Solar power: a bright future at last?

published 24 October 2007

Beijing is the air-pollution capital of the world. More than 400,000 people die prematurely from pollution-related diseases in the city each year. Tourists find that a day spent there is enough to leave them with burning eyes and a hacking cough, and local residents are regularly urged to stay indoors as the city is shrouded in a yellow sulphurous cloud. The rest of China is little better. A recent World Bank report found that 16 of the world's 20 most polluted cities are in China. The cost of water and air pollution amounts to more than $100bn a year, or 5.8% of China's GDP, says the report.

But after years of watching its cities choke with smog, China's government is investing in a solution to lift the gloom: solar power. China is building a solar industry that it hopes in the next decade will rival global leaders Germany and Japan and rid the country of its reputation as the "dirty dragon". The Olympic stadiums are being glazed with solar panels, venture capitalists are pouring funds into solar research and solar power stations are already bringing electricity to 30 million rural Chinese who had no access to it before. By 2010, China aims to meet 15% of its energy needs through renewable sources, of which solar will play a major part. And China isn't alone here: solar power is rapidly becoming the alternative energy source of choice it's an $11bn global industry that's growing by more than 25% a year.

But could the Chinese government be betting on the wrong horse? The last time solar energy was this popular, during the oil crisis in the 1970s, governments poured huge subsidies into solar technology in the hope that it would provide a cheap and stable alternative to oil. But by the end of the decade, you were more likely to find solar energy powering a remote Welsh village than a London skyscraper. Since then, solar power has been written off as an unviable energy option and today accounts for less than 1% of the world's power generation.

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The problem is that solar panels did not prove very efficient at converting sunlight to electricity. A solar cell works by absorbing the sun's photons through its silicon panelling, churning the sun's energy into a flow of electrons, and producing electricity as a result. But at the time, the average rooftop solar cell, called a photovoltaic (PV) cell, only converted about 6% of these photons. "So most solar electricity is made and consumed at a single site and in many cases isn't even enough to meet the needs of a single house," says Alex Seagle of Fraser Management Associates. But new advances in solar-cell technology have allowed PV producers to make a thinner, more efficient solar cell converting around 15% of sunlight on standard solar cells, and even 21% in more recent versions.

The cost of solar has also dropped, from around $20 per watt of production capacity in the 1970s to $2.70 in 2004. Within five years, solar power will be cheap enough to compete with carbon-generated electricity. Given the advances in technology in the pipeline, it may even undercut oil, gas and coal as the most efficient energy source within a decade, says Ambrose Evans-Pritchard in The Daily Telegraph.

That kind of efficiency gain just isn't possible for the other green-energy solutions that China could have tried. Biomass might account for 10% of the world's energy consumption, but there is not much room for efficiency gains when a huge dollop of that production comes from villagers in developing countries burning cow dung on makeshift stoves. Flooding a few low-lying plains and building hydro-electric dams is an equally impractical solution for bringing electricity to rural China. Apart from the problems that would follow from the enforced urbanisation this would bring, the Chinese government already has enough infrastructure projects on its hands without complicating its preparations for the Beijing Olympics.

That leaves wind power the only renewable energy solution that comes anywhere close to solar power in terms of efficiency gains. During the wind boom in the 1970s, wind turbines were just five to ten metres long and produced about 200-300 kilowatts (kWh) of energy, costing about $2 per kWh, says The Economist. Today, the blades are likely to be more than 40 metres long, producing 2,500 kWh at a cost of five to eight cents per kWh. So there's certainly a case for peppering China's hilltops with vast wind turbines. The only problem with this power source is that there's not much chance of building an industry that can be exported. And Beijing certainly has its eye on foreign markets as it makes its grand plans for a domestic solar industry.

As a new entrant into a market that requires its fair share of investment, how will China's solar industry compete with the Germans and the Japanese? A key factor in making solar power a feasible energy solution is government backing. Solar power might have a great deal of long-term potential, but in the short term it remains uneconomic and won't get off its feet without government subsidies. France and Germany have got it right, says The Economist they both operate a feed-in tariff system that offers fixed payment for the electricity provider. The guaranteed price for solar energy works out at 55-57 cents per kWh, against 8.4 cents for wind. Germany has invested $1.3bn in PV research over the past decade, creating a $5bn industry that accounts for 52% of the world's installed solar panels, says The Economist. Even the fledgling Chinese solar industry has tapped into the market, with 90% of China's solar panels being exported to Germany last year most of them glazing the barns of German farmers.

