Solar report sees undamped PV market growth 

© CLSA Aisa-Pacific Markets Solar – the next big thing: »With oil prices high and alternatives such as fuel cells offering no cheap investment opportunities, investors are hungry for new energy themes,«  says Michael Rogol, author of CLSA's Sun Screen study.

The first fundamental study of the global PV market authored by a financial analyst should bring tears of joy to the eyes of the solar industry. The Sun Screen report from Credit Lyonnais Securities Asia (CLSA) deems the quickly growing PV industry a sector in a state of evolution that is hardly going to stop. With 15 priority solar investment opportunities recommended in the study, the bankers hope to attract the big money from fund managers.

Hundreds of clients of Credit Lyonnais Securities Asia (CLSA) found a sunscreen bottle on their desks in mid-July. But the cream was not meant to protect them from sunburn during summer holidays, the bottle was accompanied by a report intended to highlight an emerging market to these institutional investors that could be the next big thing. CLSA's study Sun Screen – Investment Opportunities in Solar Power is both a map and a compass for investors to explore the PV territory without burning their fingers, or more. 

Apparently CLSA caught their attention. The road show following the release of the Sun Screen report was well received. »We had high expectations for the Sun Screen road show, but the reception we received from institutional investors was beyond our expectations,« says CLSA analyst Michael Rogol. During the road show, Rogol had meetings with more than 100 institutional investors and received TV coverage from CNN and CNBC. 

Michael Rogol is not only the author, but also the initiator of the study. The 32-year-old American had worked with leading consultants Cambridge Energy Research and McKinsey in the areas of oil, gas, and power for over a decade before his interest in solar was sparked a few years ago. Each time he flew in to Tokyo and Osaka to work on projects with huge Japanese power generation companies (Gencos), Rogol saw more and more solar panels on the roofs of Japanese houses. »So I started thinking: Why are people installing this? It costs so much money and is not economic.« The analyst in him wanted to understand the solar phenomena, so he started his personal research on this subject at the Massachusetts Institute of Technology's Laboratory for Energy and Environment in 2003. »And the more I learned, the more surprising and exciting solar seemed. A year ago, it appeared that the solar power sector would hit a number of tipping points and start to take off,« he says. Rogol, who also has been working as an analyst for CLSA since late 2002, convinced the brokerage firm to fund a study on the solar market. »My job as an analyst is to generate investment ideas that are compelling to institutional investors. Then, as an organization, CLSA does everything we can to help institutional investors understand these ideas and act on them.« 

	©  CLSA Aisa-Pacific Markets Growth at all fronts: Most companies have turned their solar business into the black in recent months. CLSA expects average operating margin of the PV sector in the low two-digit percentage range between 2004 and 2010.

That's what he did. After reviewing over 300 companies involved in solar, revenues and operating profits were screened for around 150 of these firms. In May and June Rogol literally circled the world twice to meet top solar executives, tour manufacturing plants, and have discussions with leading researchers at more than 75 companies in Japan, Germany, and the US. Following a screening of stock price potential for 50 companies, the 75-page study turns out 15 priority investment opportunities (see article, p. 59).

And here the story could also pay out for CLSA. If large institutional investors really bite into the solar theme, they may in turn increase their trading through CLSA. From what Rogol tells about his experience from the three-week-long road show – which brought him from Tokyo, Hong Kong, and Singapore in Asia to meetings in London and Frankfurt on the Continent, and finally Boston and New York in the US – the response was highly positive. »Of the 100-plus fund managers and analysts I met, 99 percent were fully-engaged by the topic, with most asking for follow-up information and additional coverage. These are busy people who don't waste time pursuing ideas unless they think their time is likely to lead to positive investment returns,« says Rogol. »With oil prices high and alternatives such as fuel cells offering no cheap investment opportunities, investors are hungry for new energy themes.«

© Source: CLSA Aisa-Pacific Markets; graphic: PHOTON International Assuming 1 GW of PV sales in 2004, CLSA has estimated total industry revenues of around $7.1 billion.

And this theme seems to be solar – even if the generation cost of this technology is – at between 25¢ and 40¢ per kWh – three to 10 times higher than for coal, nuclear, gas, oil, or wind, which range from 2¢ to 8¢ per kWh. But Rogol believes that the industry will continue to grow at its current pace with solar companies' total turnover expected to increase from around $7 billion in 2004 to $30 to $40 billion by 2010 and operating earnings to expand from $700 million to $3 billion in the same period of time. 

Solar competes with retail prices not generation costs

The reasons for this development lie in what Rogol calls his five fundamental views that have changed his initially skeptical impression on solar technology:

• First, it doesn't matter that electricity generation with PV is much more expensive than with fossil fuels, nuclear, or even wind, because in its major application – on-grid rooftop systems – solar does not compete with generation costs but with retail power prices. That means the typical investor in a solar system is not weighing the generation costs of different power systems against each other; of interest is the end-consumer price for electricity. Especially in Japan, the country with the world's highest electricity prices, where average residential power costs around 25¢ per kWh, the solar-generated kilowatt-hour appears in a much more competitive light. 

