The investment trend for cutting out the middle man is throwing up lucrative opportunities in solar power, say John Stepek and Matthew Partridge.
One of the biggest investment themes of the 21st century can be summed up in one word: ‘disintermediation’. Or to put that into plain English: ‘cutting out the middle man’.
We’ve seen it in action as industries from retailing to publishing have moved online. For example, budding authors can now cut out agents, publishers, printers and bookshops, in favour of selling digital copies direct to customers.
We’ve seen it happen in the financial world too – the regulations arising from the Retail Distribution Review and the rise of ‘passive’ investing are both aimed at bypassing intermediaries who subtract, rather than add value, to the investment process.
And disintermediation looks like it could become a big theme in the energy industry too. You might be wondering how. After all, very few of us have our own electricity generators in our back gardens.
But elsewhere in the world, one particular energy source is already having a massive impact on the big, centralised utility networks – solar power.
A ‘cautionary tale’ from Germany
So far, Germany is the clearest example of this process in action. A report from Citigroup’s energy analysts, entitled Energy Darwinism: The Evolution of the Energy Industry, argues that investors don’t fully appreciate just how rapidly the energy business – and the power-generation industry in particular – is changing.
The headline-grabber in recent years has, of course, been the shale gas ‘revolution’ in the US. But in Germany, solar power has contributed to a fundamental shift in the electricity generation mix.
Thanks to generous subsidies (which we’ll return to in a moment), and also to rapid advances in solar technology, Germany’s installed solar-power-generation capacity has grown from under five gigawatts (GW) in 2007, to 35GW by July 2013.
In terms of peak-generation capacity, solar is now only second to coal in terms of German power generation.
Now, that sounds very exciting, but what you have to remember about solar is that it only generates a small amount of energy per unit of capacity. In the jargon, it has a very low ‘load factor’ of 10%-15% on average, compared to 90% for nuclear, and around 80% for coal.
So, while a coal-fired or nuclear power station can be chugging away all through the day and night, providing what’s known as the ‘base-load’ level of constant power generation, a solar panel’s output depends on the time of day and the intensity of the sunlight. And this is what’s creating an interesting – and tricky – problem for German utilities.
Energy demand peaks in the middle of the day, even though Germany isn’t an especially hot country (you’d expect this spike in demand to be even more prominent in sunny climes, due to air conditioning).
As demand is peaking, this is when electricity prices are highest. However, it’s also when solar works best – mid-day is when the sun is highest. As a result, notes Citigroup, Germany’s solar plants now produce enough electricity to satisfy this mid-day peak in demand.
Why is this a problem for utility companies? Well, this peak demand would once have been met by gas power plants. But with solar capacity having grown so rapidly, last year some gas power plants in Germany ran for less than ten days, resulting in “profit warnings from their utility owners who as recently as two years ago saw renewables as ‘niche’ technologies”. Effectively, solar power has stolen the “most valuable part” of the electricity market.
And if solar capacity continues to grow – which seems very likely at current rates – renewable sources, and solar in particular, could be eating into the ‘base-load’ supply too.
Indeed, Jason Channell at Citigroup notes that within three years, solar could cover “all German demand at peak times in summer”.
Too much capacity
Why does this matter? Clearly, solar doesn’t work all the time. So you need back-up power in place, particularly in the winter. But for the economics of running a coal or nuclear power plant to make sense, they need to “run almost continuously”, notes Channell – you can’t just switch them on and off as needed.
However, that’s also a problem, because power networks need to be in balance – if there’s too much, or too little, power going through the grid, you get blackouts.
So what may happen in the end, says Citigroup, is that energy customers may end up having to pay utility companies (via their bills) to keep these power plants open and available for when they’re needed, even when they’re not actually producing any power.
Another factor promises to push bills even higher. A lot of solar power is produced where it’s used – it goes from the roof of the house to wherever it’s needed. So it doesn’t flow through the grid. Less energy going through the grid means less money for the grid operators.
