China’s solar manufacturing industry, the world’s largest, has been an eye-catching advertisement for the country’s push into cleaner, more advanced industries. It has also yielded rich rewards for the investors who managed to ride the wave of overseas IPOs of Chinese solar manufacturers like Suntech Power, the industry leader, between 2005 and 2008.
How times have changed. Suntech’s shares, once a hot property, are now worth just one-tenth of their peak value. The photovoltaic (PV) module producer’s gross profits plummeted from US$129.7 million in the third quarter of 2008, to just US$3.6 million in the final three months of the year, and it is laying off 30% of its staff. Moreover, the falling fortunes of Suntech are a benchmark for Chinese solar technology manufacturers’ wider travails. Competitors such as JA Solar and Sunergy are also reporting quickly dwindling profits, and smaller factories have shut down production altogether.
What is driving this reversal? Not surprisingly, the usual suspect — the financial crisis — is responsible for a good portion of PV makers’ pain. It has strangled the flow of financing to the solar power plant developers who buy the modules, cutting off demand for PV manufacturers’ products. The lack of credit is far from the sole culprit, however. Huge capacity expansions have brought about oversupply and intensified price competition. On the other hand, though it may not help some stricken PV makers, the reduction in the module price that has resulted from economies of scale and a dramatic drop in the price of the industry’s basic material, silicon, could pave the way for market expansion, experts say. International policy support for renewable energy also remains strong. Nevertheless, observers note that the industry’s recovery may depend on increased government interest in renewables, backed up by more generous support for solar power. There are some early signs that this may be in the works.
A picture of the PV industry would have to be a moving one. Manufacturers’ concerns have shifted rapidly over the past year or so: Whereas in today’s financial environment tightness of credit is a dominating concern, even a year ago the dynamics were very different. Back then, the PV industry was constrained not by a lack of cash among potential buyers, but by a shortage of the basic raw material needed to manufacture PV modules: silicon.
Generous government subsidies have encouraged the deployment of solar technology in places such as Germany and Spain. However, two years ago, polysilicon supplies could satisfy only 20% to 30% of manufacturers’ demand, says Jifan Gao, chairman and CEO of New York-listed solar manufacturer Trina Solar. An increasing number of PV manufacturers had to compete for scarce supplies, pushing up the price and making the end product (PV modules) prohibitively expensive. Spot prices for incremental supplies of polysilicon reached a high of $450 per kilogram in some cases last year, says Julia Wu, an analyst with research consultancy New Energy Finance.
PV makers therefore preferred to eschew silicon spot markets in favor of strategic purchases of large quantities directly from sources, despite a heavy burden of pre-payment. They also started to build their own silicon plants. Jiangxi-based SinoVideo LDK, another large player, started a silicon project with an annual output of 15,000 tons and total investment of more than 12 billion Yuan in August 2007; Suntech developed relationships with silicon producers including Glory Silicon and Hoku Material through minority stakes.
Severe as the shortage was, however, it is set to vanish this year, says Wu. Inspired by potentially high profits, builders of new polysilicon manufacturing plants have sped up construction schedules. For example, polysilicon manufacturer Hemlock plans to expand capacity from 10,000 tons to 19,000 tons by the end of the year, and Wacker from 10,000 tons to 18,000 tons. Total planned capacity for high-purity silicon production currently being built in China supposedly exceeds 80,000 tons. This has prompted big PV manufacturers to change tack.
Anticipating the end of the silicon glut, big manufacturers have ditched plans to build in-company polysilicon facilities. Trina, for instance, abandoned plans to pour nearly a billion U.S. dollars into a 10,000 ton plant. At the same time, they have cranked up capacity expansion, which enabled them to reap high profits (until conditions worsened at the end of last year). Suntech again boasts the most impressive numbers. The company’s module production capacity reached 1GW (1GW = 1000MW) in 2008, roughly equal to the output of all the entire Chinese PV industry the year before, Guangchun Zhang, Suntech’s vice president, disclosed in a public speech during the 2008 China Solar Photovoltaic Conference & exhibition in September. He added that he expected it to reach 4.2GW in 2010.
