Rising Oil Prices Eclipse Weak Solar Industry Fundamentals

As crude oil futures cross the $72 a barrel mark, advocates of solar energy are trumpeting an industry turnaround across the photovoltaic supply chain. But judging from comments by chief executive Tom Zarrella of GT Solar, a supplier of fabrication equipment, a rebound in customer demand is unlikely to occur prior to mid-2010.

Zarrella announced last month that a slowdown in customer spending on GT Solar’s directional solidification systems — specialized furnaces that make solar wafers — would likely last through March 2010. He expressed confidence on the earnings call, however, that customers would honor their existing photovoltaic purchase contracts, due to “anticipation of the promising long-term future growth of solar.” Evidence in the company’s recently filed 2009 annual report suggests that cancellation risks on existing multi-million dollar contracts remain high:

During the fiscal year ended March 28, 2009, some of our customers failed to make deposits when due under their contracts, and we terminated those contracts as a result of the customers’ breach, resulting in a $39 million reduction in the order backlog. [In addition] certain of our large customers have requested that we extend the delivery schedules under our contracts with them. We are currently in negotiations with these customers over their requests. Any contract modifications that we negotiate could include an extension of delivery dates, and could result in lower pricing or in a reduction in the number of units deliverable under the contract, thereby reducing our order backlog.

Highlighting the contract cancellation risks at GT Solar is important, too, because changes in delivery dates can ripple through to other parts of the supply chain. For example, the company had to reschedule and/or cancel a significant portion of its commitments to its own material vendors to reflect its reduced production plan. In fiscal year 2009 GT Solar recognized losses of $11.3 million, a result of contractual forfeitures of planned inventory purchases and the write-down of advances on inventory purchases with suppliers that went bankrupt.

All along the PV value chain — from raw material suppliers of polysilicon feedstock to the megawatts shipped and installed by solar module manufacturers — prices are still in freefall. Since hitting about $500 per kilogram last year, spot polysilicon prices have plummeted to around $70 per kilogram. Some forecasts are calling for solar-grade crystalline ingots to drop as low as $25 per kilogram. If true, this could prove to be bad news for fabrication wafer customers of GT Solar and good news to consumers.

In a research note to clients, Hapoalim Securities analyst Gordon Johnson warned that solar industry fundamentals are in bigger trouble than most think. Many Chinese solar vendors are offering modules at prices far below what most American and European solar cell makers could conceivably match, even with only marginal profitability. As recounted in Eric Savitz’s Tech Trader Daily, Johnson claims that some of his “most trusted industry contacts” say that companies like Yingli, Suntech, and Trina Solar are able to offer modules for sale at $1.70-$1.80/watt, or €1.21-€1.28/watt, by slashing wages of their Chinese workers. He notes that at the recent Intersolar conference, the talk was that solar modules were priced in the €1.60-€1.70/watt range.

At the risk of sounding obvious, the strategy of Yingli and other Chinese vendors is to leverage the cost-competitive advantage of their commodity business model to expand market share at the expense of its American and European competitors. Whether or not these solar cell makers can improve utilization and throughput yields and lower variable costs enough to generate even marginal gains on their end products is debatable.

Solar enthusiasts opine that government policies towards alternative energy in the United States and European countries gives reason to be confident in the future of the global solar market. But it’s unclear which companies along the PV value chain can survive a coming price war — and ensuing industry-wide shakeout. Also, the longer the time it takes for an actual recovery to occur, the quicker the weaker capitalized companies will be eclipsed by their peers.