Tuesday, April 14, 2015

The Growing Role Of Module Efficiency In The Solar Industry

Disclosure: The author is long SCTY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Summary

  • Module efficiency is becoming more important than ever with the rise of distributed solar.
  • Scale will have increasingly marginal benefits for solar modules, while module efficiency is nowhere near its theoretical limits.
  • Solar manufacturers that are already emphasizing module efficiency should have a marked advantage in the changing solar landscape.
  • While efficiency is becoming a more significant factor in module manufacturing, it only matters in the context of overall cost-effectiveness.
Module efficiency has become an increasing topic of conversation within the solar industry. With the period of severe module overcapacity  finally over, the solar industry has started to shift towards higher-efficiency modules. Even the commodity-style Chinese manufacturers are starting to put a heavier emphasis on module efficiency. Regardless of the current trend, there is still an intense debate on just how important module efficiency is.
While cost-effectiveness is the only thing that truly matters, this would assume that higher efficiency is not an advantage in itself. In other words, it is the total cost/watt that determines a module's worth. Although this is true, the cost-effectiveness of modules changes depending on the types of projects they are involved in. Soft costs play a large role in this, as higher efficiency modules save time on installation costs due to the fact that less modules are needed to be installed.
This also means that the current growth trends of differing solar segments will determine the role of efficiency moving forward. If distributed solar starts to become the predominant solar segment, high-efficiency manufacturers such as SunPower (NASDAQ:SPWR) or JA Solar (NASDAQ:JASO) are extremely well-positioned. If utility-scale solar remains the dominant form of solar energy generation for the foreseeable future, lower-cost/lower-efficiency manufacturers such as First Solar (NASDAQ:FSLR), Canadian Solar (NASDAQ:CSIQ), and the vast majority of Chinese solar manufacturers will likely be better off.

The Current Trend

Given the fact that different types of solar projects have different proportions of installation costs, higher-efficiency modules can actually become more effective for small-scale distributed solar projects. For instance, if installation labor costs account for 40% of a distributed project's total costs, and higher-efficiency modules amounts to a reduction of 25% in installation labor costs, then 10% of the total projects costs are saved due to higher-efficiency modules. On the other hand, if installation labor costs account for 20% of total costs for a utility-scale project, only 5% of total costs would be saved given the same percentage reduction in installation costs.
Precisely because of the differing proportions of soft costs across the solar segments, the current solar segment growth trends will play a huge role in determining which solar companies are currently the most well-positioned. While utility-scale solar still accounts for the overwhelming majority of solar PV installations, industry data  suggest that distributed solar is rapidly gaining ground. Utility-scale solar is looking particularly bleak in the United States, where the slated solar ITC step down is expected to devastate this solar segment.
Of course, the solar ITC step down would be worse for U.S. solar manufacturers like First Solar. On the other hand, the utility-segment on the international stage will very likely remain dominant for much longer. Nonetheless, distributed solar is also gaining momentum on the international level which suggests that high-efficiency manufacturers will slowly gain an edge over their commodity-style competition. U.S. based high-efficiency manufacturers like SunPower will likely enjoy immense benefits from the changing solar landscape dynamics, especially if the solar ITC steps down as intended. While high-efficiency manufacturers on the international front should also experience higher levels of upside, lower-efficiency international manufacturers will likely retain their dominance in the near-term given the absence of an ITC drop.
SolarCity decided to enter into the higher-efficiency module manufacturing arena precisely because the company understands that higher-efficiency modules would save a disproportionate amount in overall costs for its distributed projects. Here is SolarCity's graphic illustrating just this.
(click to enlarge) 
Source: SolarCity

Limits of Scale

When the solar manufacturing industry was in its truly infant stages, scale was largely a foreign concept. With the explosion of the solar industry over the past decade, manufacturers had been able to achieve scale on a truly significant level. All the benefits of scale came along with this, and is credited as one of the biggest reasons for solar PV's precipitous cost declines. Cost-reductions from scale cannot go on forever, as diseconomies of scale will eventually kick in. For the most part, the economies of scale are starting to reach its limits, which means that benefits from scale will become increasingly marginal from this point forward.
While there are still additional economies of scale to be had, the industry may reach its limit within a few years. SolarCity (NASDAQ:SCTY), for instance, is planning to build manufacturing factories with annual capacities on the scale of tens of GW, and SunEdison (NYSE:SUNE) is already preparing to build one of the largest solar facilities  in the world with similar levels of scale. Efficiency improvements, on the other hand, still have some ways to go before reaching its limits. Even the highest commercial module efficiencies only come in around the 20% range, which suggests that there is still huge room for improvement on the front.
Time and resources will likely be much better spent improving module efficiencies as opposed to lowering manufacturing costs through scale or other manufacturing related means. Again, this would make manufacturers like SunPower well-positioned moving forward, as these manufacturers already have a head start in the high-efficiency R&D department. While this does not at all imply that lower-efficiency solar companies are bad investments, higher-efficiency manufacturers seem to have larger overall promise.

Risks of Overemphasis on Efficiency

While the current trends in the solar industry certainly suggest that efficiency will play a larger role moving forward, companies still have to be careful not to focus an excessive amount of attention on efficiency. At the end of the day, the only function of solar modules is to produce electrons, which means that efficiency does not matter outside the context of overall cost-effectiveness. While a company like SunPower prides itself on its high-efficiency modules, and even calls itself a technology company first and foremost, such companies need to be careful not to become too fanatical about high-efficiency. There still has to be a fine balance between efficiency and manufacturing costs.
So far, the emphasis on efficiency seems to be paying off for high-efficiency manufacturers in the form of higher gross margins. The ability to differentiate from other manufacturers is becoming increasingly important in the highly competitive solar manufacturing industry. While the high-efficiency manufacturers are currently in a comfortable position, more players are starting to enter the high-efficiency module arena, most notably SolarCity. In fact, SolarCity plans to construct facilities magnitudes larger than its initial 1 GW facility, which could considerably crowd the high-efficiency space.

Conclusion

With the shifting solar landscape, module efficiency is starting to become an increasingly important factor in solar PV manufacturing. High-efficiency manufacturers such as SunPower, JA Solar, and possibly SolarCity will have additional upside due to their heavier focus on module efficiency. As smaller scale solar starts to play a larger role in the overall solar picture, the low-cost/low-efficiency mass manufacturing model may no longer hold up as well as it had in the past. Although the solar industry as a whole is immensely promising, the companies that manage to maintain a high-efficiency technological edge will be able to stand out from the rest of the manufacturing industry.

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