Read full report in PDF with graphs: MAC-Solar-Sector-Update-Oct-2018
Solar Index Performance
The MAC Solar Index, the tracking index for the Invesco Solar ETF (NYSE ARCA: TAN), has fallen sharply from May’s 1-3/4 year low to post a new 14-month low. The index is currently down -24.2% on the year, reversing part of the annual +52% gain seen in 2017.
Bearish factors for solar stocks include (1) China’s sharply reduced subsidy support for solar that was announced on May 31, 2018, which caused an inventory overhang and sharply lower solar panel pricing, (2) the Trump administration’s 4-year 30% tariff on imported cells and tariffs that took effect in February, which dampened U.S. solar install growth, and (3) ongoing solar trade disputes that have resulted in tariffs and various market dislocations.
Bullish factors for solar stocks include (1) the improved solar project economics that have resulted from the sharp drop in solar panel prices, (2) Europe’s decision to end its duties and minimum price scheme on Chinese solar panels, which will improve European solar growth, (3) broadening solar growth from India, Turkey, Latin America, the Middle East, and Southeast Asia (see page 5 for the world solar growth outlook), (5) strong demand for solar power as solar reaches grid parity and as countries seek to meet their carbon-reduction targets under the Paris COP21 global climate agreement, and (6) low valuation levels that indicate that solar stocks are very cheaply priced.
Solar stocks are trading at very low valuation levels compared with the broad market. The median trailing P/E for the companies in the MAC Solar Index is currently 14.6, which is far below the comparable figure of 20.0 for the S&P 500 index. Meanwhile, the median forecasted 2018 P/E of 15.5 for the companies in the MAC Solar Index is well below the comparable figure of 17.0 for the S&P 500 index. The median price-to-book ratio of 1.21 for the companies in the MAC Solar Index is well below the 3.34 ratio for the S&P 500. The median price-to-sales ratio of 1.12 for the MAC Solar Index is well below the 2.16 ratio for the S&P 500.
Solar stocks are undercut by reduced Chinese subsidies
Solar stocks have fallen sharply since the Chinese government on May 31, 2018, surprised the industry with a sharp cut in its subsidy support for solar. That resulted in a sharp overhang of excess panel supplies and a sharp decline in solar cell and panel pricing, which in turn put downward pressure on the profits of solar manufacturers.
However, the lower pricing is bullish for the solar industry as a whole on a longer-term basis since it means that solar is becoming even more competitive against alternatives and can increasingly stand on its own without government support. The lower pricing is supportive for solar developers and installers who can boost their profit margins and who will see increased demand due to more attractive project economics.
Solar stocks also saw weakness in early October as the broad market fell into a sharp downward correction and as Chinese stocks fell to a 3-3/4 year low. On the bullish side, solar stocks are now priced at very cheap levels that should attract value buyers. Solar stocks should be able to recover in coming months as the industry works down the excess inventories and as demand strengthens.
UN IPCC says renewables growth must greatly accelerate to curb climate change
The UN Intergovernmental Panel on Climate Change (IPCC) in early October released a report saying that the annual growth of renewables needs to accelerate by seven-fold from current levels if the world wants to come close to halting the worst effects of climate change.
The IPCC report was written by 91 scientists from 40 countries drawing upon more than 6,000 scientific studies. Commenting on the IPCC report, former Norwegian Prime Minister Gro Harlem said, “This report is not a wakeup call. It is a ticking time bomb. Climate activists have been calling for decades for leaders to show responsibility and take urgent action, but we have barely scratched the surface of what needs to be done.”
The world has already warmed by 1 degree Celsius (1.8 degrees Fahrenheit) since pre-industrial times and the effects of climate change are already being felt. The Paris Climate agreement seeks to limit global warming to “well below” 2 degrees Celsius (3.6 F). However, the fact that the world is not living up to its Paris commitments suggests that the world is on its way to a temperature rise of at least 4 degrees (7.2 F) by 2100.
