Unpacking Lex on solar power

Today’s FT has a short Lex column on solar power (subs). I think it’s worth unpacking what it has to say.

First, the good news. Solar is in the new because investment guru Warren Buffet has committed a further $2.5bn to the industry through his MidAmerican Energy Holdings. This is part of a wider trend, with shares in solar-panel makers rising on the back of increased demand from China and US tax credits surviving the fiscal cliff.

The better news is that Lex backs Buffet’s judgement that the solar industry is a good long-term investment.

But now the bad news. Lex points out that the  global industry is still dependent on subsidies, and those subsidies are subject to politics. Here in the UK the government unexpectedly cut the feed-in tariff, which caused an almighty kerfuffle – not so much because the industry should always have a subsidy but because the announcement seemingly came out of nowhere. Regulatory uncertainty hits companies and investors.

What Lex doesn’t mention is that the reliance on subsidies is a phase. New technologies go down a cost curve, where the first few are expensive but the price goes down as there is economies of scale (making lots is cheaper than making a few) and learning effects (what you learn from making the first means the second is easier). Most observers expect the price to continue to go down, McKinsey expect underlying costs to go down by 10% per year until 2020 (subs).  In some parts of the world solar has already reached grid-parity.

Lex says that the true cost of solar must also include that of storage capacity (for instance batteries). Now, I think that might be a little out of date, or rather, a little narrow. Certainly the intermittent nature of the energy means that solar is not sufficient by itself. But doesn’t mean that each solar assembly must have a battery. It means that any electricity system has to plan how to provide energy throughout the day and with varying weather. That might mean storage in batteries or fly wheels, it might mean a mix of energy sources, it might mean a smart grid where extra generation in one area compensates for a shortage in another. Most likely we have a mixture of storage, sources and smart grid.

Sometimes people imply that solar isn’t a good investment, so it will never be significant (Lex doesn’t). The best response to that point is airlines. A lousy investment – losing 20% of value since 1992 compared to 200% gain for the wider market – but clearly a vital part of the global economy. (Also, an argument for being careful in markets with large political risks.)  The difference here is as solar gets cheaper the politics will be less important, while the over-capacity will remain as long as governments keep wanting their flag carrier.

Finally, Lex points out that “a supply glut mean that most manufacturers will not return to profitability any time soon” and that short-haul investors are “in for an Icarus moment”.

So, long-term investors will be rewarded, and short-term investors punished. Why, is that an argument for investing for the long-term? What a good idea!

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