Stefan Heck: Darkest before dawn

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These are dark times for solar. Brutal consolidation will slaughter the field of manufacturers from 1,200 to 100 companies. Solyndra may have taken the headlines, but even global subsidiaries such as BP Solar, REC Wafer, Schott, Siemens Solar have fallen alongside VC-backed startups such as Evergreen, SpectraWatt and Abound.

Demand excess has sliced profit margins from 30% a few years ago, often into negative territory. Global capacity still exceeds demand by 50% this year and is not set to reach equilibrium until 2015.

There appears no end to the bloodletting. So what makes Stefan Heck, director at McKinsey, so optimistic?

Heck opened the Intersolar North America 2013 conference in San Francisco in July with a portrait of an industry at its darkest point before a bright dawn.

“We think there's two more years of bloodbath while there's oversupply. So hang on for a tough ride.

“Why am I optimistic after all that darkness and bad news? Fundamentally, the real motor of solar is alive and kicking and actually going faster than anybody has been predicting.

“We're going to see explosive demand just driven by economic potential, not driven by government subsidy schemes.”

McKinsey forecasts that solar could potentially see global investments in the range of US$600-900 billion over the next decade with 500GW in economically viable capacity, though not necessarily built out, driven largely by price declines that make solar more competitive against conventional fuel sources.

The consultancy's most recent forecast also predicts that the cost to produce a PV system will fall at least 60% by 2020 (US$1/Wp by 2020) for both thin film and crystalline technologies [see slide 1]. Increased productivity, supply chain and system design optimisation, economies of scale, incremental technology improvement will all reduce costs.

Balance of system cost reductions will follow through improvements in labour techniques, scale and standardisation and even how solar is marketed in the US. This is currently way more expensive than in countries such as Germany where customers need less convincing that going solar is cost effective and residential soft costs are already low at US$0.06/W versus the US$3/W total.

Distributed generation will be “in the money” anywhere with high solar resources and average prices or high prices and average solar resources [see slide 2]. Denmark, Germany, Italy, Japan, Spain and parts of India and California are already in this band. But the behemoths outside that band are the US, where electricity prices are low thanks to shale gas, and China, where rates are subsidised – though that may change.

“The big 900lb gorilla that will ultimately come is China,” says Heck in an exclusive interview with PV Tech. “It's still outside that 'in the money zone'. China has said it will push solar when it gets to grid parity but prices are subsidised.

“But if you look at what they did with wind, they went from nothing to 150GW. So when they decide to make it part of their mix it will go large scale, they have the capacity, they have the demand growth, they have the solar producers. They have the big utilities that can install and finance it.”

In many regions, solar power today is already cost-competitive with renewable sources and new-build conventional power options [see slide 3].

But apart from the more sophisticated financial institutions such as Goldman Sachs and JP Morgan, Wall Street still takes some convincing that solar makes a good investment, says Heck.

“People in the US still think it's risky,” he says. “All this negative perception, they've all read the newspapers about Solyndra that's all they know about solar.

“But the risk is dramatically over-estimated. The actual technology risk is very low and yet that is not what you see if you talk to Wall St investors about solar because they don't understand the difference between upstream manufacturing which is getting killed and project development.

“Some of them have fiduciary limitations, if they're long-term investors they are designed not to take any technology risk. But you can have a technical failure in a gas plant, just like you can in a solar farm.”

Payments risks are also low, with one director of US renewable energy investments at a large bank claiming a default rate across nearly 20,000 residential customers of less than half a percent over three years.

Perceptions are already shifting, says Heck. And solar's first-movers such as Google and Wal-Mart are making repeat investments based on good returns.

“What will really shift it is more and more people making money on good solar investments,” he says. “But the first time a company looks at any kind of renewables or energy efficiency, they start very sceptical.”

In the US, McKinsey estimates the economic potential in the US is already 10GW and could be 260GW by 2020 [see slide 4]. However, the consultants estimate that cumulative capacity additions are more likely to be in the region of 85GW-100GW, largely driven by the distributed market.

Much of the growth to a 3GW US market by 2012 has been driven by the 30% Investment Tax Credit (ITC), which will sunset to 10% from the end of 2016. But Heck says that the market can tolerate the drop in incentives as prices decrease and sources of capital grow.

“The ITC doesn't make that big a difference beyond 2016,” he says. “Bigger things will be whether the financing costs continue to come down. So that could be either the Real Estate Investment Trust structure, Master Limited Partnerships or just larger institutions getting on board and viewing this as power plant investment. The ITC is helpful but that will do more to grow the market than the tax credit.”

One major trend Heck points to is the broader spread of fresh competition in solar from incumbents in other industries such as IBM, GE and Vivint [see slide 5].

“It will increase competitive intensity, which is healthy for the industry because it will give it credibility and a level of scale and professionalism that it hasn't had,” he says.

“IBM will think about how to help utilities manage a much more dynamic grid with electric vehicle charging, solar and smart grid. That's their opportunity. The current utility objections are: we can't manage the grid with too much solar. But that really is just an IT problem because we can manage a telephone system with very dynamic calls and data.”

Utilities are heading for dark times themselves, as solar casts long shadows over the industry [see slide 6]. Market adoption for solar has typically been ~0.1% per annum before grid parity is reached.

“The utility death spiral is a real threat because we have a relatively low growth environment in the US already,” he says. “Most utility executive teams have grown up in a world of low single-digit load growth. It's not a lot but enough to cover rising rates, rising earnings, unless you happen to be in a hotspot that people are moving to, in the US most of them are looking at 1%.”

Utilities must adapt or die to this new paradigm, says Heck, and that can only come through business model innovation. But either way, solar will force consolidation in the utility industry.

“Many of them have ridiculed solar as 'the next best thing for 30 years' and they are relatively sceptical of new technologies because they are so concerned about reliability and stability,” he says.

“We have a couple hundred utilities of scale in the US not counting municipal utilities and I'm willing to bet that a couple of dozen will figure this out and be very proactive and they'll wind up consolidating some of the others.”

An attempt by utilities to defend their territory with proposed changes to rate structures that shifts more transmission and distribution charges back to solar customers, would significantly slow solar's progress [see slide 7].

“It is fair there is some kind of interconnection fee if you're using the grid as backup,” he says. “I could see numbers as high as US$50-$100 a month which would be a substantial proportion of a utility bill for residential customers.”

To avoid the death spiral, Heck says that utilities could look to the telecom industry for clues as to how they might adapt, by bundling packages of services, something other companies in the solar industry are already doing [see slide 8].

“Similar to the wireless telecom world where TV, internet, cell phone are all bundled this same phenomenon is happening in solar,” he says. “If you look at the telecom industry 20 years ago it went through the same shift. That's the closest analogy I see for what's going to happen for utilities. Not all of them made it, even though they were monopolies some of them don't exist any more as companies. The same will happen to utilities.”

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