reduce the corporate tax rate to 20% from 35%, which by itself means that companies may allocate less capital to tax equity since they will be paying lower taxes. Moreover, there is major concern that tax equity could take a heavy hit depending on whether Republicans go through with ideas to impose a tough alternative minimum tax (AMT) on U.S. corporations and/or put what amounts to an AMT on U.S. affiliates of foreign corporations with a Base Erosion Anti-Abuse Tax (BEAT).
The effect of alternative minimum taxes is to reduce or eliminate the benefit of tax equity financing. The reduction of tax equity financing would mean that some solar projects would have higher overall financing costs, which would translate to less advantageous project economics.
See PDF for more commentary and graphs…