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The battle between cost and efficiency in solar panels has been brewing for years. The falling cost of commodity solar panels has made higher efficiency less attractive in some cases because more efficient panels are usually more expensive. But I highlighted last week that the cost of solar panels has fallen so far that efficiency is now extremely important in the residential solar market. 

Driving the importance of efficiency in residential solar is the fact that the solar module itself is only 15%-20% of a standard system's cost. Squeezing more efficiency out of each panel leverages those costs. But the same dynamic doesn't work in utility scale solar, which is why costs remain extremely important for large solar projects. 

The importance of cost in utility scale solar

As common as residential solar has become in the U.S., it's only expected to be around 20% of the market in 2016, according to GTM Research. 70% of the market will be large, utility scale projects that are far lower cost to build. 

The heart of the cost vs. efficiency battle can be shown in the cost to build solar systems large and small. SolarCity said that its overall cost per watt was $3.05 last quarter and GTM Research says that utility scale fixed tilt solar systems have reached $1.17 per watt and tracking systems are now $1.30 per watt. 

Using those numbers and GTM Research's $0.59 per watt panel costs in the second quarter we can pull out the non-panel cost to build residential and utility scale solar projects. Then we can model the impact of panel prices falling to $0.40 per watt, which has taken place in the last few months, to show how important panel costs can be. You can see that panel prices affect the overall cost of utility projects much more than residential projects. 

Data Source: GTM Research U.S. Solar Market Insight Report Q3 2016. Table by the author. 

Unlike residential projects, where costs per watt can actually go down with higher efficiency, utility scale projects are much more sensitive to the price of a solar panel. Efficiency matters, but it's often overshadowed by sheer panel costs. 

The impact on solar companies

This dynamic between cost and efficiency puts a lot of pressure on solar companies. There's little ability to differentiate on efficiency, something SunPower (SPWR -9.82%) found out and a big reason it bought Cogenra Solar to produce its new low cost P-Series product, but you have to be efficient enough. For a few years, First Solar (FSLR -6.16%) was the lowest cost supplier of solar panels, but was behind on efficiency. Its fortunes only improved when efficiency improved, so there's a minimum viable product concept in solar panels. 

What's clear is that utility scale solar projects won't pay much of a premium for more efficient solar panels. Paying more per watt makes sense when the panel is only 15% or 20% of an installation's total cost, but when it's nearly 50% the cost of panels matters a lot, while efficiency doesn't. 

This should play into the hands of low cost module manufacturers like Canadian Solar (CSIQ -5.70%), Trina Solar (NYSE: TSL), and JinkoSolar (JKS -3.67%). They'll have to sell panels at lower prices, but lower costs are going to be an advantage in the utility market. 

Different solutions for different solar markets

As it stands today, cost is still the biggest differentiator in the utility scale solar market. That doesn't mean efficiency doesn't matter at all, but it doesn't outweigh the cost side like it does in residential solar. That's something investors need to keep in mind when they look at solar stocks in a market where panel costs are falling rapidly.