Just as China’s PV firms may have thought their troubles were coming to an end, however, the surge in production has given rise to another problem: massive oversupply. Long before the global financial storm began, observers were worried that supply would radically outstrip demand. In July 2008, Edwin Koot, the CEO of SolarPlaza, a leading photovoltaic research institution, issued a report titled “Fasten Your Seatbelts,” which predicted that in 2009, global demand would be 6GW, but production capacity would reach 9GW. “This could create an oversupply situation, leading to falling prices and margins,” he wrote.
Some experts worry that manufacturers will be trapped in a bind reminiscent of the prisoner’s dilemma from game theory, in which players’ rational actions (in this case, to seek economies of scale by capacity expansion) have results counter to their best interests (by creating an industry-wide price war). At the same time, though spot silicon prices are now down US$150 per kilogram — a third of their peak — manufacturers costs are still locked into their high inventory prices, says New Energy Finance’s Wu.
There are also demand-side factors in play that help explain the collapsing profits of the likes of Suntech, Wu notes. Developments in Spain and the U.S. are key. Spain’s market has played a tremendous role in propelling the rise of Chinese PV manufacturing, contributing to 2.5GW worth of new installation last year alone. This year, however, it has been capped at 500MW. At the same time, U.S. President Barack Obama’s “New Deal” for renewable energy, which aims for 10% of gross energy consumption to come from alternative sources by 2012, has led to predictions that the demand for PV will grow at a rate of 30% over the next few years. The new administration has already bolstered the attractiveness of the old regime’s investment tax credits, which allow investors in solar plants to retrieve 30% of taxes after they are built.
This has led some to hopes that the U.S. will be able to make up for weaker Spanish demand. While this will be true to some extent, the U.S. cannot take up all the slack, says Wu. Predictions of massive oversupply this year are therefore almost certain to come true. New Energy Finance estimates that, based on optimistic projections, producers will churn out at least 2GW more than the market can absorb, and that PV prices will fall by 35% to 40% in 2009. PV makers’ margins are therefore being squeezed from both the demand and supply sides, while pressures are amplified by the depreciation of the Euro, Wu notes. In these difficult conditions, production expansion and the construction of new facilities were halted in the second half of last year.
Consolidation of the plethora of smaller solar companies is another likely consequence of the industry’s present difficulties. “Their orders are being lost and cash flow is tightening,” said Qidong Wei, the secretary-general of the Jiangsu Photovoltaic Industry Association. There were roughly 400 module producers in China in 2008, twice the number from the previous year, but some suspect that over 300 may have already closed their doors. Although no one has precise figures, Wu believes most are mothballed, awaiting a market recovery. Rumor has it that the government may step in to help that recovery happen, she says.
Oversupply and the end of the silicon crunch have further ramifications for PV makers, promising to change the focus of competition. As the advantages to be won merely from generating economies of scale shrink, companies are beginning to look for new ways to remain ahead of competitors.
Pushing into downstream activities is one option. This could involve providing not only engineering services such as design, procurement, construction and connection to the electric grid, but also financing and long-term maintenance. A May 2008 Deutsche Bank report argued that fully integrated system providers have the most insulated business models to withstand the shrinking margins that come with oversupply. Trina’s Gao also believes that “selling energy rather than modules and systems will likely offer the best long-term returns.” Even without direct investments in photovoltaic power stations, branching out into solar power EPC (engineer-procure-construct) services could promise handsome profits. Jianhua Zhao, chief technical officer of China Sunergy, notes that “it costs the same amount to move PV systems onto the roof as to purchase those systems.”
Downstream business plans hold attraction not just for big manufacturers, but also for investors. In early 2008, Zhang Lihui, who has invested in three solar enterprises as a partner of the China Environment Fund (CEF), began looking for new business models. He is convinced that integration into downstream activities will become important when polysilicon becomes abundant. “Once the shortage ends, the PV market will turn into a buyer’s market immediately,” he says. “Then, the chase for end clients will become the focus of competition.” Becoming a total-solution provider is one way for producers to become more competitive, Zhang notes.
