Solar Annual 2006: The Gun Has Gone Off

Initially, this 40-50% annual expansion of production raised concern that a "glut" might reduce prices and margins. Further, we worried about negative impacts on demand if interest rates were to rise, hydrocarbon prices fall or pro-solar policies be reversed. However, interviews with 400+ solar power executives and policymakers in 10 geographic markets have fortified our conviction that demand will significantly exceed supply through the end of the decade, that prices are likely to remain high and that margins are likely to continue expanding for at least 3 more years. Overall, we suspect that many managers and analysts are significantly underestimating the sector's strong prospects for volume, price and earnings for 2006 through 2010.

Supply:

10 GW BY 2010. Interviews with 400+ solar companies and 50+ site visits have convinced us that sector production will reach at least 10 GW by 2010 (530% growth versus 2005). The bulk of this growth will be in crystalline silicon (c-Si) solar cells/modules. With production of high purity Si feedstock rising from 32,000 tons in 2005 to at least 85,000 tons in 2010, the solar sector will have at least 59,000 tons available in 2010. At the same time, increasing cell efficiencies and decreasing waste will enable silicon usage per watt to improve by 40%, from 11.5 g/W in 2005 to 7 g/W in 2010. The result is that total c-Si cell/module production will likely exceed 8 GW by 2010. In addition, we see even stronger percentage growth of non-traditional technologies (CdTe, a-Si, CIS, ?c-Si, concentrators) which are capable of filling a portion of demand unmet by c-Si. We expect nontraditional production to expand from 0.15 GW (9% market share) in 2005 to 2 GW (20% market share) in 2010. There is upside potential for both c-Si and non-traditional beyond our forecasts.

Demand: No Glut

With so much production coming online, we spend most of our time worrying that over-supply will drive down prices, margins and returns. This concern is exacerbated by risks that could diminish demand, such as higher interest rates, lower hydrocarbon prices or reversal of pro-solar policies. After months of research, we have come to the conclusion that there is much, much more demand than capacity, and that demand is growing faster than supply. Today, global demand isapproximately 5 GW for modules at prices of $3.50 to $4.50/W. This is far greater than production (2.4 GW in 2006); the results are a 16% increase in module prices and 30+% average pre-tax margins for the overall sector in 2006. By 2008, we expect underlying demand will expand to 8 to 10 GW at current prices compared with production of only 5 GW.

Demand growth results from a variety of factors, with two dominant drivers of demand. First, residential grid electricity prices are rising quickly in many markets as high hydrocarbon prices are passed through to residential customers. 2008 prices for residential grid electricity appear likely to be 20 to 30% higher than 2005 prices in many markets. Second, the political case for solar is strengthening due to high energy prices, climate change risks, national security concerns, and the desire for solar job creation. In this setting, we believe significant reductions of existing solar support programs are unlikely and that there is realistic potential for global solar policy spending to increase from $1.8bn in 2005 to $7.2bn in 2008 (60% CAGR). While we are deeply concerned about factors that could derail solar demand growth, these two trends (significant increase in grid prices and strengthening political case that is expanding policy spending faster than production) makeit likely that demand will outstrip supply through at least 2008, likely 2010.

Price & Profit: Increased Expectations

Based on interviews with executives who oversee more than 80% of industry volume and fund managers who oversee more than 70% of the industry's float, we are convinced that consensus is too conservative. Specifically, we believe that most business plans and models for this sector include assumptions about volume, price and margins that are unrealistically low. With demand outstripping supply, prices will remain firm and revenue will expand quickly from $12 bn in 2005 to $19 bn in 2006 (+51% YoY) and $27 bn in 2007 (+43% YoY). At the same time, incremental efficiency gains and manufacturing improvements are driving costs 7 to 10% throughout the supply chain (excluding feedstocks) and industry average pre-tax margins are expanding from 22% in 2005 to 30% in 2006 and 33% in 2007. By 2010, there is realistic potential for revenue of at least $70 bn in 2010 (40% CAGR 2005 to 2010) and for pre-tax profit to grow at least as quickly. For the last three years, many business managers and analysts have been too conservative in their evaluations of the sector. We recommend incorporating stronger volume, price and margin assumptions into strategies and models.

Strongest Sprinters: 20 Industry Leaders

The leading solar companies are in a full sprint to grow faster than the overall sector and establish sustainable long-term advantages. As we screened the sector, we have sought to identify "leading runners" who are building sustainable competitive advantages and other "fast runners" who are likely to deliver faster-than industry-average earnings growth.

This includes:

Applied Materials (US)
BP (UK)
Carmanah (Canada)
Conergy (Germany)
Ersol (Germany)
Evergreen Solar (US)
First Solar (US)
GT Solar (US)
Hemlock (US)
Kyocera (Japan)
M.Setek (Japan)
Motech (Taiwan)
Q-Cells (Germany)
REC (Norway)
Sanyo (Japan)
Sharp (Japan)
SolarWorld (Germany)
SunPower (US/Philippines)
Suntech (US/China)
Tokuyama (Japan)

A detailed profile for each of these 20 sprinters - including evaluation of their growth potential over the next five years - is given in the new Solar Annual 2006, published on July 11, 2006 by PHOTON Consulting. Michael Rogol is the report's lead author. Paul Choi, Joel Conkling, Anthony Fotopoulos, Keith Peltzman, Scott Roberts also contributed to it. For more information on the report see the following link.