Investors and politicians have been debating the merits of solar power for decades. In the late '70s and early '80s, the industry went through a boom because of government subsidies that were extremely short-lived, and it took until a subsidy-driven boom in Germany in the early 2000s to get back on the map again. Solar power was always a pipe dream that couldn't get off the ground, unable to compete with fossil fuels that were cheap and plentiful.
But over the past decade, the narrative has changed. Today, solar power is becoming a force in energy, and while subsidies play a role in solar energy's growth, it's the falling cost of solar power that's driving the boom. Like it or not, solar power is here to stay.
The U.S. begins to see the light
The entrenched energy industry and political powers in the U.S. have been fighting any assistance to the solar industry, but their efforts have failed to slow down its growing momentum. Last year, Congress failed to extend the 1603 Treasury Grant program -- a 30% cash grant given to anyone who installed solar -- cutting one of the main subsidies to the industry. Solar installers were still left with an investment tax credit, but that requires taxable income, creating a financing challenge.
How did the solar industry respond to the cut in subsidies? U.S. installations rose 76% last year on the back of a 27% drop in installation costs, according to GTM Research. Growth was driven by utility-scale installation, but even the less volatile residential market grew 62% as leasing programs from companies such as SunPower (NASDAQ:SPWR) and SolarCity (NASDAQ:SCTY.DL) spread like wildfire.
The largest federal solar subsidy -- an investment tax credit -- is due to expire at the end of 2016. If the industry's reaction to previous subsidy cuts is any indication, I wouldn't be worried about solar power when it is.
Europe cuts solar lifeline -- solar lives on
Europe has been even more aggressive cutting subsidies the solar industry once relied on. Germany began 2011 with feed-in tariffs that ranged from 0.29 euros per kilowatt-hour for a rooftop system to 0.21 euros per kW-hr for a large ground-mounted system. Today, a rooftop system will earn 0.165 euros per kW-hr and a utility scale system will earn 0.195 euros per kW-hr. The driver of feed-in tariff reductions is the rapidly falling cost of solar. We talk about how the flood of cheap Chinese panels affect prices and competition here in the U.S., but solar giants Yingli Green Energy (NYSE:YGE) and Trina Solar (NYSE:TSL) count on Europe for most of their demand, and they're responsible for a lot of the drop in costs there.
Despite the rapid drop in solar feed-in tariff rates and the relatively weak solar conditions Germany has to deal with, the country installed a record 7.6 GW of solar in 2012, a slight increase from a year before. So why are solar installations up if subsidies are down?
The cost of electricity from the grid in Germany is 0.26 euros per kW-hr, making solar electricity far cheaper than the grid. If you live in Germany and don't have solar power on your roof, you're making a bad investment.
This is a theme we're starting to see around the world. Solar power is cheaper than the grid in Hawaii, the Caribbean, Saudi Arabia, and even Southern California.
It's all about the Benjamins
I hear over and over again that solar energy is simply too expensive and too reliant on subsidies to survive, but few people know just how cheap solar electricity has become. Earlier this year, Todd Myers of the Washington Policy Center said, "The fundamental problem is it's not economically sustainable." The problem with that thesis is that facts about solar power get in the way.
Germany is now driven by the economical cost of solar. First Solar (NASDAQ:FSLR) says that its cost to produce energy, which are lowest in the industry, will fall from about $0.15 per kW-hr in 2010 to about $0.075 per kW-hr in 2016. These costs are before incentives or tax benefits and will be below the cost of retail electricity in all 50 states.
Still don't believe the numbers? First Solar just signed a deal to sell power from a 50 MW facility to El Paso Electric for 5.79 cents per kW-hr. That's less than half of the 12.8 cents per kW-hr Bloomberg estimates it would cost to build a new coal plant.
Last year, SunPower won a contract to supply power for 10.4 cents per kW-hr to Kings County, Calif. That's about two-thirds the cost of retail electricity in the state.
As you can see, solar power is already competitive on a cost basis -- which is what really matters. The biggest difference between solar power and fossil fuels right now is their cost trajectory. The cost of fossil fuels is rising and the cost of solar is dropping -- fast. What other energy source can you say that for?
How to play solar now
There are three -- and only three -- solar companies I would consider investing in, given the landscape I've laid out. SunPower is my top pick because it makes the most efficient modules and has exposure to all parts of the solar industry. First Solar is in the running because it has a great balance sheet and industry-leading utility scale costs. SolarCity is also worth keeping an eye on because it is the dominant residential and commercial installer in the United States.
I would stay far away from Yingli and Trina, the latter of which incidentally lowered its first-quarter guidance this morning. Chinese solar is too risky to bet on.
Fool contributor Travis Hoium manages an account that owns shares of SunPower. He also owns shares of SunPower and has long January 2015 $7, $5, $15, and $25 calls on SunPower. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.