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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Will U.S. Solar Suffer The Same Fate As Fracking?

Will U.S. Solar Suffer The Same Fate As Fracking?

In textbook economics, markets rapidly balance and establish prices at a point where supply equals demand and then remain in equilibrium absent any external shocks after that point. In practice, markets rarely work as smoothly as economists’ models predict. For evidence, witness the early stages of market confusion that are starting to play out in the solar market. Solar markets are in hyper growth mode right now, rushing to take advantage of federal tax credits that are set to expire in 2016.

With Congress bitterly divided on nearly every issue and the 2016 election promising to be contentious, there is a strong possibility that solar credits will not be extended. If that happens, then it would completely change the dynamics of the solar market, and many firms that have relied on generous rebates would have their business models thrown into substantial doubt. Even absent the expiration of solar credits though, it is hard to see how the solar market can continue to grow at its current pace. Solar growth has been explosive in recent quarters, and the infrastructure being built to support the growth in the market requires that more and more businesses and individuals continue to sign up for solar each year. Related: LNG Glut Set To Worsen Considerably Over Next 3 Years

Unfortunately, the industry is probably overestimating the sustainable growth rate for new installations. That reality is reflected in the divergent opinions of publicly traded solar companies. First Solar, for instance, sees an on-going boom in solar market growth, while Solar City is already preparing for hard times in the industry and is rebalancing its business accordingly. If the dry bulk tanker market, the mining industry, the offshore oil drilling market, and the oil market overall are any indication, then Solar City may be making the right choice.

The one commonality between all of these industries is that each group overbuilt their infrastructure when times were good and growth was heady under the assumption that the world was “different” and that growth would continue. It’s an old story really; company executives cannot (and have little incentive to) resist taking on risky levels of capacity expansion that end up oversupplying the market creating a dramatic boom and bust cycle. Now this same story appears to be playing out in the solar market. Related: How To Play A Potential Collapse In The HAL/BHI Merger

Solar advocates would argue that the solar market is fundamentally different today because prices are falling and the country is finally realizing the necessity of going green. And there is little doubt that input costs are falling rapidly. But that falling set of prices is precisely why so many people and businesses are interested in solar at present. As prices fall, the quantity demanded of a product increases. At some point though, most of the best and most economical areas for solar installation will hit their saturation point and when that occurs, many assets built for solar panel installation will be worth considerably less. One could argue that point is probably fast approaching. This is exactly analogous to the fracking boom.

Moreover the expiration of Federal tax credits in 2016 is not going to help. That expiration is probably already pulling 2017 demand forward in the same way the “cash for clunkers” program pulled car demand forward. In light of this, 2017 and 2018 are likely to be very lean years for solar installation. In 2020, new incentive programs will come online, but the multi-year incentive hiatus will have radically reshaped the solar supply chain by then. With that in mind, investors should be very careful about extrapolating solar company earnings from 2015 and 2016 into the future.

By Michael McDonald of Oilprice.com

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  • zipsprite on November 12 2015 said:
    Fly over most any part of the country and look down, then think about this statement:

    "At some point though, most of the best and most economical areas for solar installation will hit their saturation point and when that occurs, many assets built for solar panel installation will be worth considerably less. One could argue that point is probably fast approaching."
  • Lars Mors on November 13 2015 said:
    We looked into solar several times in the last couple years, and just can't make solar work. Even with the ideal model of buying into a 25% excess of the above base tier energy requirement, we come up with a 16-year payback ... and, have doubts of living in the same home that long.

    Comments from neighbors, friends, and acquaintances seem to confirm the story ... the assumptions floated by promotors are far short of user experience. Payback is not the 5 years discussed during sales calls, but much, much longer.

    In short, solar is great for power companies accessing electricity at 3-5 cents per kWHr, and then selling back for 3-5 times the buy price. But, its a boat anchor for those who own it [save cases of self installation].
  • md on November 13 2015 said:
    Saturation? According to the Institute for Energy Research (March 2015) solar energy provides four-tenths of 1 percent of the total energy consumed in the United States. As materials and installation prices continue to decline new surface areas (e.g., parking lots, landfills, brownfields) will become viable sites for solar (PV) development.

    Fracking? I don't see any correlation at all.
  • mulp on November 14 2015 said:
    The difference between "fracking" and solar is the lifetime of the assets built with all the investment.

    The subsidies for fossil fuels in being able to pollute and harm billions of people without penalty are huge and will continue for some time, but the nature of pillage and plunder investment is that selling stuff that is free results in profits going negative as the investment delivers the free stuff to a glut in the market and the price must keep falling. A finished oil or gas well must keep producing if the labor costs are well below the market price, even if the return on invested capital is negative. Market equilibriums will occur when the investment becomes worthless because all the free stuff is depleted and the well produces less than labor costs. That point might be 5-10 years, but it will be reached for each well, and with return on capital at zero or less, no new wells will be drilled.

    For solar, the investment in growth is in building the factories and the value chain of sales and marketing, the project management, the financing structure, the history to justify and direct sales. The factories have been built along with the value chain, and thanks to the tax credits and other subsidies, the factory financing has been possible, but due the temporary nature of these subsidies, plus the rapidly changing technology, capital returns have been based on 5-7 year life cycles. Except, a given solar technology can be manufactured on a given machine for two decades if their is no competing technology eliminating all its sales. A solar factory only needs to slightly exceed its total labor costs of its value chain to stay operating for two decades. While the market might not grow in terms of solar sales, the installed solar capacity will continue to grow exponentially for two decades.

    The solar roof installer is faced with either unemployment or operating at low margin, installing on WalMarts or partnering with green builders. Or giving up autonomy by becoming a contract laborer for the SolarCity's who have large installed capital bases that will eventually go off lease and transfer to the roof owners and need replacement with new investments. The SolarCity's will have the capital to incorporate storage to get around the utilities blocking solar's ability to send power into the grid. The SolarCity's will be able to finance a 30 year investment over 20 years to have the lure of splitting the backend 10 year cheap energy profit.

    Solar is like the 1000 barrel well for the first year being a stripper at 500 barrels at 30 years old, instead of the typical well under 10 barrel stripper oil well.

    And solar and wind and nuclear and hydro are a long way away from creating an electricity glut, especially as electric heat pumps replaces burning heating oil, electric cars replaces gas burning cars.

    Perhaps we should thank Cheney's secret cabal that did everything possible to ensure enduring high oil profits by attempted restriction of exploration to big oil. Uncertainty around Obama's policy of favoring big oil with cheap and abundant Federal leases made investing in the small guys working on private land look really lucrative, which has created the oil glut. But not before it made investment in wind and solar and electric cars look lucrative as well.

    The difference is the free wind and free sun never get depleted making the capital investment always generate a positive return when there exists no glut in electricity, while the oil and gas and coal do get depleted, but when a glut exists, capital investment never has a positive return.
  • cold_beef_cake on November 14 2015 said:
    Indeed, when I fly and look down, I would say about 0.0000001% of all land has a solar panel on it - likely less. Not sure how saturation could even be mentioned in this blurb.

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