	© Source: CLSA Aisa-Pacific Markets; graphic: PHOTON International CLSA expects dramatic growth in solar revenues for companies active in this industry.

• Second, Rogol was convinced by PV's steady learning curve showing an about 20 percent cost reduction for modules for every cumulative doubling in production. With an average market growth of over 30 percent per year in the last decade, this translates into a 5 percent cost decrease per year on the system level. In his interviews with representatives from the solar industry, he got confirmation that this trend will generally continue through 2010, and with potential for even stronger cost cuts for BOS and installation.

• The driver for this cost reduction is not R&D breakthroughs as Rogol initially expected; rather, it is improvements in the manufacturing process. »The pipeline of research breakthroughs is huge, but the real challenge for the industry isn't in the labs, it's on the plant floor. Manufacturing process is the key for this industry for the next 10 years,« according to a scientist quoted in the Sun Screen study. Almost all major PV players – except RWE Schott Solar – said that the largest portion of capital expenditures is spent on expansion of production equipment that incrementally improves processes while it is already proven in series production. »We believe that we are unlikely to see a major shift in industry's basic process until 2010. When the change does come, the most likely nominee is ribbon technology, because many companies have been burned by investments in thin-film technologies over the last 10 years,« says Rogol. In consequence, bulk silicon will dominate the market for several more years, and with improvements on the factory floor for crystalline module costs are expected to decrease (excluding overhead and marketing) by more than 25 percent by 2010 from the current $2 to less than $1.50.

© Source: CLSA Aisa-Pacific Markets; graphic: PHOTON International While the solar share of big corporation's total revenues is rather small, this is changing quickly.

• Another finding made Rogol do a double take before he believed it: the revenues for solar and wind capacity sales are almost equal. While 2004 solar turnover will be around $7 billion, wind capacity – although with higher installed wattage and lower in cost – is estimated at gaining »only« $8 billion. When looking at the average operating margin, the scale even turns significantly to the solar side, with 11 percent compared to negative 0.6 percent for wind. And unlike wind power, which is facing increasing opposition, on-grid solar usually is welcome everywhere – »at least so far.« Rogol ends the sentence in parentheses, thereby keeping in mind opposition to large ground-mounted PV plants on undeveloped areas in OECD countries as sometimes encountered in Germany (see PI 7/2004, p. 28). 

• Finally, solar power is economic for end-consumers in many countries – Japan, Germany, and Spain, for example – with several more new markets emerging. In all of these countries, it's government incentives that close the gap for solar power to become competitive with residential grid power prices. »Our initial reaction to solar's dependence on incentives was to discount the potential of solar power, but our view has changed as we became more convinced that incentives result from perceived global climate change risks, energy security, and price concerns that are unlikely to disappear soon,« says Rogol. The increasingly widening gulf of cost improvements for PV electricity and price hikes for grid power will strengthen solar's position in the power pool regardless of subsidies. In this regard, the study points to Japan, where all of the 25 biggest Japanese PV companies contacted are upbeat that the market will continue to grow over 30 percent by 2010 even though the government is planning to phase out its national residential rooftop program in 2006. Rogol interprets the Japanese way as a successful strategy to establish an industry and create a domestic market with the help of subsidies, which now is in the process of turning into a free market without disrupting growth rates. 

	© Source: CLSA Aisa-Pacific Markets; graphic: PHOTON International CLSA sees growth in solar operating profits especially for big cell and module manufacturers.

Based on these positive »fundamentals,« CLSA believes the PV industry is poised for further expansion. Sales staff of PV exhibitors at Europe's largest solar fair Intersolar, held in Freiburg, Germany in June, anticipate growth in demand of more than 40 percent in 2004, which is believed to remain at over 30 percent per year until the end of the decade. Summarizing his interviews, Rogol says this is »the best solar market« senior PV executives have ever seen.

The boom also positively impacts the solar companies' financial results. The solar quarterly operating profits of the large Japanese module manufacturers – from Sharp to Sanyo – turned from red ink to black in the second half of 2003, followed by European oil companies BP and Shell in 2004, when several of the smaller stock-listed pure PV companies also entered positive territories (see article, p. 50). Since a lot of solar players are private companies or subsidiaries of larger corporations, they don't publicly report financial details, so Rogol points out that all discussion of profitability in the study for these type of firms should be considered rough estimates based on informal interviews. But even if the data is not 100 percent accurate, the truth is that most PV players are and should remain healthy for quite a while, simply because demand is much higher than supply.

Inventories, especially for modules, are depleted and waiting times have increased to several months, whereas new customers can face delivery times as long as 1.5 years. This situation won't change for the next 2 years at minimum, since the main supply problem along the solar production chain is silicon feedstock, which has become tight in recent months due to quick growth of the PV industry and a rebounding of the semiconductor industry (see PI 6/2004, p. 36). In consequence, solar-grade silicon prices have increased from $24 per kg last year to $32 in the first half of 2004 and are expected to swell further to $36 during the second half of the year. At the same time, wafer prices boasted 10 to 15 percent increases with prospects for a rise to 25 percent until year's end. »We expect that silicon and wafer prices will stay at higher levels for at least three years – time enough to bring on line a greenfield silicon plant – and could remain high for the rest of the decade,« says Rogol.

