Yesterday, the Chinese government announced more subsidies for the solar industry, subsidies that total $2 billion for now. These are meant to build projects that will generate as much as 5.2 GW of solar power, on its way to as much as 40 GW by 2015. That's a lot of solar power for a country that, until recently, hasn't shied away from building coal plant after coal plant.
So, what's with China's new need to subsidize solar projects, and how did it get here? Let's take a look back at how all of this started.
Build it and they will come
The philosophy of Chinese solar manufacturing was similar to other Chinese manufacturers over the past few decades. Remember when Apple (NASDAQ: AAPL ) executives went to visit Foxconn, and they had already started construction on an expansion for iPhone production "just in case" they got the contract? Build it and they will come.
In the early 2000s, there was little solar production in China, but the government soon saw an opportunity to dominate an up-and-coming market. Germany, and other countries in Europe, had implemented feed-in tariffs that gave installers a guaranteed payout for electricity generated from solar. Now, all that the industry needed was lower costs and demand would explode.
By 2010, it appeared like a sure bet. Chinese manufacturers had seen revenue explode over the past few years, except for a blip during the recession.
YGE Revenue Quarterly data by YCharts
And profits were growing along with revenue.
YGE Net Income Quarterly data by YCharts
What could possibly go wrong? State-run banks handed out more than $25 billion in loans to panel manufacturers, including $8.9 billion to LDK Solar (NYSE: LDK ) , $7.3 billion to Suntech Power (NYSE: STP ) , $4.4 billion to Trina Solar (NYSE: TSL ) , and $5.3 billion to Yingli Green Energy (NYSE: YGE ) . The buildout of solar capacity was on.
The buildout was fast and easy because these manufacturers could use relatively standard equipment from GT Advanced Technologies (NASDAQ: GTAT ) that had become industry standard. It was high quality and readily available so they ordered everything they could.
The rise of solar
To give you an idea how quickly capacity expanded, Trina Solar produced 28 MW of solar panels in 2006 and, by June of this year, it could produce 2.4 GW of panels. LDK Solar had 703 MT of polysilicon and 1.8 GW of wafer capacity in Q1 of 2010 and, by Q2 2011, it had 2,774 MT of poly capacity, and expected to have 4 GW of wafer capacity by the end of the year. Suntech grew cell capacity from 30 MW in 2003, to 540 MW in 2007, and 2.4 GW in 2011.
This same trend played out at manufacturers like ReneSola (NYSE: SOL ) , Hanwha SolarOne (NASDAQ: HSOL ) , Canadian Solar (NASDAQ: CSIQ ) and others, although the companies listed above were the quickest to expand.
By 2012, the industry had built out 70 GW of capacity, enough to supply 10 Germanys at its peak.
The fall of solar
By 2011, many industry observers started to see a big problem ahead. There was no way that demand would live up to the capacity China and others had built; remember, First Solar (NASDAQ: FSLR ) was also expanding rapidly.
When Germany, Italy, Spain, and others reduced feed-in tariffs, it became a battle for every sale. Since Chinese panels were made with similar equipment, there was little to differentiate one panel from another, so the only point of competition was price. So, the price of a solar panel plummeted in 2011 and into 2012, driven by intense competition. Chinese companies went from huge profits to huge losses, as you can see in the chart below, which is just an extension of the net income chart above.
YGE Net Income Quarterly data by YCharts.
Companies started to throw the towel in and declare bankruptcy. Technologies like Solyndra's didn't become cost-effective fast enough, and few companies outside of China survived.
But Chinese solar companies were still propped up by Chinese state-run banks. As long as the flow of money didn't stop, they wouldn't have to close up shop. And since China is more worried about full employment than profits, it could potentially be assumed that the flow of money wouldn't stop.
China to the rescue
With 70 GW of capacity, and just 31 GW of demand for 2012, who is going to fill the gap? The U.S. market is growing, and so is Japan and India, but there's a giant gap left in the market. Add in the tariffs that the U.S. and Europe have either implemented or are pursuing, and China's manufacturers are left with an immense amount of overcapacity, and challenges selling in some markets.
So, the Chinese government swooped in with another $2 billion subsidy for solar, on top of more than $25 billion that has been spent to build these behemoths. It will fill some of the gap in the market, but it won't solve the problem entirely. Some Chinese capacity is going to have to exit the market, especially considering upcoming technology changes.
The next generation of solar
I've laid out the history of how we got here, but I have yet to go over where we're going; and that might provide an even greater challenge to Chinese solar. China has built billions of dollars of capacity, primarily with GT Advanced Technology's equipment, but the company is about to release a new technology that will increase cell efficiency. The HiCz technology that GT has been excited about for some time will make cell efficiencies of over 22%, 3.5% above the high end for most manufacturers right now.
This will lead to a new round of investment in solar equipment, because module makers will soon demand higher efficiency cells. So, who is interested in this next generation technology? Not China.
According to GTAT's CEO Tom Gutierrez, China may have spent so much on current capacity that it won't be able to afford the buildout for the next generation. He said that customers in Europe, Saudi Arabia, and Japan were highly interested in the technology, and may be the next big manufacturers of solar cells.
It's ironic that U.S. subsidies for solar, like Solyndra, ended in disaster because of China's subsidies, and now China's subsidized solar market may be heading to another disastrous end.
China won't be able to build enough solar to fill the capacity for all of its manufacturers and, as the next generation of supply is built, the country may actually fall behind.
One profitable company is a sea of losses
Through all of this, First Solar has remained profitable. The company has challenges -- there's no doubt about that -- but, so far, it has survived an onslaught from China. So, is it time to buy First Solar, or will this U.S. company fail along with so many others? If you're looking for our outlook on the company, and on how to play First Solar, along with continuing updates and guidance on the company whenever news breaks, we've created a brand new report that details every must know side of this stock. To get started, just click here now.