January 13, 2015

Deutsche Bank’s 2015 solar outlook: accelerating investment and cost competitiveness

For 2015, Deutsche Bank Markets Research expects an increase in investments and improvement of cost competitiveness in the solar sector

We believe the recent volatility in solar stocks, driven largely by oil price weakness, presents an attractive entry point for investors as we expect 2015 to be a year of stable industry pricing and accelerating volume growth.

We expect a balanced supply demand outlook as strong demand from the US and improving demand from China/other emerging solar markets offsets any potential demand weakness in the UK/Japan. While weak oil prices could remain an overhang, our work suggests very little impact on solar demand fundamentals and expects several company specific positive catalysts in terms of execution of new/existing yieldcos.

Q4 earnings season/Q1 seasonality & Fundamentals

While solar stocks gave up nearly all of the outperformance during Q4'14, mostly due to declining oil prices, we believe Q4 earnings of most companies would generally be inline/ahead of expectations. China demand in 2014 could turn out to be 9-10GW vs expectations of 13GW, but we believe strong demand from markets such as UK/Japan would likely cover up any shortfall in China demand.

We also expect companies to talk about incremental progress in the permitting and payment process in China and believe a number of companies could get closer to launching yieldcos of international assets during 1H15 timeframe. While normal seasonality could likely impact China demand in 1H15, we expect UK/Japan to act as primary drivers for strong 1H volumes/margins. Consensus estimates have generally come down and we believe Q1 guidance from most companies would be more or less in line with expectations.

We expect other company specific catalysts such as announcements of yieldcos/project sales along with acquisition of new project pipelines to act as important catalysts for solar stocks over the next 3 months. Q1 seasonality typically affects module pricing, but we expect strong demand from higher priced markets such as the UK and Japan to drive pricing and margin improvement in Q1. We also see limited supply growth in the near term and as such expect relatively stable pricing environment.

Key Themes

1) We expect more countries to reach grid parity in 2015:

Unsubsidized rooftop solar electricity costs anywhere between $0.13 and $0.23/kWh today, well below retail price of electricity in many markets globally. The economics of solar have improved significantly due to the reduction in solar panel costs, financing costs and balance of system costs. We expect solar system costs to decrease 5-15% annually over the next 3+ years which could result in grid parity within ~50% of the target markets. If global electricity prices were to increase at 3% per year and cost reduction occurred at 5-15% CAGR, solar would achieve grid parity in an additional ~30% of target markets globally. We believe the cumulative incremental total available market for solar is currently around ~140GW/year and could potentially increase to ~260GW/year over the next 5 years as solar achieves grid parity in more markets globally and electric capacity needs increase.

Countries with regions of Grid Parity

Länder und Regionen, in denen Netzparität besteht
Source: Deutsche Bank Estimates

2) Solar demand growth should be increasingly more diverse and a greater percentage of demand should be from sustainable markets.

While some uncertainty about growth in markets such as Japan and the UK will remain an overhang on solar stocks in 1H15, we expect sector volatility to decrease in 2H15 timeframe as demand from the US, China and other emerging markets takes off.

3) Rooftop solar demand in the US should accelerate,

especially as leasing companies expand in more states, get new sources of financing and customer adoption increases ahead of the 2016 expiration of the ITC.

4) 2015 will be a transformative year for the US utilities

We expect some utilities to enter the residential solar market and compete directly with Solarcity and Vivint whereas other utilities would most likely continue to lobby against the growth of distributed solar market.

5) We expect a relatively stable supply demand outlook in 2015 timeframe as most companies are planning only limited supply growth.

Q1 seasonality typically affects module pricing, but we expect strong demand from higher priced markets such as the UK and Japan to drive pricing and margin improvement in Q1. We also see limited supply growth in the near term and as such expect relatively stable pricing environment.

6) Our constructive view on solar is largely dependent on improving cost curve of the underlying technology.

Overall solar system costs have declined at ~15% CAGR over the past 8 years and we expect 40% cost reduction over the next 4-5 years as a solar module costs continue to decline, panel efficiencies gradually improve, balance of system costs decline due to scale and competition, global financing costs decline due to development of new business models and customer acquisition costs decline as a result of increasing customer awareness and more seamless technology adoption enabled by storage solutions.

7) YieldCos will continue to gain popularity among investors and solar companies looking to lower cost of capital.

2015 will be an important year for YieldCos, both in terms of asset and geographic diversification. We expect solar only YieldCos to become more active in wind and other renewable assets; YieldCos with emerging market exposure to go public and more companies to spin off their solar assets into YieldCos.