But the cost of maintaining the grid is going to stay the same. So they’ll need to charge more per unit. That’ll drive up consumers’ bills too. In turn, reckons Chanell, this will “ironically… make consumers more likely to put panels on their roofs in a desire for a greater degree of energy independence”.
This issue is most apparent in Germany. But it’s far from being the only country where solar could seriously disrupt the market. Installed solar capacity is growing rapidly around the world.
In the US, solar capacity grew by 35% in the year to June, says the Wall Street Journal. A report from the Edison Electric Institute, which represents US power producers, warned that “new forms of power put utilities in danger of a vicious cycle by stealing some of their best customers, potentially forcing the utilities to raise prices and risk losing still more”.
Then there’s Japan, which last year introduced the most generous subsidies (feed-in tariffs, where providers of solar electricity are given guaranteed rates for their power) yet seen.
Once the world leader in solar before Germany took its crown, rapid take-up of the subsidies saw Japan this year become one of only five nations to have more than 10GW of solar capacity, according to consultancy NPD Solarbuzz (the others being Germany, Italy, China and the US).
According to the Wall Street Journal, the country is now “the world’s leading laboratory for overturning the traditional grid and the century-old business model behind it.”
In short, as solar power grows, centralised power grids lose out, driving prices higher, which in turn encourages more users to generate their own power.
The solution: storage
So what’s the answer? Given that solar panels are becoming ever cheaper at a very rapid rate (they’re not dissimilar to micro-chips from that point of view), they are only likely to make more and more in-roads into the power systems of countries around the world.
So turning the clock back isn’t an option – and wouldn’t make a lot of sense in the long run, given that the sun is, after all, a fantastic, entirely renewable energy source. So a solution needs to be found to the potential problems it causes for national grids.
And the obvious answer is – storage. “Japanese companies are working on batteries that could let homeowners store solar-generated power for use at night, reducing the need to sell the excess back to the grid,” notes the Wall Street Journal. This would solve the big problem with solar – its intermittent nature.
If solar energy can be stored at peak times for use in the evening and at night time, then solar’s overall contribution to the energy mix becomes more predictable and more flexible.
In turn, that means you can have back-up plants running all-year round again (albeit at lower generation levels), reducing the need for compensation payments to plant owners.
In Europe, Germany – again – is near the forefront. German state bank KfW started a pilot scheme in May this year to subsidise solar storage systems, making €50m available for systems that pair batteries with solar panels, reports The New York Times.
German feed-in tariffs helped lead the first solar boom (which was followed by a bust, as the panels dropped sharply in price amid hefty competition).
Now analysts – from Citigroup to solar research group IHS – reckon that German energy-storage subsidies could give a similar kick-start to the battery market.
The fact is, as British consumers, we can’t promise that the rise of solar power will mean you end up with cheaper fuel bills anytime in the near future. However, it’s also clear that on a global basis, solar is here to stay, and that it will have a big impact on other forms of energy generation.
You can find out more about how to profit from the UK’s feed-in tariffs below (bearing in mind that these are given by the government, and can therefore be taken away too).
As for the growing demand for solar power and storage, we also look at some of the companies best placed to profit.
How to profit from feed-in tariffs
If you want your neighbours to know you’re investing in solar, you could put solar panels on your roof, writes Ed Bowsher. You’ll save money by buying less electricity from your supplier, and you’ll be paid a guaranteed rate for the electricity you generate, thanks to the government’s Feed-in Tariff scheme.
This price is set when you install your panels and lasts for 20 years, rising in line with Retail Prices Index inflation. If you live with a family in a medium-sized house, panels could save you as much as £10,000 over 20 years, according to the Energy Saving Trust.
However, do be aware that the size of the potential savings can vary dramatically depending on the size of your roof, the direction it faces, and whether it’s sheltered or not. You also need to consider any impact on the resale value of your house.
A more convenient option, perhaps, is to invest in solar power projects via a crowdfunding platform – you can often find community-based solar projects on the Energy4All website.
If you’d prefer to invest your money over a shorter time period, look at Secured Energy Bonds (SEB), which offers solar power ‘mini-bonds’ to investors. The annual interest rate is 6.5%, and you should get your money back after three years.
