Solar energy is playing an increasingly important role in how the world is powered. And even with the drop in the costs to produce oil and natural gas, the reality is, fossil fuel's days are numbered -- and potentially much sooner than most people both expect. Over the past five years, twice as much capital has been invested in developing renewables than fossil fuels on a global basis. The trend has already begun.
If you want to profit as an investor in the rise of solar energy, there are a number of things that are set to tip the balance in favor of solar, and potentially disrupt the energy industry as we know it. This could set up a handful of companies, including SunPower Corporation (NASDAQ:SPWR), First Solar, Inc. (NASDAQ:FSLR), Tesla Inc (NASDAQ:TSLA), and even utilities including NextEra Energy Inc (NYSE:NEE) and Pattern Energy Group Inc (NASDAQ:PEGI) for decades of big profits.
The surprising reason solar will be bigger than you think
For years, the big hole in any thesis for solar energy becoming a dominant source of global electricity has been one thing: The sun doesn't shine all the time. The popular thinking has been that there would always be a need for baseload power plants, which are typically powered by fossil fuels like coal and increasingly natural gas. But energy storage is starting to change this thinking.
Over the past several years, technical innovations and cost improvements have changed the calculus for energy storage and the grid. Since 2010, lithium-ion battery pack costs have fallen over 70%, and are expected to fall nearly as much again within the next decade. Some utilities are starting to use storage as part of managing demand. There is also growing interest from commercial users for storage as a way to reduce their peak demand from their utility, in order to drive down demand costs.
For residential customers, it's still very early in the game, with Tesla's Powerwall one of the few market-ready products. At this point, adding energy storage to a rooftop solar system isn't a money-saver for homeowners, but energy storage costs are on track to fall sharply in coming years, and utilities are pushing back on the net metering policies that make rooftop solar a cost-saver for residential users. We are years away from storage costs reaching the point where residential consumers will save money by pairing storage and solar and getting off the grid, but costs fall and efficiencies improve with each passing year.
The big takeaway here is that energy storage and solar panels are getting cheaper and becoming more efficient. At some point in the future, pairing solar energy and storage will generate clean energy with the ability to meet demand more cheaply than a new natural gas power plant. That's going to be massively disruptive when it happens.
Rooftop solar has potential, but also huge uncertainty
Distributed solar should continue to grow for years to come. That could bode well for companies involved in residential and commercial solar installations, including Tesla (through its SolarCity subsidiary), Sunrun Inc (NASDAQ:RUN) and Vivint Solar (NYSE:VSLR) if they can leverage their scale.
However, the bigger scale hasn't necessarily delivered lower costs for these installers, and that could limit their ability to outcompete smaller, regional installers. At the same time, there's also a much bigger concern on the horizon for residential and commercial U.S. solar: Proposed tariffs on imported panels could wreak havoc on companies that rely heavily -- or in some cases entirely -- on the U.S. market. So investors should be very cautious when it comes to investing in installers like Sunrun and Vivint while the ongoing Section 201 trade case plays out. Even if the tariffs don't cause major disruption in residential solar, Sunrun and Vivint should probably be avoided until there's evidence they can drive down installation costs.
On the other hand, First Solar and SunPower appear to be in better -- or at least less-bad -- positions. While they both get a significant portion of their business from the U.S., there's a chance that their panels could be excluded from the proposed tariffs. First Solar's thin-film panels are completely different than the silicon-based panels that are at the heart of the trade case, and shouldn't be subject to tariffs or import duties. SunPower is also making the argument that its panels should be exempt as well based on the technical differences in their high-efficiency panels.
First Solar also has the ability to scale up its U.S. manufacturing capacity, which would allow it to avoid tariffs if they were imposed on its Asian-made panels. First Solar is in a strong position either way, since its panels are the preferred technology for utility-scale solar projects, due to their ability to generate consistent output in extreme environments where silicon panels don't perform as well. SunPower, which does count on a significant amount of business from commercial and residential U.S. installs, is considering opening a manufacturing facility in the U.S. This could prove to be a game-changer if tariffs are indeed placed on its panels.
However, the global solar market is enormous, and overseas panel makers will adapt to the market conditions if tariffs make the U.S. market uncompetitive. After all, despite its potential, the U.S. isn't the world's biggest solar market. In other words, there's massive uncertainty around the U.S. solar market right now, but SunPower and First Solar should be able to adapt because of their technologies, and their international reach.
Utilities and yieldcos could be some of the biggest winners
Surprising, right? Falling manufacturing costs for both solar panels and energy storage are set to change the playing field and, potentially, make it cheaper for someone to buy panels and a battery than stay connected to the grid within the next decade. But it's not that simple. Utilities will see the same cost benefits as residential rooftop solar, but they'll be even bigger. Utility-scale solar projects can be implemented for far cheaper than residential rooftop solar, and those benefits of scale also apply to energy storage. This should help utilities to remain quite competitive in the future.
They will also remain necessary, since every business, manufacturing plant, apartment building, or other structure isn't an ideal location for distributed solar or storage. At the same time, plenty of people and companies will prefer to utilize a utility for power versus owning panels and batteries.
But it's the utilities at the forefront of renewables that should make for the best investments, as well as yieldcos that provide utilities -- as well as commercial and industrial power users -- with access to cheap, clean solar energy.
This includes AES (NYSE:AES), which already counts on renewables for more than one-quarter of its energy capacity, and growing. Maybe most importantly for AES is its aggressive push into storage. The future of utilities will almost certainly be tied to energy management and storage services for major energy users looking to move away from demand charges and lower their energy costs.
NextEra Energy is also one of the biggest renewable utilities, with plans to build up to 16,500 MW of wind and solar projects by 2020, including spending almost $3 billion on solar in Florida alone. Its master limited partnership NextEra Energy Partners LP (NYSE:NEP) could do exceptionally well as a dividend growth investment since this will be a major vehicle used by NextEra to develop renewable projects and should see its cash flows grow sharply.
Yieldcos that help manage large-scale distributed solar installations, as well as utility-scale projects, should also do incredibly well. This includes TerraForm Power (NASDAQ:TERP), which owns 2,600 MW of capacity, about 40% of which is solar. TerraForm Power recently underwent a major corporate change, with asset management stalwart Brookfield Asset Management (NYSE:BAM) acquiring a controlling stake and assuming the role as its sponsor. If Brookfield's track record is any indication, TerraForm Power should deliver solid returns for investors. Brookfield is already positioning TerraForm Power for solid growth, with a 3.5 GW pipeline of potential assets it has first rights to acquire.
Pattern Energy Group is set to be a major winner in the solar future. The bulk of its current capacity is from wind generation, but it's also investing in more solar as time goes by and positioning itself to be a major player in storage.
Imagine a world...
The growth of solar around the world in coming decades isn't just about people wanting cheaper, cleaner energy. We are in the first stages of a major transition away from fossil fuel-powered vehicles, and electricity demand to power the cars of the future is going to add substantial demand for more solar energy generation.
Factor in a doubling of the world's middle class over the next couple of decades -- we are talking about some 2 billion more people -- and it's going to take a substantial amount of growth to supply the world's power needs in the future.
But as solar panels and energy storage continue to get cheaper and more efficient, solar is on track play a major role in disrupting and changing the way the world is powered in the decades to come.
Jason Hall owns shares of First Solar, Pattern Energy Group, SunPower, and Tesla. The Motley Fool owns shares of and recommends Tesla. The Motley Fool recommends First Solar. The Motley Fool has a disclosure policy.