Brave New Solar, or Grave New Solar?

NEW YORK ( TheStreet) -- There has been a debate within solar circles over the past year concerning the fate of the solar industry's bellwether stock, First Solar ( FSLR), and that debate boils down to this: Is First Solar still a growth stock?

In May of 2008, First Solar was trading at over $311. On Wednesday, First Solar closed at $114.

While the specific solar industry dynamics that have driven First Solar down do not define the solar industry -- it has been the rise of low-cost Chinese solar players that have been instrumental in changing First Solar's fortunes -- the question about First Solar's growth prospects may be one solar investors are forced to extrapolate onto the entire solar space, given recent political events in Germany and Italy.

By most accounts, Germany is still planning to move ahead with a bigger and faster feed-in tariff reduction than the solar industry expected, and Italy is planning to implement an 8 gigawatt (GW) cap on its solar industry by 2020 that would position it -- one of the the biggest growth markets for solar -- with a less-than-expected growth scenario.

Thus, are we in fact headed into a brave new world of solar, or do the political currents in Europe that are seeking to wipe out the lucrative feed-in tariffs -- which have served as a form of solar welfare -- spell doom for photovoltaic solar before it has a chance to evolve into a more mature industry?

Burt Chao, an analyst with energy firm Simmons & Company, doesn't view the public solar companies, first and foremost, as growth stocks with a high risk-high profit opportunity -- though many investors and capital markets players have acted as if that is the solar end-game. Chao, rather, thinks it is high time for solar to actually begin acting like a long-term energy play. The solar industry needs to reinvent itself to finally be a part of the renewable energy future.

"The fact that all of these companies are still alive and kicking is because of government subsidies," Chao said bluntly, adding, "There has been undisciplined, irrational growth for too long, and a pace of growth less frenzied is better for solar."

The solar industry has known that the reductions in feed-in tariffs would be coming, and solar executives have said all the right things in the past about the need to move past tariffs as a way of growing the solar industry. Still, the solar industry hasn't exactly walked the walked of evolving itself while the getting has been good on lucrative feed-in tariffs, which generate high rates of return for solar projects.

Case in point: analysts note that while solar stocks are considered technology growth stocks, there is virtually no research and development in the big public solar companies. There hasn't needed to be any.

Chao's hope is that the next outcome -- after what he thinks will be a painful period in solar, especially if China and the U.S. don't pick up the slack from the declining tariff regimes in Europe -- will be a more civilized and rational period of healthy growth for solar.

The potential implications of "Brave New Solar" are many: For one, a potential reclassification of the stocks away from their high-growth profile to a classification that better reflects long-term energy production and power purchase agreements. Steady, utility-like returns, which are pretty far from the current solar profile to which investors have become accustomed. Some analysts have even hypothesized about an era in which solar stocks are defensive plays, which, given the solar sector profile today, is not easy to imagine.

Secondly, there will be a period of protracted mergers and acquisitions as second-tier solar companies are absorbed or go bankrupt. Mehdi Hosseini, an analyst at FBR Capital Markets, said he doesn't expect the big public solar companies to go bankrupt -- particularly with the Chinese government unlikely to allow its solar cadre to fail -- but there will be many private solar players unable to make it, and that may mean the once-lucrative IPO market for solar -- which hasn't come back since the market downturn -- may never return to its former glory days.

On the other hand, there is the potential that new solar technologies emerge -- the industry equivalent of a disruptive technology that improves efficiency at a cost-effective level -- and pushes the current slate of big public solar companies to a position of weakness.

To that point, another big issue for solar is the potential need to ramp up the non-existent research and development among the public photovoltaic players, to improve efficiency and, as a result, increase returns in an era of declining feed-in tariffs and solar project returns.

These are all big "ifs" for solar, though, and there are skeptics who see the lack of current research and development as the doomsday indicator: the sector, they argue, has been acting like Nero, playing the feed-in tariff fiddle while the once-vast tariff empire burned.

Gordon Johnson, an analyst at Hapoalim Securities well-known for his bearish outlook on most photovoltaic players, believes that the recent political turn against solar is setting up the industry to be the next ethanol. "People assume you have to have photovoltaic solar, but that's not the case," Johnson said.

Johnson's point is not that investment in renewable energy will slow, but that the solar industry that has grown up on lucrative feed-in tariffs may not be entrenched enough within the global economy to ensure its survival.

"The cheapest renewable energy technology that emerges will be the most preferred, and right now, solar photovoltaic energy is the most expensive," Johnson said. Solar has received the most attention because it is one of the easiest forms of alternative energy to get up and running quickly, with low costs to build solar plants and low barriers to entry.

As a result, government feed-in tariffs and the capital markets have created a feedback loop that has incentivized solar into a less-than-perfect cycle. "The solar companies are not being incentivized by the feed-in tariffs to improve technology, but just to increase capacity," Johnson argued.

What's more, if big solar has to return to the days of ramping up research and development to create much more efficient photovoltaic technology, that means quarter after quarter of losses -- almost back to the days of being start-ups. "With current rates for solar electricity 6% to 8% more than conventional electricity generation costs, any solar innovation means going back into losing money every year," Johnson added.

