THREE THOUGHTS ON THE STATE OF THE SOLAR MARKET
There has been some upheaval upstream in the solar industry. If you follow the solar business for any reason you know that solar manufacturers are challenged by excess supply and dropping panel prices, just this week rumors that industry stalwart JA Solar was facing possible delisting by NASDAQ surfaced. There have obviously been some high-profile failures of solar manufacturing companies. None of this should have come as a surprise - industry consolidation was expected (or should have been). Consolidation occurs naturally when an industry or technology moves up the adoption curve - new participants, new approaches to technology, new manufacturing techniques, increased scale and competition all accelerate price declines, which inevitably leaves some early industry participants vulnerable because sunk investment forces higher per unit production costs. In the case of solar, a surprisingly rapid drop in prices for photovoltaic panels was further accelerated by significant Chinese government investment in panel manufacturing capacity. The pace of the price drop surprised much of the industry and overleveraged solar manufacturers were caught trying to meet price points that were economically unsustainable.So is the industry ready to stabilize? Not quite yet. While longer term the industry looks extremely well positioned for very significant growth, here are three observations about the near-term state of the industry that would keep me awake at night if I were in the business of selling solar panels for the next 12 months.
1) PANEL OVERSUPPLY IS WORSE THAN YOU THINK
Stories about oversupply and warehouses full of panels are well documented -- but this is not the whole story. At the end of December a number of companies (mostly, but not exclusively, developers) took large positions in panels in an effort to qualify the panels and associated projects under the safe harbor for the expiring 1603 Treasury Grant (allowed project owners to take a direct cash grant from the Treasury in lieu of applying tax credits to a renewable energy project). More than a few companies are still looking to place a lot of these panels (rumors are that more than 1GW - enough to put panels on roughly 200,000 houses - of 'pre-qualified' panels are sitting in warehouses), creating a disruptive secondary market and undercutting direct demand for new panels from manufacturers.
The disruption of these 'pre-qualified' panels may get worse. As more time lapses, the risk associated with the safe harbor qualification is quite likely to increase. Separation from purchase time to deployment makes the critical project narrative of a purchase attached to a specific project harder to hold together during the 1603 review process. Additionally, there is a real possibility that the scale of the claims made under the safe harbor may force the Treasury to increase scrutiny over safe harbor qualification. (NOTE: if you are considering buying safe harbored panels, do some serious diligence before committing). Also looming is a potential automatic haircut to the value of the 1603 grant in the event no resolution on sequestration is reached by Congress. In any event, as qualification risk increases discounting will become increasingly necessary to find buyers for these panels, creating further pricing disruption.
2) THE INDUSTRY IS SHORT ON TAX EQUITY
There is not nearly enough tax equity in the market to support the projected growth in solar deployment in the U.S. market. Tax equity represents an investment in the tax benefits - the Investment Tax Credit and accelerated tax depreciation - applied to a solar installation (tax equity is also used by other renewable energy projects, as well as low income housing and historic rehabilitation developments). These tax benefits are the primary vehicles for federal government subsidy of solar. Tax equity investors generally have low risk tolerance, and expect returns only slightly better than what would be paid for secured debt (really from the investor's standpoint tax equity is quite similar in character to debt). During 2006 and 2007 there was abundant tax equity available for renewable energy projects, offered primarily by financial institutions. During the financial crisis in 2008 tax equity for energy projects disappeared, slowly returning in 2009, led by JPMorgan, and has grown steadily, albeit slowly through this year. From late 2008 through the end of 2011 the need for tax equity was limited, as the 1603 program was in place to bridge the shortfall in tax equity with respect to the tax credit portion of project finance. Despite some recovery, the return of several tax investors and the emergence of a handful of important new investors, the amount of tax equity available in the market remains far less than necessary to support renewable project development now that the 1603 program has expired.
Without tax equity, there is inadequate project financing capital available in the market and many projects won't be able to obtain adequate financing and so will not get built (tax equity can provide 50% or more of necessary project finance capital). As of this writing and at least for the near future, the shortage of tax equity represents the most significant bottleneck in the U.S. solar market. The market will naturally expand to accommodate demand over time (and there are several in the industry, including this author, actively educating potential new investors in an effort to accelerate this expansion). However, tax equity investments are complex transactions and as a result the learning curve is steep and adding new investors to the market takes time. This complexity and learning process, combined with the lack of currently active participants is virtually guaranteed to act as a throttle on the pace of deployment over the next 12 to 18 months. Once this imbalance corrects itself, and as the importance of tax incentives diminishes, the extraordinary projections for solar deployment in the U.S. market through the next decade will accelerate.
3) WE'RE STARTING TO SEE SOME STATE REGULATORY TARGETS MET
An example is the market of California investor owned utilities (IOUs) as buyers of renewable energy (last year's disruption in the New Jersey SREC market would be another). Until recently the California IOUs were an assumed off-taker for the electricity and, specifically the RECs, from a solar project - if a solar developer could get power into Cal ISO the IOUs would offer a PPA with some premium for the power being from a renewable source. Today, none of the three large California IOUs are actively engaging in negotiations for output from new projects generating renewable power outside of the state. There are limits on the amount of renewable power that counts against the state renewable portfolio target that can be procured from outside the state, and between active and committed projects, the IOUs have hit their limits for out of state RECs. The decline in certain state regulatory markets may not represent significant impact for solar growth in the U.S. - there is still market interest for California-based renewable generation by the IOUs and other California buyers are still sourcing outside of the state, while entirely new markets like Georgia are emerging - but it does create near-term challenges and uncertainty for developers, slowing project development and with it the immediate need for new panels.
WHAT DOES IT MEAN?
The secondary market created by 1603 safe harbored panels, the tax equity bottleneck and some potential near-term decline (or uncertainty) in the appetite for new RPS driven utility scale solar are combining to create something like a perfect storm for distressed panel manufacturers despite unprecedented growth in solar deployment. Distressed manufacturers are facing several more months of challenges in the important U.S. market. Regardless of the outcome of the election, the pace of consolidation will stay high and the downgrades, closures and struggles of solar manufacturers will be a regular part of the energy news cycle.