A temperature rise of just 2 degrees Celsius (3.6 F) would be bad enough with IPCC forecasting that: (1) coral reefs would mostly disappear, (2) the sea level would rise by nearly three feet and subject 32-80 million people to flooding, (3) about 37% of the world’s population would be exposed to severe heat waves, (4) 411 million more people would be exposed to the effects of severe drought, and (5) the need would arise for a “disproportionately rapid evacuation” of people from the tropics. CarbonBrief.org has an informative factsheet on the impact of climate change at various temperature increases.
In order to avoid the worst effects of climate change, the IPCC concludes that the world must limit warming to 1.5 degrees Celsius (2.7 F). The IPCC says that this would require CO2 emissions to be cut by 45% by 2030 from 2010 levels and to zero by 2050.
The IPCC’s middle-range recommendation to meet that 1.5 degree Celsius goal is that (1) renewables should supply 70-85% of power generation by 2050, (2) coal should be cut to 2% of power generation capacity or less, and (3) natural gas should be cut to 8% of total capacity if sufficient carbon capture technologies can be deployed to offset the emissions from burning natural gas.
To get to that goal, the world would need to boost annual investment in clean energy to $2.4 trillion per year through 2035, representing a seven-fold increase from current levels.
If the global temperature continues to rise unchecked, the IPCC estimates the damage at $54 trillion from 1.5 degrees Celsius (2.7 F) of warming and $69 trillion from 2 degrees Celsius (3.6 F) of warming.
Subsidy-free solar is spreading quickly as solar reaches grid parity
With its subsidy cut in May, China became the latest country to realize that it is no longer necessary to provide big subsidies to the solar industry since solar pricing has reached grid parity in many areas.
Recent competitive auctions, for example, have produced extremely low subsidy-free solar pricing of under 2.5 cents/kWh in Jordan and under 3 cents/kWh in Egypt for projects financed by the European Bank for Reconstruction and Development.
Indeed, subsidy-free solar is spreading quickly throughout the world in Europe, Latin America, Middle East, and southeast Asia. The U.S. and Japan are now the only major countries that are still providing strong subsidy support to solar, although both of those countries are progressively stepping down that support. The U.S. solar investment tax credit (ITC), for example, is already scheduled to largely phase out by 2022.
The move to subsidy-free solar is being seen in Europe where governments have largely dropped their previous solar support via generous feed-in tariff (FIT) programs. Europe is moving quickly towards competitive auctions and private development without subsidies. SolarPlaza reports that 2.5 GW of subsidy-free solar has been announced in the last six months just in Portugal, Spain, Italy and France.
In Spain, there is a pipeline of 29 GW of subsidy-free solar projects in the planning or construction stage, including 3.9 GW tendered by the government, according to Spain’s national solar trade group, UNEF.
UNEF chief Jose Donoso said, “The market has realized that they can expect very little from the government and they aren’t going to wait around for a new support scheme. With the degree of competitiveness that solar has, we can go straight to the market on a merchant basis or we can look for PPAs, without any need for input from the government.”
Spain’s Energy Minister Jose Dominguez Abascal said at a recent London conference, “We are not thinking of subsidies at all. At this moment the cheapest way of producing electricity in Spain is the sun. It’s much cheaper than any other form of energy. At this moment in Spain there are gigawatts that are under construction without any knowledge of the government.”
The growing use of power-purchase agreements (PPAs) is accelerating the ability of solar developers to build and finance subsidy-free solar projects. When a large corporation or utility signs a long-term contract to buy electricity from a solar facility with a PPA, the solar developer can then use that PPA to help guarantee the bank financing. Subsidy-free solar projects are also being built on a merchant power basis where the owner of the solar facility takes on the risk of electricity price fluctuations and sells electricity directly to the wholesale electricity market.
Chinese solar shake-out results from government’s “China-531” subsidy cut
The Chinese government on May 31, 2018 surprised the industry by announcing a dramatic cut in its subsidy support for solar. The Chinese government’s policy action has become known as “China-531” since it was announced on May 31.
Before May, the Chinese government had been providing generous subsidy support to the industry, thus causing runaway solar production and demand. In addition, the Chinese government’s subsidy backlog reached an unsustainable $17 billion. The government in May therefore bowed to reality by cutting subsidy support and forcing the industry to downsize to more sustainable long-term levels.
