The great riddle of solar energy

Solar power is starting to take off. The technology is great, but… Solar power companies haven’t made much money for investors over the last 10 years.

I finished yesterday’s article with a riddle. One that’s been niggling at me for a while.

Solar power is starting to take off. You probably already know that. It’s doubling in price performance every couple of years. And it’s doubled its share of the world energy market seven times in the last 15 years.

The technology is great. But…

Solar power companies haven’t made much money for investors over the last 10 years. The Guggenheim Solar ETF (ARCA:TAN), which invests in big solar companies, is down 90% in the last 10 years and 60% in the last five.

There’s a weird disconnect between the product and the business. What gives?

I think I’ve an answer. Read on to find out what’s happening.

The hubris!

SunEdison (NYSE: SUNE) is one of the biggest names in solar energy. It was worth around $5bn this time last year. And on Friday, sources close to the company leaked that it was on the verge of going bankrupt.

SunEdison makes solar panels, runs solar power plants, and makes silicon wafers. Its share price is a potted history of the entire solar industry over the last ten years.

SunEdison’s share price tells the story of the solar industry

So what are we looking at here? Before the financial crisis in 2008, the whole solar industry was on a roll. Investors were happy to take a punt on risky technology. Of course, the crash put an end to all that. The rest of the market bounced back in early 2009, but solar was left behind. What happened?

In a word: China. The Chinese government wanted China to be big in the solar business, so it spent billions on solar panel production. That led to overcapacity, and overcapacity led to a vicious price war. The price war smashed solar panel producers, in China as well as the rest of the world.

The net result is that from 2008 to 2013, solar stocks got wiped out. SunEdison shares lost 90% of their value between June 2009 and June 2012.

At this point it’s worth pausing to explain in a bit more detail how the solar industry works. You can divide it in two: companies that make solar panels and companies that install solar panels. Making solar panels has been a terrible business, as I’ve explained. But for the installers, it’s been great. The panels are their raw material, and they’re getting cheaper and more efficient every year.

That’s roughly what you see happening with the SunEdison share price from 2013 up to 2015: it moved out of panel manufacturing and into panel installation. It bought some 27 other companies in 2014 and 2015 (they weren’t all panel installers – I’m simplifying the story a bit).

The second crash you can see on the diagram, where SunEdison buys a company called VivintSolar, is where the story of SunEdison diverges from the overall story of the solar industry.

What basically happened is that SunEdison’s big-headed CEO figured out a way to tap the market for cheap money by selling off core assets, then used that money to buy up as much of the installation business as he could (27 deals, like I said).

Eventually, the music stopped. VivintSolar was one deal too many. The company had been worth £5,600m in July of 2015, now it’s worth £75m.

Bubbles and their splendid aftermath

So that’s the sorry story of SunEdison. A silicon wafer company that got into solar panels because solar panels were the next big thing. The problem is that everyone else could see that too. The net result: nobody made much money.

Here’s the thing though: this has happened before. It’s not a random quirk of the solar business. It’s a feature of capitalism.

Daniel Gross wrote a book about the idea: that financial bubbles are actually good for the economy, because they result in big investments in important new things. I’ll let him explain it:

[I]f you take the long view … it’s possible to detect a pattern that emerges in bubbles and their aftermaths. Especially bubbles that leave behind a new commercial and consumer infrastructure. With apologies to Oliver Stone, these bubbles, for lack of a better word, are good.

These bubbles are right; these bubbles work. Thanks to the American penchant for creative destruction and the U.S. bankruptcy system, investors — and the economy at large — tend to get over bubbles quickly. … The stuff built during infrastructure bubbles — housing and telegraph wire, fiber-optic cable and railroads — doesn’t get plowed under when its owners go bankrupt. It gets reused — and quickly — by entrepreneurs with new business plans, lower cost bases, and better capital structures.

Simply put, bubbles are how new commercial infrastructure gets built in this country. In the 1840s and 1850s, European governments slowly strung up telegraphs from large city to large city. But in the United States, bubble-drunk entrepreneurs rampaged throughout the countryside, stringing up competing and often redundant wires way ahead of demand. Most went bankrupt. In the 1880s, vast competing, and often redundant, rail networks were built way ahead of demand. By 1894 about a quarter of the rails were in bankruptcy. The 1990s saw an orgy of commercial infrastructure built for the Internet. We all know how that ended.

Gross wrote all this back in 2007. But it sounds familiar, right?

“Bubble-drunk entrepreneurs” like SunEdison and the Chinese “rampaged” through the business, “way ahead of demand”. But all the extra capacity lowered the price of panels and got people buying. That’s why solar’s share of the global energy market is rising so fast.

So that leads to an obvious question – where are we now? Are we still in the bubble phase? Or are the current crop of solar businesses “entrepreneurs with new business plans, lower cost bases, and better capital structures”?

I aim to answer that one tomorrow. Until then…

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