Some Chinese enterprises are already trying to make the transition. ET Solar Group, a Nanjing-based PV company, caught Larry Zhang Lihui’s eye, and subsequently received US$20 million from the CEF. It set up a branch company, ET Solutions AG, becoming a total-solution provider in the middle of 2008, with most staff based in Germany. In December 2008, ET Solar signed an agreement, worth 200 million euros, with the Wattner Group, a German initiator of closed-end energy and infrastructure funds, to deliver solar installations.
Dennis She, vice president and chief sales officer of ET Solar Group, believes that the company’s advantage lies in a unique combination of manufacturing experience and in-depth EPC knowledge. Project engineering in China and the Chinese staff’s participation in the construction help keep project costs low, while ET Solar also provides the financing services through a partner.
ET will soon face competition from some big fish, though. Suntech has declared its intention to go down the total-solution provider route, and at the end of last year founded Gemini Solar Development Company. The joint venture, jointly owned and operated with MMA Renewable Ventures, Suntech and their third-party finance partners, will develop and finance photovoltaic projects of 10 MW and larger to capitalize on the growing demand for large-scale solar power projects in the U.S.
Small-time PV makers will face obvious difficulties in trying to move downstream, of course, but even the big fish may find themselves swimming against a strong current. Chinese labor may be cheap, but maintaining teams of workers in Europe is not. This is important, as 98% of demand comes from overseas. “The salary of the director of ET Solutions AG is equivalent to headquarters’ entire marketing staff costs,” Dennis She observes. Managing an international team will be a new challenge to Chinese companies’ corporate culture. There is also a risk that offshoot companies such as ET could actually compete with their parent company for customers.
Seeking Solace at Home
While looking to the U.S. market and new business strategies, Chinese PV manufacturers have been lobbying the Chinese government to boost the deployment of solar technology at home. So far, China boasts only around 130MW worth of installed PV power facilities, notes Wu, as solar power production costs far more than that from fossil sources, especially coal. More cost-efficient wind and nuclear energy are known to be favored by state planners.
There is a chance this could be about to change, though. If grid parity is defined as achieving costs competitive with those of fossil-fueled power generation, it is still a long way off; in fact, solar need only be competitive with peak grid prices in order to be financially justified in its own right. Shi Zhengrong, chairman and CEO of Suntech Power, and other industry leaders say they think this will occur in China by 2012, by which time they say prices will have fallen to one yuan per kilowatt hour.
“Based on the dropping module prices, falling silicon prices and improving technology, I think this is achievable,” says New Energy Finance’s Wu. She notes that in certain parts of the United States, $0.2/KW solar generation has already been seen, adding the caveat that in China, likewise, the one yuan target will only be reached in certain regions by 2012.
“From that moment on, the PV industry be heading towards rapidly growing demand once again, which will no longer be dependent on and limited by subsidy programs,” SolarPlaza predicts. “This could lead to unprecedented growth opportunities for the PV industry and perhaps even an undersupply situation.”
The Chinese government seems to be alive to the possible opportunities, even as it surely rues the troubles of its domestic PV manufacturers. “We think the government really needs to do something to rescue them,” says Wu, noting that solar technology is a significant employer, and that the government will not allow a “green” industry to fail. Already, with the cost of solar power falling, the government appears to be testing the potential of the domestic market, she says. It has launched its first concessionary bidding process for a 10MW solar plant in Dunhuang, Gansu province, the country’s largest to date, and will provide a subsidy equal to the difference between the cost of the electricity generated and the local coal fire energy price. By late February, 50 Chinese and foreign developers had shown themselves eager to join the fray. Bidding closes on March 20. This project should help China not only to take a step nearer to its (albeit conservative) target of 300MW solar power by 2010, but also to gauge the scale of the potential market and funding required, Wu says. Several other plants are planned.
Elsewhere, too, policy support remains strong. This is true of many traditional markets, Wu says, but also in emerging markets such as Greece and Eastern Europe. Fundamental drivers of industry development, such as environmental issues and energy security concerns, also remain in place. Though it may spell the end for some PV producers, the downward pressure on prices should open up a far larger market for those able to survive the current crisis. Though burning dimly of late, it seems there is reason to believe that solar’s star has not fallen.