The Chinese government’s 531 order was contained in the “2018 Solar PV Power Generation Notice” issued jointly by the China’s state planner The National Development and Reform Commission (NDRC), the Ministry of Finance, and the National Energy Administration. The order removed subsidy support for utility-scale solar until further notice. For roof-top distributed generation (DG), the order capped support at 10 GW for 2018 (which was already reached by mid-2018), and also shifted responsibility for the feed-in tariff (FIT) to the local level from the central government level.
The government also cut the tariff for ordinary solar farms by -9% and cut the subsidy for DG projects by -14% or 0.3 yuan/kWh. The government instructed utility-scale solar projects to use competitive bidding to choose developers. The government left its solar Poverty Alleviation and Top Runner programs unchanged. The government also left residential solar policies unchanged.
The Chinese government clearly intends to move over time to subsidy-free auctions for providing solar resources, which is a strategy that is working well in many other countries. While the Chinese solar industry is currently experiencing a serious dislocation from this policy switch, the industry will come out on the other side as a much more sustainable and competitive industry.
The China-531 action caused a sharp drop in forecasts for China’s 2018 solar installs to about 30-40 GW from previous forecasts near the 2017 install rate of 53 GW, indicating an expected year-on-year decline of 25%-40%. China already installed 24 GW of solar in the first half of 2018, according to the China Photovoltaic Industry Association, which indicates that Chinese installs will be very low in the second half of 2018.
The cut in forecasts for Chinese solar installs caused a cut in forecasts for global installs as well since China in 2017 accounted for 54% of global market share. Indeed, BNEF, as a result of China-531, cut its 2018 global install forecast by 12 GW to 95 GW from its January forecast of 107 GW, implying a -3% year-on-year drop in 2018 installs.
The sharp slow-down in Chinese installs in the second half of 2018 means that the industry must work off a big overhang of excess inventories, which is driving down solar prices. In addition, there is no doubt that a significant number of smaller solar companies with me-too technology and a lack of scale will be forced to shut down. Over the medium-term, that will force the inefficient players out of the market and allow the Tier 1 solar companies to stabilize their pricing and profitability.
China-531 has caused silicon module prices to plunge by -20% since May to a record low of 23.3 cents/watt, according to PV Insights. Meanwhile, multicrystalline silicon solar cell prices have plunged by -52% since May to the current record low of 11 cents/watt, according to BNEF. Polysilicon prices have plunged by -30% since May to a record low of $10.87/kg.
The main impact of the Chinese government’s cut in solar subsidies is being felt by domestic producers in mainland China. However, China-531 is having a major impact on the world solar markets as well due to the sharp drop in solar pricing and the attempt by Chinese solar companies to off-load excess panels overseas.
The current solar shake-out is somewhat similar to the last major solar shake-out in 2012/2013, which was also driven by excess subsidies and temporary overcapacity. However, the current shake-out should be substantially less severe since the solar industry is now spread out across the whole world and there are now many countries that can absorb solar inventories, particularly at such low and economically attractive prices.
California mandates 100% carbon-free electricity by 2045
California in September passed a law that requires 100% carbon-free power for the state by 2045. That made California the second state after Hawaii to adopt a 100% carbon-free mandate.
The mandate is expected to allow large-hydro and nuclear to qualify for the carbon-free goal, which is important since large-hydro currently accounts for 15% of California’s electricity and nuclear accounts for 9% of California’s electricity. The main goal of the legislation is to phase out fossil fuels, which currently account for 47% of California’s electricity (natural gas 34%, coal and other 13%).
The need for California to meet its carbon-free goals means that California will significantly step up its efforts to build solar and wind facilities. In addition, California will step up its focus on using batteries to compensate for the intermittent nature of solar and wind resources, thus allowing solar and wind plus storage to provide 24/7 base-load electricity to the grid.
U.S. solar industry adjusts to import tariffs
The U.S. solar industry since the beginning of this year has been buffeted by import tariff challenges but is adapting and moving forward.