FBR's Hosseini, admittedly also further to the bearish end of the solar analyst spectrum than many of his peers, also sees major problems for the solar industry if innovation is the key. "This industry is not high-tech, and not high-growth. It is a commodity industry, unit-driven and with declining average sales prices," Hosseini said.

If solar firms are forced to innovate, it could be a process that takes at least three to five years, and that would be during a period of declining returns from lower tariff regimes and accumulating losses from investments in research and development.

One thing that seems clear -- whether the end result is a brave new solar era or a grave and protracted period of diminishing profiles for solar companies -- is that the political winds have changed considerably, and not in the solar industry's favor.

It is important to remember that Germany, more or less, gave birth to the installed solar market on a major scale in 2004, and since then, a huge change has occurred in the global economic conditions, while solar prices have also dropped precipitously. The drop in average sales price in solar is something the industry can absorb over time, but it may not be aligned with the rapidity at which the big feed-in tariff regimes seem to be moving away from their lucrative support for solar.

Analysts note that the economic problems being experienced by export economies like Germany are larger than concerns about the fate of solar. Some analysts believe the real issue in Germany is that the big, export-oriented German conglomerates are seeing electricity rates climbing ever higher due to the feed-in tariffs, adding to their handicap in trying to compete effectively on a global basis.

If 96% of a country's gross domestic product is not coming from the solar industry, it is hard to imagine how influential the solar lobby can be in setting the economic future of a country like Germany. If Siemens goes to the German government and says it is going to move thousands of jobs overseas unless electricity rates go down, that has more clout than the solar industry lobby in Germany complaining about the hit its industry is going to take with a reduction in feed-in tariffs.

Of course, all the focus is on Europe right now, but as Simmons & Company's Chao said, it is possible that the U.S. and China can pick up the slack and buffer the solar industry. China, though, has not even moved ahead with its feed-in tariffs, while it has allowed its solar companies to grow on the lucrative feed-in tariff deals from European nations.

Maybe that makes China the smartest solar investor of all, at least in the short-term, as Trina Solar ( TSL), Yingli Green Energy ( YGE), Suntech Power ( STP), Solarfun Power ( SOLF) and JA Solar ( JASO) have rapidly gained market share.

The best-case scenario, which is being argued by those most confident in the future of solar, is that the low-cost Chinese players will merely extend their market share gains as the feed-in tariffs are reduced, market by market. This would spell big trouble for higher-cost solar companies, like First Solar, and even Chinese player Suntech, which is more expensive relative to its Chinese peers.

However, this scenario doesn't take into account the extent to which political currents, churned by continued economic trouble, could bring tariff regimes down at a pace that outmatches the solar industry's ability to counterpunch.

Indeed, the extent to which the previous five years in solar and the original feed-in tariff regimes no longer reflect what may be a new economic reality is also beginning to stir up trouble in the U.S., a market that is supposed to make up for feed-in tariff reductions in Europe, and where players like First Solar and Suntech have been repositioning their book of business.

A new report from Wedbush Securities on Wednesday should add more fuel to the growing fears that the political climate is changing rapidly, maybe too rapidly, for the current form of the solar industry.

In California, an economy hit as hard as any in the global recession -- and an economy as large as that of many countries -- there are rumblings of a pullback in the state's planned Renewables Portfolio Standard (RPS), due to the economic weakness. California currently has a requirement for retail sellers of electricity to provide 33% of their power load with renewable energy by 2020. That mandate will expire at the end of the current governor's term, and will have to be renewed by a new legislative effort.

Wedbush solar analyst Christine Hersey wrote on Wednesday that there is now an initiative that may be included on the November 2010 ballot in California that would effectively halt extension of the RPS mandate for 2020 until the unemployment rate in California is 5.5% or lower for four consecutive quarters.

The Wedbush analyst wrote: "We believe that California utilities have already achieved a large portion of the 20% RPS requirement mostly through biomass, wind, and hydro power, and the incremental increase to 33% would include a larger portion of solar PV and solar thermal generation...If the implementation of the 33% RPS in California is delayed pending an economic recovery and/or overturned by a newly elected governor, the impact to the large-scale solar utility projects could be significant."

One gubernatorial candidate, the former eBay CEO Meg Whitman, has already said she would place a moratorium on the RPS mandate until the economy recovers in California.

As solar investors consider First Solar's stock movement from a level over $300 less than two years ago to its current price of $114 -- like one of Whitman's eBay auction items -- they may be wondering about the solar industry's ability to bid itself up once again.

It's all a race to grid parity -- and the long-term goal has always been for solar to reach the stage at which its costs are no greater than conventional electricity generation.

Thus, whether solar is headed for a brave, or grave, new era, may now center on the timing of the grid-parity race. Does solar have what it takes -- given the political and economic situation -- to move ahead at a pace which is equal to the pace at which the feed-in tariff regimes from which solar is being weaned dissipate?

-- Reported by Eric Rosenbaum in New York.

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