Solar 101

It's no secret that the energy equation is changing. Demand in all forms is growing and will continue to rise for the foreseeable future. Electricity usage is increasing at twice the rate of overall energy use, and analysts expect it to go up 76% by 2030. China's booming economy and the threat of peak oil have driven up prices and increased volatility in the oil market. And with convenient fossil fuel supplies dwindling and threats of climate change building, renewable energy has attracted more attention and funding as a solution to these problems.

As a clean abundant resource, solar power has become a key piece in the renewable energy portfolio, but does that mean it's good business? With that question in mind, I set out to learn a few things about the solar energy industry: how the technology works, who the major players are, and what the market forces tell us about its future.

A little background, please
For a brief history of solar power, let's take a look at the timeline below:

Source: Department of Energy.

As we can see, human beings have been harnessing the power of the sun for more than 2,500 years. The ancient Greeks even used its reflective properties to set fire to invading Roman ships.

More recently, as the chart below shows, solar PV (photovoltaic) capacity has grown dramatically from just 0.7 gigawatts in 1995 to 40 in 2010.

Source: REN21.

Despite that recent growth, however, photovoltaic technology is actually quite old. Entire industries have come and gone in the time since Alexandre Becquerel first discovered the sun's ability to generate electricity, and the technology still remains mostly peripheral.

How it works
Solar power comes in multiple forms, such as heat and as a source for power plants, but for this article series, we will focus on solar photovoltaics, since that is of most interest to investors.

Solar modules, or panels, are a collection of solar cells that convert light into electricity. Traditionally, the cells are made from silicon crystals derived from sand. Trace amounts of the elements boron and phosphorous are then added in a process called doping. The n-type (boron-doped) and p-type (phosphorus-doped) combine to form what's called an n-p junction, which establishes a permanent electric field. When sunlight hits the solar cells, electrons are ejected from the atoms, and the electric field generates a direct current (DC), which then must pass through an inverter to become the alternating current (AC) that we use in our homes.

There are two major forms of solar cells: traditional crystalline silicon and thin film. Crystalline silicon has historically dominated, but a newer thin-film technology -- produced primarily by First Solar (Nasdaq: FSLR) and made from a variety of compounds -- has gained traction in recent years. Despite its recent growth, however, thin film actually lost market share in 2010, declining from 17% to 13%.

There are a number of differences between the two technologies. Thin film is cheaper to produce and more aesthetically pleasing, but is less efficient. Its conversion rates -- the percentage of light converted to electricity -- are only half that of crystalline modules. Thin-film technology is more heat-resistant, but it takes from six to 12 months to reach stable levels of output, while crystalline cells stabilize right away.

The big picture
According to global energy information firm Enerdata, worldwide electricity production passed 20,000 terawatt-hours (or 20 trillion hours) in 2010. With just 40 gigawatts (40 billion watts) of capacity available in the same year, the solar industry still has a long way to go to become a mainstream energy source. The good news is that there's plenty of sunshine available to support the world's energy needs. In the U.S., just one square meter of sunlight can potentially generate on average a kilowatt of power an hour. On a global scale, the sun radiates more than 6,000 times the world's energy needs every day. In other words, we need less than 0.02% of the sun's energy to power the world.

In the U.S., average residential electricity costs are about $0.12 per kilowatt-hour, and prices for solar power have been declining rapidly in recent years. Since there are no fuel costs and minimal upkeep, the expense comes from the initial investment. In 2011, a residential solar system in the U.S. cost $5/watt, but a larger utility scale system cost only $3/watt. For a comparison, the unsubsidized installation cost of a residential system would be equal to about 40 years' worth of traditionally sourced electricity at today's prices. Based on the levelized cost of energy -- a metric that allows for cost comparisons between different forms of energy -- and assuming a potential 15% decline in solar PV LCOE, solar electricity will become cheaper than nuclear, coal, and natural gas by 2015, as the graph below shows.

Source: Solarcellcentral.com.

Photovoltaics are already cheaper than natural gas peakers, power plants that are mainly used in the summertime to fill excess demand.

The players
As the chart below shows, Germany dominates the $29 billion user market for PVs with 44% of the world's capacity.

Source: REN21.

Like much of the rest of the world, the Germans subsidize solar energy, using a process known as feed-in tariffs. They mandate that utilities buy renewable energy at a higher cost, which then gets passed on to customers in the form of a more expensive electric bill. The extra fees go to the owner of the clean energy generator.

As far as production, the PV industry is highly fragmented, with no single company holding more than 6% of market share. Backed by government incentives, Chinese companies have gained the upper hand, with 10 of the 15 largest PV makers now based in Asia. China and Taiwan alone accounted for 59% of production in 2010. Listed below are the five biggest PV producers, all of which are Chinese, except for First Solar:

Sources: Yahoo! Finance, PVinsights.

With the exception of Suntech, these stocks all look incredibly cheap. The easy explanation for that seems to be that investors don't fully understand this nascent industry and have little faith in the stream of subsidies needed to prop it up. We'll discuss that question further in "Solar 201," and go into detail on industry dynamics, competition, and future prospects, as well as current news items such as German solar policy and the U.S.-China trade wars. Stay tuned.

For more information on another intriguing energy play, I recommend checking out one of The Motley Fool's newest special free reports. It details a small-cap alternative energy stock that is up 20% in just the past two weeks and has nearly tripled in the past year. To learn all about this promising company, click right here to watch the free video: One Stock to Buy Before the Nat Gas Act Becomes Law.