How China’s Woes Can Hurt Solar Companies In North America And Europe

China has come to dominate the global solar market, producing about 70% of photovoltaic panels sold globally, driven by various government incentives and policy mechanisms. ((Tenth of Chinese solar production capacity located overseas by end of 2015, PV Magazine, July 2015)) Solar companies in the country have built up a massive 65 GW of production capacity and have emerged among the lowest-cost solar vendors in the world. However, the recent concerns over the Chinese economy have cast a shadow on the solar sector in the country, and there is speculation that the Chinese government could scale back on its renewables agenda, diverting resources into more pressing areas of the economy. So, will the current environment provide an opportunity for western solar players such as First Solar (NASDAQ:SPWR) and SunPower (NASDAQ:SPWR) to bolster their share of global market, as their Chinese rivals potentially face reduced government backing? While they may benefit from their Chinese rivals being weakened to an extent, the current slowdown in China actually will likely be detrimental to them overall. Below we explain why.

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Diminished Subsidies May Not Help Western Players 

Per the United Nations Environment Program, China invested a record $83.3 billion in renewable energy in 2014, with new solar installations coming in at roughly 12 GW. ^[1] Now, there is a real possibility that the government will curtail renewable subsidies as the economy transitions into a slower growth phase. While this would undoubtedly impact Chinese players, it may also be a negative for Western firms. In terms of specific incentives, a large chunk of China’s renewable subsides are essentially paid to stoke domestic solar demand. The feed-in-tariff mechanism, for example, pays above-market tariffs (as much as RMB 1 per kWh in 2014) for power generated from solar projects. A reduction of these demand-side subsidies is unlikely to have an impact on Western players, since it relates purely to the domestic Chinese market, to which they have little exposure.

On the supply side, while Chinese manufacturers have benefited from tax breaks, cash grants and incentives at the state-level, the single-largest driver of the solar growth story in China has been the easy access to capital. State-backed banks such as the China Development Bank have offered solar manufacturers funds at low interest rates, and loans are often backstopped to a degree by the Chinese government. According to EU ProSun, a trade group, loan guarantees worth $32.5 billion were offered to the top Chinese manufacturers in 2010. This made it easy, cost effective, and less risky for solar companies to build and expand factories and fund their working capital needs. This in turn allowed them to get a leg up over their western peers, who do not have access to similar amounts of cheap funds, since the solar industry has generally been perceived as high-risk by the banking community in North America and Europe.

It is unlikely that much will change with the current economic situation. The debt of most Chinese players is Yuan-denominated (listed as short-term liabilities on most balance sheets) and these loans are perpetually rolled forward by state-backed lenders, and this is likely to continue. And while the scale of support to solar firms by state-backed lenders has declined in recent years, most large manufacturers should be able to live with this. Most tier-1 manufacturers have reached profitability in recent years, reducing their dependence on cheap funds and government support. Additionally, investors are also warming up to solar as an asset class, and the current low interest rate environment should allow companies to raise funds from other sources.

Yuan Devaluation Helps Chinese Firms, Hurts U.S Players

Chinese solar companies have generally competed with western solar firms on the basis of cost leadership rather than product differentiation; accordingly, the current environment in China actually benefits them for two primary reasons. Firstly, the Chinese Central Bank’s move to devalue the Yuan will prove beneficial to most tier-1 Chinese players such as Trina Solar and Yingli Green Energy, since they incur a substantial portion of their costs in Yuan, while more than 65% of their revenues and contracts are denominated in foreign currencies. This should make their products more competitive in export markets. Although Chinese players face trade barriers in the form of the minimum import price agreements in the European Union and anti-dumping and countervailing duties in the U.S., the currency devaluation should still provide some tailwinds, as the minimum import price is reviewed quarterly, while the U.S. duties are percentage-based.

International manufacturers have been able to make some inroads into the fast-growing Chinese solar market, as project developers see greater value in the differentiated technology, higher efficiencies and better energy yields that imported panels offer. However, the devaluation of the Yuan will be a setback for western manufacturers, since their products are likely to be significantly more expensive in Yuan terms, hurting demand in an already price-sensitive market. While players such as SunPower do have manufacturing joint-ventures in place in China, they still import high-value components such as solar cells. Separately, there is also a possibility that the government could rethink its feed-in-tariff policy for projects that use imported panels, in order to encourage domestic production.

Commodity Price Deflation Helps Chinese Firms 

Unlike many western solar manufacturers who have used technology and panel efficiency improvements to move down the cost curve, Chinese players have traditionally leaned on their supply chains to manage costs, and the current commodity price deflation should prove positive in this regard. Trina Solar noted that the price of polysilicon and other commodities fell by roughly 10% over the second quarter. ^[2] Although lower input prices will help solar companies across the board, the incremental benefit to Chinese firms should be greater, since their panel efficiencies are typically lower, implying that a greater amount of raw materials are required to manufacture every watt of solar panel capacity. For perspective, Trina Solar’s popular PC05 multi-crystalline modules offer efficiencies of roughly 15%, while many of SunPower’s panels have efficiencies upwards of 20%.  First Solar is targeting efficiencies of 16% by the end of this year.

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1. Renewables Re-energized: Green Energy Investments Worldwide Surge 17% to $270 Billion in 2014, UNEP, March 2015 [↩]
2. Trina Solar’s (TSL) CEO Jifan Gao Discusses Q2 2015 Results – Earnings Call Transcript, Seeking Alpha, August 2015 [↩]