The biggest challenge came from the Section 201 safeguard 30% tariff on imported solar cells and modules that took effect on February 7, 2018. That tariff started at 30% in 2018 and then steps down by 5 percentage points per year to 25% in 2019, 20% in 2020, and 15% in 2021, expiring in 2022. The first 2.5 GW of solar imports are exempt from the tariff. Thin-film solar panels, such as those produced by First Solar, are exempt from the tariff even if those panels are imported from overseas factories.
The tariff applies to imports from all major countries in which solar cells and panels are produced, including U.S. free-trade partners Canada and Mexico. There are a number of countries that are exempt from the tariffs, including India, Turkey, Brazil, and South Africa. However, imports from those exempted nations are capped at 300 MW each and at 900 MW as a group.
The tariff has been a negative factor for the U.S. solar industry, which is dominated by installation companies and has very few American-based solar factories. In fact, the U.S. has so few manufacturers that it needs to import more than 80% of the solar panels that are installed in the U.S. The tariff is putting upward pressure on the cost of solar installs, thus making solar project economics less attractive. However, the good news is that the sharp drop in solar panel pricing seen from the China-531 policy move has partially offset the upward price effects from the U.S. 201 tariff.
The U.S. solar installation industry is adjusting to the tariff by using stockpiled or non-tariffed panels, such as those produced by First Solar (FSLR) and those imported from countries not covered by the tariff. SunPower (SPWR) can now also supply non-tariffed panels since it received an exemption from the tariff for its IBC panels.
In addition, several Chinese companies have announced plans to build manufacturing facilities in the U.S. so that they can sell panels not subject to the tariff. Unfortunately, those new factories will take time to build and will be highly automated, which means they will not produce a large number of new jobs.
In some good news related to the Section 201 safeguard tariff, the IRS in June announced that solar developers will be able to qualify for the Investment Tax Credit (ITC) in the year in which “construction” begins, which is defined as either the beginning of physical work or upon the expenditure of at least 5% of the total project cost. That means that developers of big utility solar plants that take multiple years to complete will be able to qualify for a 2018-2021 ITC credit while delaying the actual purchase of their panels until later years when the 201 safeguard tariff will be lower or phased out.
Aside from the 201 safeguard tariff, the U.S. solar industry was also hurt by the Trump administration’s tariffs on imported steel and aluminum implemented on May 31. Those tariffs sparked higher prices for the steel and aluminum that is used in the ground and roof racking systems that are used to support solar panels.
Another challenge emerged when the Trump administration placed a 10% tariff on Chinese inverters as part of its move to place tariffs on $200 billion of Chinese goods effective September 24. That tariff will rise to 25% on January 1, 2019. The inverter tariff will make it difficult for the big Chinese inverter companies such as Huawei and Sungrow to achieve market penetration into the U.S, with inverters they manufacture in China.
The good news for U.S. solar industry is that there are already plenty of inverter sources for U.S. installers other than China. Major inverter companies such as Enphase (ENPH) and SolarEdge (SEDG) are expected to see little impact from the tariffs on Chinese-built inverters since they can shift what production they have out of China to other countries in order to avoid the tariffs.
Europe ends its failed anti-dumping program
The EU ended its anti-dumping duties against solar panels imported from China and the associated minimum import price (MIP) scheme effective September 3. That MIP scheme had been in place since 2013 when the EU tried to protect local European solar manufacturers from Chinese competition.
The EU was forced to finally end the MIP scheme as its failure became clear. The scheme did not lead to a flourishing European solar manufacturing base. The MIP instead only caused higher solar panel prices for European solar projects, thus curbing the growth of solar power installs in Europe. The failure of Europe’s MIP is a lesson to other countries that protectionist measures are unlikely to meet their intended goals.
Commenting on the end of the EU’s MIP scheme, the president of SolarPower Europe, Dr. Christian Westermeier, said, “This is a watershed moment for the European solar industry. By removing the trade duties, the European Commission has today lifted the single biggest barrier to solar growth in Europe. The Commission’s move to end the trade measures is unquestionably the right one for Europe. We expect to see a significant increase in solar jobs and deployment — which will only propel the energy transition in Europe.”
The end of the European MIP scheme is a bright spot for the global solar industry since European solar installs should now see a significant increase due to more attractive project economics.