America's method of offering tax credits has been far less successful in stimulating its solar industry. But after years of neglect, it's getting the backing of its government. "The Energy Department's proposed research plan for 2008 to 2012 includes $1.1bn for solar advances, more than the $896m going toward fusion," say Andrew Revkin and Matthew Wald in The New York Times. Scientists have been slow to take up solar research because of its boom-and-bust legacy.

The biggest hurdle facing the solar-power industry is a shortage of polysilicon, the main ingredient of PV cells. Competition with the microchip industry for silicon has resulted in a major supply crunch, says Gary White on Outstanding Investments, and "it will be a couple of years before significant new production comes on stream". This will mean a serious squeeze on margins for solar-cell manufacturers during that time. The price of polysilicon has already jumped from $200 to $300 per kilogram since 2003. This has set off a scramble to expand production of polysilicon. Hemlock Semiconductor, the largest polysilicon maker, is spending nearly $500m to double its annual capacity from 7,700 to 14,500 metric tons by 2008. Germany's Wacker Chemie is also boosting its production from 5,500 to 9,000 tons. But according to RBC Capital Markets, we can expect the supply/demand imbalance to remain until the latter half of 2008. It seems the only ones in the solar industry who will make any real money until then will be polysilicon manufacturers.

"But after that, solar-industry profits look set to soar," says White. According to the International Energy Agency, we will be consuming almost 60% more energy in 2030 than in 2002. Solar power won't replace coal as the world's main energy source in that time the fossil fuel is just too cheap. But the government backing behind solar power makes it the most promising story in renewables. RBC Capital Markets analysts Stuart Bush and Anthony Riley reckon that gross profits across the photovoltaic solar industry will amount to $7.7bn this year and will grow to $11.5 bn by 2011. China's aim to meet 15% of its energy needs through renewable energy by 2010 means its PV capacity will rise to two gigawatts within three years that's twice the current size of what is already a booming German market, notes Oppenheim Energy analyst Hartmut Moers. And with advances in solar technology, solar cells will become cheaper, more efficient and easier to install. The sun delivers more energy to the planet in an hour than we can consume in an entire year. We may soon have a decent way to tap into that supply.

One of the most exciting prospects for solar technology lies in the desert. Each year, every square kilometre of desert receives the solar energy equivalent to 1.5 million barrels of oil. This amounts to nearly 1,000 times the world's current energy consumption. By constructing a type of solar farm in the desert using vast arrays of mirrors, such as the one recently completed in the Nevada desert, you have a very cheap and powerful means of producing electricity. This is Concentrated Solar Power (CSP). It works by concentrating the sun's heat onto the mirrors using a central tower, in much the same way as you would start a fire with a magnifying glass, says Polly Higgins for The Lazy Environmentalist. The mirrors heat oil running through a pipe below them, which is used to create steam to turn a turbine, powering electricity. Just 1% of the world's hot deserts would be called upon to meet the planet's entire electricity needs.

CSP is on the verge of being competitive with conventional power plants. It costs nine to 12 cents to generate one kilowatt hour of electricity by CSP not counting any subsidies compared with about three to five cents to generate the same amount of electricity by burning coal. But at the moment, because the technology is so new, the equipment is expensive in itself and costly to maintain. Even so, plants have already been completed in Spain, Australia and California, and more are under construction in South Africa and China.

With the supply crunch in polysilicon holding up expansion plans in the industry, the smartest way to play solar power in the short term is through polysilicon suppliers. MEMC Electronic Materials (NYSE:WFR), the leading US producer of silicon wafers, has seen its shares gain 70% this year on the back of strong demand for polysilicon. However, analysts at UBS reckon it could go a lot further. They have a target price of $77; the shares currently trade at $59. The forward p/e is 15, which looks cheap considering the price-to-earnings-growth ratio of 0.54.

One particularly interesting play on China's newfound enthusiasm for solar power is Aim-listed Jetion Holdings (JHL). The company constructs the solar cells that are used in solar panelling using cheap silicon wafers, but is also expanding into making the panels themselves, which have higher profit margins. Jetion Holdings is already turning a profit, with $5m earnings on $45m revenues last year. Production capacity has already doubled this year and is expected to double again by the end of next year. The firm has a superior product to rivals, says Investors Chronicle, converting 16.5% of the solar power it absorbs into electricity against the 15% industry average. Despite the short supply of polysilicon stifling margins in the industry, it's worth considering Jetion Holdings as a long-term play on what should be a very profitable trend. The shares trade on a forward p/e of 7.4 for 2009. "That is far too low for a fast-growing company in a booming industry."

Eoin came to MoneyWeek in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.