The Solar Blood is in the Street

Solar Industry Cliffs Notes

By
Tuesday, May 22nd, 2012

I've had lots of requests lately to shed some light on the solar industry.

And it isn't hard to see why...

Solar Stocks 2012

That's a one-year chart of the Dow Jones versus the Market Vectors Solar Energy ETF (NYSE: KWT), which holds well-known names like First Solar (NASDAQ: FSLR), Suntech (NYSE: STP), and SunPower (NASDAQ: SPWR).

As you can see, the solar ETF has lost almost 80% of its value. 

Let's see if we can figure out why, draw some historical comparisons, and find a way to make some money from this still nascent market.

Economies of Scale

Put on your freshman econ hat for a second while I give you a textbook definition:

In economics, economies of scale refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased.

Just think about the computer industry, to which I like to compare the solar industry.

In 1946 the first ever general purpose computer weighed 27 tons and cost over $5 million to build.

No company was getting rich selling those. Economies of scale had to be created, whereby the cost of production decreases as more units are produced and more customers are attracted.

I think today is the 1946 of the solar industry.

Dismissing it now would be just as foolish as dismissing the computer industry back then.

Solar Cliff's Notes

The main argument against solar is that it's expensive. That's true — but so was the first computer.

The important thing to notice is that it's getting cheaper.

And at this stage in the game, that's actually detrimental.

When solar stormed on the scene in 2004 and 2005, it was touted as a panacea to rising oil prices and An Inconvenient Truth.

Actually, it's neither.

It's just one part of the energy industry. That said, it's susceptible to the same booms and busts as any other industry.

Back then the main ingredient was polysilicon. And it was expensive... exorbitantly expensive.

It sold for about $100/kilogram in 2006, but more than quadrupled to $400/kilogram by 2008.

Two things happened as a result:

  1. Countries introduced subsidies to help consumers afford solar panels; and

  2. Companies looked for other ways to make solar panels with less or no polysilicon.

The first gave us the feed-in tariff programs in Europe that led to widespread solar adoption in Germany, Spain, and a few others. But as the Great Recession ensued, governments began taking a knife to those subsidies.

The second spawned the development of other solar technologies, like cadmium telluride and copper indium gallium selenide (CIGS). Those are the technologies used by First Solar (NASDAQ: FSLR) and Solyndra, respectively.

As it turned out, the monumental spike in polysilicon prices leading up to 2008 was a red herring.

Between then and now, prices have plummeted from $400/kilogram all the way down to $23/kilogram last week.

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You've already seen the impact that's had on the market. Cheap silicon is killing competitive technologies.

Solyndra went bankrupt. So did Energy Conversion Devices. First Solar (NASDAQ: FSLR) has lost 90% of its value since last summer.

Makers of traditional crystalline solar panels have only fared moderately better...

When European nations started cutting subsidies, demand all but collapsed and took German and Chinese solar companies with it.

Q-Cells and SolarWorld were once the most dominant players in the industry. Now they're struggling to survive.

Chinese firms had it so bad, they were selling panels to the United States below market price, which led us to declare a 31% tariff on Chinese-imported panels last week.

The solar blood is in the streets.

Economics Again

Subsidy cuts and margin squeezes are part of an industry's maturation.

Those two hurdles, plus the current oversupply of polysilicon, will ebb.

Current lackluster demand and stiff competition from decade-low natural gas prices are forcing innovation and cost reduction.

There will also be consolidation.

This is all part of an industry's natural growth cycle.

The point here is that the industry is out of favor because prices are falling rapidly. That's what's supposed to happen.

And as prices fall, customers will once again be attracted. You know, all that supply and demand stuff.

In fact, it's already happening...

Solar attracted more than half of all clean energy investments last year, fetching $128 billion — up 44% from 2010. Installations were up 54% to 29.7 GW.

Once that hits the balance sheets, strong solar companies will start to rise once again. I'm looking at JA Solar (NASDAQ: JASO) on the module side and MEMC (NYSE: WFR) on the silicon side.

Apple (NASDAQ: AAPL) shares fell from $26 to $8 in 2000... That's where solar is now. 

Call it like you see it,

Nick Hodge Signature

Nick Hodge

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Nick is the Founder and President of the Outsider Club, and the Investment Director of the thousands-strong stock advisory, Early Advantage. Co-author of two best-selling investment books, including Energy Investing for Dummies, his insights have been shared on news programs and in magazines and newspapers around the world. For more on Nick, take a look at his editor's page.

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