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- 2005-11-19
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China energy: Here comes the sun
FROM THE ECONOMIST INTELLIGENCE UNIT
China’s solar-energy industry is poised for takeoff. Still, foreign investors who want to be part of the
action should protect themselves against getting burned
With triple-digit growth, record-breaking profits and seemingly insatiable market demand, China’s
solar-energy technology sector is sizzling hot. The country’s photovoltaic (PV) industry is on a trajectory
to produce up to US$10bn in revenue by 2010 and could become the world’s top producer of solar-
energy technology. However, investors who want to partake in the Chinese solar boom must not get
blinded. The industry may look golden right now, but it faces a host of challenges that could bring on
a darker future.
Record-high oil prices and growing urgency for non-greenhouse-gas-emitting energy have ignited
global demand for solar energy, particularly in Germany and Japan. In 2005 worldwide PV production
increased by 30% to 1.5 gw, with revenue growing from US$8.3bn to US$11.1bn and profits, from
US$1.2bn to US$2.3bn, according to Michael Rogol of CLSA, a Hong Kong-based investment bank.
Chinese PV firms, numbering more than 100, have been major beneficiaries of this development.
Their production capacity of PV cells—the plates that absorb the sun’s rays and convert it to
electricity—rose 373% to 250 mw in 2005 from 52.8 mw in 2004. Meanwhile, the production capacity
of modules—the panels comprised of the PV cells—grew 350% to 400 mw from 88.8 mw. Such growth
has elevated China to third place in the global PV production-capacity league, behind Germany and Japan.
Investors’ darling
Leading China’s charge is Suntech Power, which controls 40% of the Chinese PV-cell-and-module
production market. Based in Wuxi in Jiangsu province, the firm posted US$226m in revenue in 2005
and has become the darling of investors since its initial public offering (IPO) on the New York Stock
Exchange in December. “The potential for this market is unlimited,” says Shi Zhengrong,
Suntech Power’s CEO, who has become China’s richest man in just five years.
Business is looking up also at CEEG Nanjing PV-Tech Company, based in the eponymous city 150 km
west of Suntech Power’s hometown of Wuxi. “We can’t keep up with the demand even with our
production lines running 24 hours a day,” says Zhao Jianhua, the firm’s CEO. The company, which
launched production in June 2005 and makes only PV cells, is already turning a profit, according to
Mr Zhao. This year it plans to expand production capacity more than six times from 33 mw to 200 mw.
Chinese PV firms typically report profit margins averaging 20% and back-orders of up to two years.
As international and domestic demand is both increasing, the near-term future is expected to be even
brighter. The US state of California recently announced that over the next ten years it will pay rebates
of US$2.9bn to consumers for the purchase of solar panels. Meanwhile, China’s Law on Renewable
Energy, which requires the government to actively promote the use of solar, wind, hydro and other
alternative-energy technologies, went into effect on January 1st. According to the
National Development and Reform Commission, China hopes to install PV-electricity production capacity
of 400 mw by 2010 and 2.2 mw by 2020. Mr Rogol of CLSA, which played a part in Suntech Power’s
IPO, predicts that Chinese PV firms will collectively earn more than US$2bn in revenue this year and up
to US$10bn by 2010.
With such glowing prospects, foreign investors are bullish on the industry’s future and are rushing in to
be part of the action. For example, Warburg Pincus and the buyout arms of Goldman Sachs and JP Morgan Chase are currently in talks to purchase a minority stake in
Tianwei Yingli New Energy Resources, China’s second largest PV producer.
However, some experts warn that the continued success of China’s PV industry is not guaranteed.
“I’m cautiously optimistic, but there are many unknown factors,” says Meng Xiangan of the Chinese
Solar Energy Society. For one, China lacks top-quality, indigenous expertise in PV technology. “The
quality of researchers in China is very poor,” says one executive. This dearth of local talent is due to
the fact that there are no national solar-energy research centres in China. Indeed, Mr Shi,
the billionaire CEO of Suntech Power, and Mr Zhao of CEEG Nanjing PV-Tech both earned their
doctorates in electrical engineering at the University of New South Wales in Australia. They say they
hire only foreign-educated Chinese scientists for their research teams.
