Plummeting Costs are Changing the Game For Solar Power

Guild Investment Management |

The dramatic fall in the price of oil over the past several months has captured the attention of analysts and investors, including us. However, we recently noted several pieces of research from another corner of the energy world that indicate an important watershed may be imminent: solar power generation is approaching ‘grid parity’ in many U.S. markets. That means that the cost of solar-generated power is equal to or lower than the average cost of electricity in that market. In a few cases, this is true even without subsidies. Analysts have often viewed grid parity, particularly grid parity without subsidies, as a critical tipping point that would accelerate solar adoption. Our analysis has pointed out that a solar inflection point would eventually come, and now we see that it may come in the next two to three years.

Grid Parity

Solar analysts usually discuss the competitiveness of solar electricity generation in terms of “levelized cost of electricity” or more broadly, “levelized cost of energy” (LCOE). LCOE represents the per-kilowatt hour cost of building and operating a generating plant over its whole lifecycle. Key inputs to calculating LCOE include capital costs, fuel costs, operations and maintenance costs, and financing costs. The relative weight of each factor depends on the energy technology. Fuel costs figure significantly for gas generation, and capital costs are most significant for solar.Solar_Costs.jpg

Grid parity implies that solar’s LCOE is at or below the average cost of electricity. Right now, solar is at grid parity in ten states after a 30 percent investment tax credit. Analysis suggests that number could rise to 36 states in 2017, even though the tax credit is slated to drop from 30 percent to 10 percent by then.

In short, even as subsidies decrease, solar is about two or three years away from competing with other generation technologies in a majority of U.S. markets. That could be the basic math behind an inflection point in solar adoption.

There are countervailing forces in the regulatory landscape. Subsidies may decline, but there may also be pressure to reduce trade barriers that are adversely affecting panel prices (such as anti-dumping duties on Chinese panels). The finalization of EPA rules may imply an acceleration in the retirement of coal generation capacity.

Large plant construction increases the rate base for regulated utilities, which often allows them to raise rates for consumers. Any increase in the average cost of electricity in a market will favor solar, as it incrementallypushes the cost above solar LCOE. This is especially true for “distributed generation,” such as roof-top solar.

Cheaper Panels Have Led the Way

Most of the drop in solar’s LCOE has been due to falling prices for solar panels. Panel costs were more than $4 per watt in 2008, of which a little less than half was the cost of polysilicon; they’ve fallen more than 80 percent from there. Falling polysilicon prices accounted for the lion’s share of the decline (and margin compression almost all of the rest).

After its fall, the price of polysilicon has stabilized over the past two years, and in the longer term, prices will likely continue to fall as companies lower their non-silicon costs with improved manufacturing processes and technologies.

Don’t Forget the Technology

We’ve pointed out many times in our analysis of unconventional oil production that many pessimistic energy scenarios omit a critical factor: technological innovation. By ignoring the power of technological revolutions, some commentators with political agendas miss transformative shifts. For example, over the years, commentators who leaned towards the left painted dire pictures of hydrocarbon depletion -- pictures shown to be incorrect by the shale revolution.

Unsubsidized_Cost_of_Electricity.jpg

 

On the right, some commentators have inveighed against renewables, claiming that they could never be more than an insignificant part of the total energy mix -- and that also is going to be proven wrong. The market doesn’t miss those shifts, however. In the end, economic reality, as demonstrated by the numbers, wins.

Investment implications: Technological innovation is bringing an inflection point for solar energy, just as it has for unconventional oil and gas production. Innovation has driven down the price of solar-generated electricity to parity with average electricity price in many U.S. markets. Even as subsidies are dialed back, solar will be competitive, and any incremental increase in average electricity costs will make it more so. When we think it is time to buy solar companies, we will favor exposure to U.S. rather than Chinese companies in this space given the uncertainties of current market conditions in China (although Chinese solar companies might be a good trade from time to time). In the future, when we recommend these stocks, we will favor installers and generators rather than panel manufacturers, due to the likelihood of continued sharp competition and margin pressure on the manufacturing side of the industry.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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