This year solar eclipse reduced solar power generation in the US by as much as 30 gigawatts, a significant decrease that requires utilities to rely on supplementary power sources. This event served as a reminder that solar power now contributes a substantial portion of the energy mix in many countries.
While solar capacity continues to expand, investors find that investing in the solar industry is more complex than it may seem. This week, we’re taking a closer look at the current outlook for solar stocks and the key factors shaping the industry’s future.
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Solar Stocks: The Challenges and Tailwinds
In May of last year, solar stocks were the least favored sector, but over the past six months, stock prices have stabilized, and investors are cautiously optimistic. However, the industry still faces several challenges. At the same time, there are tailwinds that could drive long-term growth for the industry’s leaders.
The Nature of the Solar Industry: Solar is both cyclical and growth. While cyclical factors can create opportunities that might not be available in other growth sectors, investors must understand the fundamentals behind each business rather than simply projecting trends into the future.
The Challenges Facing Solar
Interest Rates: Interest rates have been a significant headwind for solar companies over the past few years. For many solar firms, interest rates impact sales volumes, margins, and valuations. Residential installations are usually financed by the customer or the vendor, and the financing costs can vary greatly. At current rates, some solar installations may offer little savings over the system’s life, even with available incentives. If cost savings are the primary motivation for installation, many potential buyers postpone their decisions until interest rates drop.
The stock prices of residential solar companies like Sunrun and SunPower are closely tied to rate-cut expectations. As discussed earlier, rate cuts are expected to be pushed further out, complicating short-term price expectations. When rate cuts occur, the magnitude of those cuts will determine how affordable solar installations become.
Commercial Projects: Commercial solar projects are less sensitive to interest rates, as businesses tend to secure cheaper financing and plan projects further in advance. Therefore, while residential solar demand is more immediately affected by rate changes, the commercial segment may remain more resilient in the face of current rate environments.
Looking Ahead: Tailwinds for Solar
While interest rates remain a challenge, other factors could fuel growth in the solar industry. We’ll explore those positive catalysts in the next section.
Feed-In Tariffs
Feed-in tariffs (FiTs) are a vital incentive for homeowners to install solar panels, as they compensate for the electricity fed back into the grid. In California, however, the state has modified how it compensates homeowners, moving from paying the total retail rate to a rate determined by demand. This change has significantly reduced homeowners’ compensation, with some estimates suggesting that payments are now 75% lower.
While attractive feed-in tariffs can encourage more homeowners to install solar panels, a balancing act is involved. Utilities need to ensure that they don’t overpay for electricity coming from homes, as this could make the program economically unsustainable. As more homes contribute power to the grid, the tariffs must be adjusted to maintain a balance between incentivizing solar adoption and keeping utilities’ costs manageable.
Similar changes in feed-in tariffs are expected to happen across the US and globally, which could impact the financial viability of solar projects, especially for residential customers.
Costs
A primary driver of solar adoption over the last 15 years has been the rapid decline in the cost of solar panels. As the cost of panels has dropped, more people can afford solar installations, leading to greater adoption and higher potential savings. This price reduction was primarily driven by technological advancements and economies of scale.
However, the future outlook for prices may be less favorable. While prices have recently reached a new low, this decline is partly due to oversupply and government subsidies in China. The US government is now considering implementing new tariffs, which could increase prices in the US market. If this happens, other countries might continue to benefit from lower prices, but the global cost of solar could increase in key markets like the US.
In the future, improvements in panel efficiency are expected to be smaller, and price reductions may slow down. The solar industry’s future will depend on how companies can maintain cost-effectiveness while navigating shifting policy and supply dynamics.
The decrease in panel prices has had less impact on the overall cost of solar installations than one might anticipate. While panel prices have dropped, they make up a smaller portion of the total expense, covering labor, additional equipment, and financing. Over recent years, many of these other costs have actually increased.
As shown in the chart above, the cost of installing solar panels has increased significantly in recent years, meaning consumers are unlikely to see substantial savings from the decline in panel prices.
One area that may see improvements is battery storage, which could become more affordable and efficient, making the overall economics of solar energy more attractive.
The Tailwinds and (Potential) Positive Catalysts
Despite the challenges the solar industry faces, several long-term drivers favor it. Capacity is still growing at record rates globally, fueled mainly by utility-scale installations and commercial projects. Many businesses, including data centers, are increasingly focused on securing their energy needs while investors and governments continue to back large-scale solar projects.
The International Energy Agency (IEA) and other organizations have consistently underestimated the growth in solar capacity. For instance, the IEA’s 2015 2040 capacity forecast was surpassed within just five years.
Another driving force is the steady rise in electricity prices worldwide. In the US, electricity costs have increased by an average of 2.8% annually over the past 40 years, with most economies experiencing similar trends.
As global GDP grows, electricity demand continues to climb, and this trend is expected to accelerate as more sectors of the worldwide economy transition to electrification. The resulting demand will likely push prices higher, making solar (and wind) energy more attractive. However, this may require supplementation from base-load power sources like natural gas and other fossil fuels. While nuclear energy is another potential solution, it comes with long construction times and regulatory delays, making solar a more cost-effective and quickly deployable alternative for non-fossil fuel energy.
Lastly, advancements in battery storage technology are poised to serve as an additional catalyst, enhancing the viability of both wind and solar power.
The Insight: Keep An Eye On Margins When Investing In Solar
A recent energy report from JP Morgan Asset Management highlighted the thin margins within the clean energy sector. The chart from the report compares the operating margins of clean energy indexes with those of other growth sectors and the oil and gas industry.
This chart represents the overall margins of these industries, though there are exceptions within the solar sector where companies earn much higher margins. Nevertheless, it emphasizes the importance of being highly selective when investing in clean energy stocks.
One of the main reasons for the lower margins is the commoditization of solar panels (and batteries).
When a product becomes a commodity, margins quickly shrink. Price becomes the primary factor influencing consumer decisions as differentiation between companies diminishes. This often triggers price wars, leading to further erosion of profit margins.
To maintain sustainable margins, a company must differentiate its products or services to establish a competitive edge. Companies are setting themselves apart in the solar industry by offering unique technologies for converting, storing, and managing solar energy. Key innovations include:
- Inverters: SolarEdge
- Micro-inverters: Enphase
- Solar trackers: Array Technologies, Nextracker
While offering differentiated products and services is an important first step, it doesn’t guarantee long-term success. A good example of this can be seen with Enphase Energy’s evolving narrative, which breaks down the critical factors likely to drive investor returns.
When investing in an industry cyclical and growth-oriented industry, it’s essential to understand the business model, competitive advantage, and underlying technology.
