by Sean Keyes
Posted 21st April 2016
I’ve been talking non-stop about energy for the last week. I started with the death of the coal business, moved onto solar’s amazing technology, then tried to figure out why solar investors don’t make money.
Yesterday I said that the crappy returns on solar stocks are nothing new. They’re actually an old feature of capitalism.
Here’s the pattern: an exciting new technology comes along, like rail or telegraph wire or fibre optic cables. Investors can see it’s going to be big. So they pile into it, and finance loads of new projects. The projects all come on stream at the same time, which causes a supply glut, and the investors lose their money.
It’s happened many times in history: rail, telegraph, housing, internet. And now, solar.
So solar’s problem is that it’s almost too good an idea. It’s such a good idea it’s incredibly obvious to everyone. And when everyone knows, it’s hard for any one person to profit from it.
I cogged this idea from Daniel Gross, who wrote a book about it in 2007. He says that the real money is usually made after the first big boom, once the bubble has burst. The companies to take a “first stab” at the new industry often fail. But new companies take their place. As he puts it:
“The stuff built during infrastructure bubbles — housing and telegraph wire, fiber-optic cable and railroads — doesn’t get plowed under when its owners go bankrupt. It gets reused — and quickly — by entrepreneurs with new business plans, lower cost bases, and better capital structures.”
So the question for solar investors is – have we passed the bubble phase? Do we see “new business plans, lower cost bases and better capital structures”?
Chasing its tail
Here’s where solar panel manufacturers are now: many of them owe a lot of money. They’ve been able to grow fast enough to pay their debts because the market keeps growing. But the market keeps growing because the price of solar panels keeps falling.
It’s a tough place to be. To keep the growth up they need to keep cutting the price of panels. But to make money, they need the price of panels to rise.
It reminds me of the semiconductor industry in the 1980s and 1990s. As Jim Handy writes in Forbes:
“For half a century this business has been running and churning every year, year after year, devouring significant bank-loads of capital, and, in return, delivering huge gains in performance, productivity, and cost-effectiveness. The performance gains provided by semiconductors are unheard of in any other industry, increasing by roughly 25-30% per year.
But this industry’s financial returns are completely offset by steep price declines [emphasis mine]. Users keep getting more and more performance, but in the end, they pay about the same amount every year no matter how much performance increases.”
That’s a grim picture: an industry that’s always chasing its tail, scraping out small returns on equity, as its products change the world.
Writing in Green Tech Media, Brad Mattson offers a solution to the problem. It’s about building at scale.
According to Mattson, solar companies need to build bigger factories.
Today’s solar companies were mostly set up in the mid 2000s, when global demand for solar was less than 2 gigawatts. Today, global demand is at 26 gigawatts. And in twenty years’ time, it could be ten times that amount. Solar companies need to fundamentally change how they’re organised if they’re going to serve a market that big.
In order to make a profit from making solar panels, the manufacturers are going to have to build at massive scale. I touched on this point in Tuesday’s article.
As Brad Mattson puts it:
“The reason scaling works is that these high-speed production lines would have 10X the capacity, 10X the output, but only 2X to 3X the cost. This math has been proven over and over again in flat-panel display and semiconductor factories.”
The bottom line
So to sum it all up…
Coal is on its way out, replaced by gas and renewables such as solar…
Solar is doubling its market share every year or two…
But investments in solar companies have gone nowhere for the last 10 years…
That’s because lots of companies piled into the sector at once, causing a supply glut…
The solution is for solar 2.0 to emerge from the current industry…
With a new capital structure (ie less debt) and lower costs (ie bigger factories).
As an investor, that’s what to look out for. A solar company with enough scale to profit, even as the price of its product is continually falling.
Maybe Elon Musk’s SolarCity (NASDAQ:SCTY) is that company. SolarCity is definitely thinking big – right now, it’s building the biggest solar panel factory outside of China.
But to be honest, I get the feeling that solar’s going to be a tough business for a long time to come.
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