© Source: CLSA Aisa-Pacific Markets; graphic: PHOTON International Solar turns out to be extremely profitable – especially for big integrators such as Sekisui Chemical.

But he doesn't expect this increase to have a big impact on profit margins for downstream companies, because management said in interviews that it passes on this raw material price rise to its customers – which means that executives are trying to steer their company rather on profit margins than just on volume growth. At the same time, however, top managers of 10 companies representing over 60 percent of annual global module sales said that they do not expect a significant price increase despite strong demand. Higher system prices would not be well received by politicians who have fought for PV subsidy programs, and managers views their support as more crucial for a sustainable business than high profits in the short term.

In fact, end-consumer prices for systems already have slightly increased in Japan and are mounting in Germany as well to cover the silicon price hike. »We expect systems prices to increase by 3 percent by year-end and another 1 percent in 2005, and to return to their historical trend of an over 5 percent decrease starting in mid-2007,« says Rogol. 

Risk on growth rate from increasing interest rates and utilities

If this comes true, the journey of falling prices will indeed only be shortly interrupted, and at a level that should be understandable by solar proponents among politicians. But even if a subsidy program for a market as large and as important as Germany were cut in the mid-term, Rogol is not too concerned. »Broad coalitions supporting solar exist in many markets, with the implication being that government support programs are likely to increase in the coming years, not decrease.« But Rogol is worried about another factor he considers very important for past and future PV market development. »Rising interest rates are the most dangerous risk for solar power's growth,« he says. An increase of 3 to 5 percent would dramatically lower demand, especially in the world's two largest markets, Japan and Germany. 

	© Source: CLSA Aisa-Pacific Markets; graphic: PHOTON International Higher system prices: The increase in silicon prices due to the feedstock shortage has stopped the fall of module prices. In consequence, system are slightly on the rise. CLSA believes module prices to return to their historical trend of an over 5 percent decrease starting in mid-2007.

While the Japanese government's capital subsidy is hardly measurable anymore (around 7 percent of total system costs), private sector initiatives are taking over the business to attract customers. Especially Japanese banks are striving to expand their residential loan business by offering loans and mortgage rates with reductions of 1 to 2 percentage points for PV installations. The study even reports that with many banks the reduced interest rate is applicable for the total mortgage, not just the PV system, which turns a house with solar into a lower-cost option than without. 

The case is different for Germany, where the main driver for investors is the Renewable Energy Law (EEG), which offers a premium price for solar-generated electricity fed into the grid fixed at a level dramatically above the retail price for electricity over 20 years. But these PV systems are also commonly debt-financed. And the higher the interest rate, the longer the payback and the lower the attraction to investors. »While German residential customs would still have incentive to install PV, because the net cost of solar power would be much lower than the grid price, we believe that the 50 percent growth rates observed since implementation of the EEG would decrease significantly,« says Rogol. 

For the moment, however, investors increasingly make use of the low interest rates for solar systems – especially in Japan, where time to profit from its national subsidy program soon will come to an end by March 2006.

The second big risk Rogol has identified comes from electric utilities, as a business sector most likely to suffer from solar power. »As a result, they are the most likely to eventually fight against solar,« says Rogol, but deems it a longer-term risk due to solar power's small installed global capacity of around 3 GW, which accounts for only 0.1 percent of electricity production even in both major markets, Japan and Germany. Nevertheless, the solar needle has already begun to hurt the first Gencos notably. The keyword is peak shaving. Solar's generation peak overlaps perfectly with the daily demand peak during midday hours and annual peaks on very hot days in summer – at times when electricity prices are the highest and utilities earn the bulk of its profit. A small volume of solar power thus can displace a large amount of utility profit by preventing or reducing price spikes. In a calculation example, Rogol shows that the 312 MW PV capacity installed in the service area of Japanese utility Kansai Electric (KENCO) could reduce pre-tax profits by an incredibly high 4.4 percent or $82 million for FY 2005. The statement by an unnamed source from the strategic planning department of a Japanese Genco quoted in the report should therefore be taken seriously by solar lobbyists: »For now solar is small and we have other problems such as increasing competition to deal with, but we will need to address the risks to our profits from solar before the end of the decade.« Rogol believes this could either mean that utilities buy into solar companies to profit from their growth; decommission some of its old base- and mid-load power plants to reduce the chance of solar displacing marginal operating costs; start anti-solar public relation campaigns; or begin lawsuits for whatever reasons. At least in Germany, utilities have already started all of the abovementioned – with the exception of decommissioning power plants – but as of yet with little success. 

And the larger the solar industry gets, the more difficult will it become to stop it from growing. Even more if the big money is about to discover this sector as an attractive investment opportunity. And to make sure they don't miss it, Michael Rogol is planning a sequel of his successful road show for September with about 50 additional meetings around the globe.

To download a free copy of CLSA's Sun Screen report, please click here.

Michael Schmela
© PHOTON International, September 2004