The energy business has been robust in 2022, despite an uncertain economic environment. Oil and natural gas prices have remained high and are actually a cause of some of the inflation investors are worried about. As bad as inflation is for the economy, high prices are good for oil and gas stocks.
In the past, that strength in commodity prices and energy stocks would have translated to a good year for solar energy stocks as well. But results have been mixed for First Solar (FSLR -1.80%), Sunrun (RUN -1.57%), SunPower (SPWR -0.33%), and Enphase Energy (ENPH -1.61%), and there are a few factors investors need to weigh before getting too bullish on solar energy stocks.
Costs are rising
Rising costs for everything from commodites to labor are impacting solar companies. Manufacturers like First Solar and Enphase Energy will see those costs directly in their margins and may not be able to pass additional costs on to its customers. Installers like SunPower and Sunrun will also see higher expenses, but they have more power to substitute other parts or choose to not install systems if they're not profitable. The question is, who has pricing power to push higher costs on to customers?
After decades of costs consistently falling in the solar industry, we may be in a period of higher costs. That's bad, but maybe not as bad as it initially seems because the competition is in a worse position. The price of natural gas is up 214% in the past three years in the U.S., and in Europe it's about 500%. That may lead to a surge in demand for solar products, even if the cost of electricity generated by the sun goes up significantly.
Interest rates are a big headwind
An immediate headwind is interest rates. Solar energy projects are usually built with long-term debt, and when rates rise that lowers the current value of long-term cash flows, meaning the effective cost of electricity from solar panels is higher.
The negative headwind of higher interest rates hits whether a solar project is leased (usually residential solar) or financed with a loan, so this is something that will hurt everyone.
Again, it's unclear how customers will respond to increased financing costs. In the U.S., solar installations fell 24% in the first quarter of 2022, but residential solar installations were up 30%, according to the Solar Energy Industries Association. Interest rates will be a headwind, but the strength of that headwind may be different for different segments of the industry.
A positive sign for solar stocks
Long-term, the trends do seem positive for the industry overall. Solar costs are now lower than wind or any fossil fuel on a cost-per-kilowatt-hour basis, and installations rose 42% from 2019 to 2021 to 156.1 gigawatts, according to the International Energy Agency.
Countries around the world putting more focus on domestic energy production can't hurt, either, especially in the U.S. and Europe.
I think now is a good time to buy solar energy stocks because of the long-term trends in their favor. Not only are installations growing, cost reductions are slowing and the industry is consolidating, meaning profits should increase long-term. The shakeout over the last decade has been painful for solar companies, but the industry is healthier than it's been in a long time.