The biggest player in the UK solar investment sector is the Foresight Solar Fund. This is a new investment company that hopes to raise £200m for new solar installations via an initial public offering.
The closing date for share applications was earlier this week, but you should be able to buy shares on the stock market from 29 October onwards.
Bear in mind, these investments rely on the Feed-in Tariff continuing – so sudden changes of heart by cash-strapped governments are a risk. And that comes on top of the usual warnings to make sure you are confident that the company you are lending to will be able to pay you back.
The eight stocks to buy now
Spanish engineering firm Abengoa SA (Madrid: ABG) builds, designs and runs many renewable power plants across the world, including solar energy, writes Matthew Partridge.
Its latest innovation is the construction of the Solana Generating Station in Gila Bend, Arizona. As well as conventional solar energy capabilities, the station can also store heat and light, enabling it to keep generating power after sunset.
While the price/earnings (p/e) ratio of 17.9 looks high for the Spanish market, it gets 75% of its growing revenue from outside the country. It also offers a very attractive yield of around 6.8%.
Solar-cell manufacturers have had a torrid time, amid oversupply and Chinese competition. But there are signs this glut is starting to clear, with prices and demand rising. Higher Chinese wages should also make it easier for American firms to compete.
This should help SunPower (Nasdaq: SPWR), which makes and distributes solar power cells for businesses and homes. Its major innovation has been to give customers the option of leasing cells, reducing upfront costs. Revenue is expected to grow by 54% over the next three years. It currently trades at 9.7 times 2016 earnings.
On the more experimental side, Ascent Solar Technologies (Nasdaq: ASTI) has developed a durable, ultra-flexible solar cell that can be used for very small-scale solar-energy generation.
While the company has yet to make a profit, it recently launched a range of personal solar chargers and mini-solar devices that can be used to extend the battery life of consumer products, such as mobile phones.
In the long run, it hopes that its technology can also be used in the aircraft and construction industries.
As mentioned above, generous subsidies have made Japan one of the world’s largest solar markets. Electronics giant Sharp (JP: 6753) should be a beneficiary.
It already has a high share of the Japanese solar cell market, and based on projected future earnings, JP Morgan thinks the company is more than 30% undervalued. It currently trades on 12.2 times 2016 earnings.
In the UK, Aim-listed Good Energy (Aim: GOOD) is a micro-cap energy company that produces and distributes renewable energy to nearly 50,000 customers in Britain. It has recently received planning permission for over 45MW worth of solar farms in Dorset, Cornwall, and Pembrokeshire.
Overall, it plans to add over 110MW of renewable energy capacity in the next three years. It currently trades on a p/e ratio of 13.5 and has a yield of 1.6%.
Meanwhile, The Renewables Infrastructure Group (LSE: TRIG) already has four solar parks (as well as 14 wind farms) and plans to buy more in the UK and Northern Europe.
TRIG aims to start paying an annual dividend of 6p from next year, giving it a prospective yield of 5.8%. It has negotiated long-term contracts with the aim of further limiting the downside risk further.
On the storage side of things, one firm at the forefront of solar power storage is Proton Power Systems (LSE: PPS). While its main area of operation is the development and production of fuel cell hybrid systems, it has come up (via a subsidiary) with a battery that can store electricity generated by solar energy.
This gives those with solar cells an alternative to simply selling to the grid (usually at a lower price than it costs to buy electricity from the grid).
While it doesn’t currently make a profit, it has secured an order with the conglomerate Siemens for this system, which should significantly boost revenues.
One of the most interesting Chinese solar power stocks is GCL-Poly Energy (BERLIN: 3GY). Not only does it build polysilicon wafers, one of the key components for solar panels, it also develops, manages and runs power plants.
Like other firms in the industry, it will benefit from an increase in the price of polysilicon. Research firm Oriental Patrol predicts that this, and its efforts to develop cost-efficient solar batteries, will boost margins, delivering a large boost to the bottom line. While it is loss-making at the moment, it trades on 6.6 times expected 2016 profits.
• Additional research by Jonathan Erridge.