Greentech Media

Poly - Enough already!

What about polysilicon? Some industry participants and analysts believe that "constrained" poly supplies will limit cell production to sane levels. This may be true in 2008, but it won't save 2009. Lehman (and other) analysts contend that poly prices will stay strong throughout this year and that, somehow, this is an indicator of a healthy market for PV. I believe that's incorrect. Spot poly prices are a lousy indicator of end demand; they are, however, a good indicator of producer manufacturing plans. To me, they highlight a looming, large margin problem for producers.

Given large, unused cell capacity and rapidly growing poly capacity, I believe the industry will see two distinct margin effects. First, as poly supplies increase, cell production will increase as capacity is enabled. Cell production will rise to an oversupply level as manufacturers must put their recently invested capital to work. Poly prices will remain firm as cell production rises. Cell average selling prices (ASPs) will fall as oversupply is reached. Margins will be compressed. The second margin effect will come into play as poly production continues to rise (the industry expects poly production to attain oversupply levels by 2010 or sooner). Spot poly prices will contract severely, possibly below contract poly prices (spot is around $300-$400, but was as low as $35 before the boom. I believe contract prices are around $70-ish). In this case, as cell ASPs continue to erode, some manufacturers may be trapped between their slow-changing contract poly prices and declining spot cell prices, as other manufacturers compete with cheaper poly purchased on the spot market. This sort of whipsaw price action, as supply/demand trends vacillate, plays havoc with margins. Ultimately, things will settle down, with both poly and cell markets in oversupply until demand catches up.

For the last year, the attention of analysts has been focused on poly pricing and whether manufacturers have "secured" their poly supply for '07 and '08, as each manufacturer ramps their capacity assuming unlimited demand. This is a dangerously backward-looking view. Analyst focus needs to shift from yesteryear's poly problem to this year's supply/demand imbalance problem. The key question for 2008/2009 margins is: which ASP declines faster - poly or cells? I believe that, as increasing poly supplies enable cell overproduction and as cell manufacturers keep producing, we will see cell ASPs drop much faster than poly. Look at the numbers yourself and just think through the likely scenarios.

Situation in 2008

I've focused on year-end 2008 production capacity with physical oversupply in 2009. What about 2008 supply/demand? Lehman estimates 2008 demand at 3.5 gigawatts, growing from 2007's 2.4 gigawatts. Lehman sees 2007 year-end capacity at 5.3 gigawatts and, to its credit, identifies oversupply as a potential 2008 issue in the cell market. Simply put: 2008 may already see potential oversupply of up to 40 to 50 percent. I can only assume that many believe actual cell production will still be constrained by poly shortages in 2008. I would point out that poly shortages are extremely unlikely to prevent meeting 2008 demand levels (only 3.5 gigawatts), although they may prevent suppliers shipping at maximum capacity levels. Hence, in 2008, investors already will start to see the choice suppliers face in committing to overproduction and weakening margins, or idle capacity... and weakening margins.

Manufacturer behavior

One should not assume that manufacturers will see the problem coming and adjust their capacity plans accordingly. They will not. In rapidly growing industries (I've personally watched this in ethanol, LCD panels, disk drives and housing), manufacturers set goals of desired market share several years out. They must plan to achieve sufficient scale and share in the market as it will exist when the capacity is built. This invariably leads to oversupply in the near-term and dropping ASPs and margins as the market shakes out who will ultimately lead the industry. The PV business is no different.

Major participants are making gigawatt-level production plans (STP, Sharp, Q-cells; published) in anticipation of grid parity. Someday, it will likely pay off. Near-term, however, there will be oversupply and margin compression. Consider the timeline to reach 2008 end-year capacity. I believe PV capacity has a roughly 18-month timeline from plan to turn-up. Plans, budget and financing for this year's capacity were set last year. Buildings already are getting built. Production-equipment orders presumably have six- to nine-month leads and have either been placed or will be placed in the first quarter of this year. Capacity turn-up will occur in the third or fourth quarter of this year. Basically, unless manufacturers start canceling equipment orders now, the die will be cast. However, I believe no one will cancel anything since, at the moment, the industry is still in a state of Spanish mania.