8) Lower cost of capital

Will become a key growth enabler for companies with first mover advantage in the YieldCo space and also act as a significant catalyst in lowering the cost of solar power in emerging markets such as India.

9) Project development pipelines of most companies would increase at a much faster pace, both due to organic and inorganic growth.

We expect developers with an off taker in the form of a YieldCo to take on increasingly riskier projects, because the demand for fully developed projects is expected to remain relatively high, we expect more development capital to flow into the sector.

10) Project margins will continue to increase in 2015 before reaching peak levels in 2016 timeframe.

Low financing costs and strong demand from YieldCos will continue to drive prices of downstream projects higher. While regional mix may have some impact on project margins, we do not anticipate significant variations in different regions and expect margins closer to 20% levels in the near term.

11) 2015 earnings for most solar companies would become increasingly more volatile.

As companies decide to hold more projects in balance sheet, we expect a near term negative impact both on income statement and balance sheet (in terms of increasing working capital requirements). We also expect earnings to be somewhat lumpy as timing of project completions and sales would be harder to predict.

12) Policy focus will remain front and center in many markets.

Within the US, the extension of ITC (set to expire in 2016), extending the MLP status to renewables, net metering 2.0 in California, grid integration in Hawaii and grid access charges in several states would be some of the policy items impacting solar supply chain. Additionally, trade case development in China, US and other global markets would be an important theme to watch in 2015. Adverse trade policies certainly pose the risk of slowing down growth in important solar markets, especially in light of the recent gas price weakness. That said, we believe a positive resolution of these trade disputes is likely and would set the stage for stronger growth in 2016.

13) Q4 earnings season/Q1 seasonality:

While solar stocks gave up nearly all of the outperformance during Q4'14, mostly due to declining oil prices, we believe Q4 earnings of most companies would generally be inline/ahead of expectations. China demand in 2014 could turn out to be 9-10GW vs expectations of 13GW, but we believe strong demand from markets such as UK/Japan would likely cover up any shortfall in China demand. We also expect companies to talk about incremental progress in the permitting and payment process in China and believe a number of companies could get closer to launching yieldcos of international assets during 1H15 timeframe. While normal seasonality could likely impact China demand in 1H15, we expect UK/Japan to act as primary drivers for strong 1H volumes/margins. Consensus estimates have generally come down and we believe Q1 guidance from most companies would be more or less in line with expectations. We expect other company specific catalysts such as announcements of yieldcos/project sales along with acquisition of new project pipelines to act as important catalysts for solar stocks over the next 3 months.

14) Oil price impact on demand

As explained in a few sections of the note, oil represents only about 5% of global electricity production and in some of the important solar markets such as US, China, oil based electricity generation is less than 5% of the total. Moreover, the cost of oil based electricity generation even at $50 oil prices is the 7-9c/kWh range and as shown in the note, the marginal cost is higher than solar in many regions worldwide. Bottom line is that oil prices do not have a material impact on solar demand.

15) How to Make Hay While the Sun Shines?

The solar sector has been generally owned by institutional investors and we expect greater institutional ownership to drive near term positive momentum for the sector. We expect a number of new business models focused on the downstream part of the value chain to emerge and expect innovative private companies to drive cost improvement/solar adoption.

Both of these set of companies stand to generate significant shareholder value, in our view. We believe companies involved in financing/downstream part of the value chain stand to generate the most significant shareholder value in the near term. We expect these companies to be in a unique position to take advantage of the financing arbitrage offered by inefficient private markets and publicly trade "yield" vehicles. Solar is achieving grid parity in a number of new markets globally and we expect companies involved in project development/financing to benefit the most from the significant volume growth over the next few years. As storage costs start to improve we expect companies with cost competitive storage solutions to create the most shareholder value.

Oil Concerns Unfounded

Correlation between oil price and solar stock performance has increased significantly since oil broke below $100/barrel. This has not been the case in the recent past and we believe oil largely does not affect electricity prices and therefore should not affect solar installations. In our report we provide evidence for the following points:
1) Late 2014 negative price action in solar stocks is strongly correlated with the decline in the price of oil.
2) Actual oil fired generation to produce electricity is very expensive, even with low oil prices.
3) Solar installations are not competing with oil fired generation in most instances
4) Unsubsidized solar competes with the price of electricity, which is unrelated to oil prices.
5) Companies with exposure to distributed generation are best positioned to capitalize on long term fundamentals.

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