Solar Subsidies and Why They're So Important

Lately, an Italian solar market that can't decide whether it's coming or going has held solar stocks hostage. For investors who have been following solar for a long time, the story is nothing new. We've gone through it in Germany, Spain, and now Italy. But what are the feed-in tariffs, or FITs, we keep talking about and how do they affect solar stocks? Let's take a deeper look into the subsidies keeping the industry afloat.

What is a feed-in tariff?
A FIT is nothing more than a set price solar power generators are paid for the electricity they generate. Normally a utility has to buy the power generated, and the price is pre-determined for a set of time (such as 20 years in Germany). But the way countries handle FITs can determine whether they're stable sources of demand or passing fads.

Germany
The solar boom really began when Germany decided to start the solar feed-in tariff parade. A FIT was present as far back as 1990, but in 2000 the Energy Supply Industry Act took the country's solar path to a new level. And companies like First Solar (NYSE: FSLR) and Suntech Power (NYSE: STP) took advantage by building a big footprint in the market. I'll show below just how important steady demand from Germany has become.

Spain
The risks of solar subsidies can be seen with what happened to Spain in 2008-2009. An oh-so-generous FIT was put in place in 2008, resulting in 2.5 GW of installation, only to be bounced a year later because it was "too successful." So in 2009, the country put a cap of 500 MW for FIT solar power. This put a crimp on companies like LDK Solar (NYSE: LDK) and JA Solar (Nasdaq: JASO), which were expanding rapidly as demand markets grew.

Italy
The one country throwing solar stocks for a loop right now is Italy because of an adjustment in FIT that is taking longer than expected. Like Spain, Italy set their feed-in tariff rate too high, and a flood of development came to the market. In 2010, capacity additions jumped 62% to 1.85 GW.

But it appears the country's rooftop FIT is still in order, and SunPower (Nasdaq: SPWRA) is hoping to take advantage. In smaller installations on valuable land, SunPower's higher efficiency makes more sense than First Solar's panels, for example. Manufacturers have been cautious with statements about Italy this year, but it isn't as if demand will dry up all together.

Here's a roundup of where feed-in tariffs currently stand in Europe:

*Estimated.

The next frontier
Canada and the U.S. are considered two emerging markets in solar. In Canada, a generous FIT program was put in place in 2009 that has sparked projects by SunPower among others. But problems with the program and the possibility it could end under a conservative government have held the country back from a larger presence.

The U.S. has been held back by its own complex regulatory systems and lack of defined rules for the industry. Right now, most plants are built with a power purchase agreement, or PPA, that acts like a FIT for an individual project. The problem is that these are negotiated for each individual project, and there's few rules encouraging utilities to participate in them. This makes regulatory and other indirect costs high in the U.S.

California has taken the biggest step with its renewable energy standard set at 33% of power by 2020. That has encouraged Edison International (NYSE: EIX) and Pacific Gas & Electric (NYSE: PCG) to get aggressive signing deals with solar developers. Slowly we're becoming more productive, but the U.S. won't dominate solar demand for a few years until we get some of our issues sorted out.

Ironically, some of the places that have pushed solar to the next level are some of the weakest solar markets in the world. Germany gets even less sun than Minnesota, and vast tracts of desert around the world have gone undeveloped. This is slowly changing, but intense sun sources make solar even more cost-effective, and when combined with lower costs, should make solar more attractive in places like India, Africa and the western U.S.

Feed-in tariffs and their significance
As you can see above, Germany and Italy dominated the 16 GW of solar that was installed in 2010, hence the market freak-out when they appear to be cutting FITs. Solar stocks are a volatile ride, but as costs fall and demand sources diversify the industry is slowly taking steps in the right direction. Will you be able to hang on for the ride?