Stock impact and timing ... the ethanol example

So, what to do with the stocks? At the moment, traders and momentum are in control of solar stocks. When will fundamentals start hitting them? I find the ethanol industry provides the best and most recent example. By the end of 2006, it was apparent that the ethanol industry was headed for oversupply as high ethanol prices stimulated investment. Through all of 2007, ethanol prices fell in anticipation, bottoming at cash cost near $1.55 in October. Ethanol stocks fell as well, all year long, in anticipation of an oversupply which won't actually be cresting until 1H08 as new plants complete. The stock trend shifted downward a full year before the actual supply/demand imbalance peaked and the stocks kept moving downward as the situation clarified. Now, ethanol prices and the stocks are both starting to rebound, looking ahead as the new RFS standard and declining investment should restore market balance by 2010 or so.

In the case of PV, the Spanish market is working its way through a near-term peak right now as projects need to be turned up by September, when tariffs drop from 44 euro cents to perhaps 31 euro cents. Working that wave back in time, panel orders to suppliers presumably peaked or are peaking in the fourth quarter of '07 or the first quarter of '08 for this hot sector of the market. There is hope for a similar wave of projects in the second half of '08 in anticipation of German subsidies declining. In both Germany and Spain, I believe 2008 will see installation peaks in anticipation of tariff reductions, and the stocks will soon need to start factoring this in. Overall, without attempting to time the market, I don't anticipate having to wait very long before momentum gives way to doubt in these stocks; I think they start looking ahead this quarter (the first quarter of '08).

In my view, there will be four levels of stock reactions, from most negative to least negative, basically driven by the companies' industry position. Worst hit, in my humble opinion, will be the nonintegrated silicon-based producers in the supply chain: LDK Solar (NYSE: LDK), Solarfun Power Holdings Co. (NSDQ: SOLF), MEMC Electronic Materials (NYSE: WFR), JA Solar Holdings Co. (NSDQ: JASO), etc. Vertically integrated crystalline-silicon producers will be second-worst, and the smaller they are the worse off they'll be. Evergreen Solar (NSDQ: ESLR), SunPower Corp. (NSDQ: SPWR), Suntech Power Holdings Co. (NYSE: STP), Yingli Green Energy Holding Co. (NYSE: YGE), etc., should all react.

Thin-film may have the least negative reaction because, as low-cost producers, they should fare relatively better in a downturn even though their ASPs will drop as fast as the next guy's. Nonetheless, I think First Solar (NSDQ: FSLR) gets hit hard, due to overvaluation and growing recognition that Nanosolar has a fundamentally better approach (i.e. First Solar is king of a time window). The fourth class of stock reaction is actually positive: Companies like Akeena Solar (NSDQ: AKNS) actually benefit from panel price wars. Because a significant portion of revenue comes from project business, SunPower also will benefit, which will somewhat offset the hit they'll take as a manufacturer.

What could prevent oversupply?

What could turn this around? Either a large reduction in supply, which I don't see manufacturers planning, or a very large increase in demand. A multi-gigawatt increase in demand would require significant legislative support around the world -- in 2008 -- relying extensively on new money for feed-in tariffs, in advance of oversupply conditions. Given the likely world economic situation in 2008, I don't see governments deciding to massively increase 20-year PV-subsidy payouts this year. Furthermore, it's in governments' interest to let oversupply work its charms on prices to help reduce the need for further subsidies.

China is offered as a multi-gigawatt source of demand, but China's 2007 installations are on the order of 30 megawatts. It will be several years before China is a significant source of demand regardless of government policy initiatives. Grid parity will ultimately solve oversupply, of course, but that's not happening by 2009 and it may never happen for the crystalline silicon-based suppliers. Finally, consider the behavior of large-project investors as they sense that prices are starting to fall. Their economic motivation will be to increase project returns by delaying commitments and waiting for lower prices (just like prospective homebuyers in the U.S. housing market are waiting at present), which will of course exacerbate price declines. Basically, I don't see anything solving the situation in 2008. The degree of oversupply is simply too large.

Conclusion

I'm not a pessimist on PV. There's basically infinite demand, post-parity, at sufficiently high scale and at low enough prices. But the industry will have its share of booms and busts along the way, and right now, we're heading for a "bust" even as the current headlines all say "boom." It won't happen overnight -- it'll take a few quarters to develop -- but it is coming.

The PV industry is headed for a margin-bust, shake-out and consolidation phase.

Final note: I'm not even going to talk about 2010, with current manufacturer intent of nearly 24 gigawatts of capacity. We simply won't get there.