While growing, Chinese PV demand also remains relatively small, with over 90% percent of the current
Chinese output destined for international markets. “There is not enough domestic demand,” says
Mr Meng. According to the Chinese Solar Energy Society, Chinese PV consumption in 2005 was only
70 mw and is growing at a modest 5 mw a year. To reach the government’s PV-production goal of
400 mw by 2010, China’s domestic PV demand must grow at least 40% a year—an uncertain
proposition.
Full of potential
The Chinese PV demand has yet to reach its full potential because the Law on Renewable Energy
remains a paper tiger. The government has yet to announce any specific price guarantees and subsidies
for solar-energy buyers as stipulated by the law. As a result, PV-generated electricity in China continues
to be six to ten times more expensive than highly polluting coal.
Meanwhile, the current dependency on exports not only forces Chinese firms to compete against rivals
in Germany, Japan and the US, but also exposes them to the risk that the renminbi will strengthen and
hurt their export sales. In fact, Chinese PV executives reported that the 2.1% revaluation of the
renminbi in 2005 caused a drop in PV-module exports.
Then there is the scarcity of silicon, the key material for producing the heat-absorbing PV wafers.
The exploding global demand for solar energy has led to extremely tight silicon supplies, with prices
tripling in the past few years to US$80 per kg. Although it is one of the world’s most abundant
resources, refining silicon is an extremely energy-intensive and complex process—the construction of
new production facilities require up to two years. Chinese PV manufacturers suffer more
than others because of the lack of high-quality domestic silicon suppliers. As a result, the Chinese must
rely on expensive imports, paying around US$200 per kg, or more than twice as much as what their
international competitors pay. This silicon premium on the Chinese PV firms not only off-sets their
lower production costs, (Chinese-made PV cells and modules are priced the same as or sometimes
higher than those made by their international competitors), but also cuts into their profits.
For example, rising silicon costs lowered Suntech Power’s fourth-quarter 2005 gross profit
margin to 26.5% compared with 29.8% in the third quarter and 34.1% a year earlier. This year the
company is bracing for another 10-15% increase in silicon prices.
China’s PV industry may also become a victim of its own success. The boom has attracted
dozens of new entrants into the market. These new players, particularly inefficient ones, will likely
exacerbate the already scarce silicon-supplies problem. Meanwhile, the lucrative export markets of Germany
and the US are expanding their own PV production capacity to meet demand, leading some experts to
predict the end of the current industry boom in 2007. If so, Chinese producers may soon be stuck
with excess capacity—unless of course demand within China increases.
Optimists believe that is exactly what will happen. In a country as hungry for energy as China, demand
for solar power is bound to surge— eventually. Even silicon prices that Chinese producers pay will drop
significantly, as the expansion of domestic silicon-production facilities in Henan and Sichuan provinces
come online. Chinese PV players, who obviously do not question the assumption that domestic demand
will boom, are also trying to raise their competitiveness by increasing cell efficiency and producing
thinner wafers, which minimise silicon use. This is why CLSA’s Mr Rogol believes China has the potential
to produce 2 gw of cells and modules, accounting for 25-33% of global production by 2010.
Winners and losers
Sceptics, however, wonder whether Chinese firms could survive possible post-boom scenarios, such as
a reduction in international solar-energy subsidies and a drop in PV prices. “Everybody is now making
money because of the high prices,” says one venture capitalist whose firm is seeking to invest in the
Chinese PV industry. “But once silicon prices go down, so will the prices of the cells and modules around
the world. The crucial question is, who will survive once the profit margins shrink?”
It is a legitimate question. But as the market develops in any industry, there will inevitably be winners
and losers. There is no reason why Chinese firms with a solid research base, multiple silicon suppliers
and sufficient production capacity will not be able to ride out a market slump, not only to survive but
to emerge stronger as they mature. Says Mr Meng of the Chinese Solar Energy Society: “This industry
is still in its infancy.”
The Economist Intelligence Unit
march 28th 2006
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