The challenges in the solar industry over the past three years has really come down to one simple economic concept: supply and demand. There's currently about 70 GW of solar module capacity available in the market and only about 32 GW was installed last year. That imbalance resulted in a plunge in module prices and the death of a lot of solar manufacturers worldwide.
But 2013 has seen stability emerge in the solar market and capacity was likely reduced slightly as companies went out of business. Demand is also up and could reach 37 GW in 2013, according to analysts at JP Morgan. They also think that installations will grow to 46 GW in 2014 as China and Japan increase demand.
If those predictions come true, that's great news for the solar industry. Demand is picking up in sustainable markets, and we should see consistent growth as the cost of solar comes down and the cost of other energy sources goes up.
The impact on solar companies
Increasing demand has resulted in stable pricing in the second half of 2013, and that's been a boon for manufacturers. Once struggling to break even, SunPower (NASDAQ:SPWR), Canadian Solar (NASDAQ:CSIQ), JinkoSolar (NYSE:JKS), and Trina Solar (NYSE:TSL) are now profitable and trends look to be in their favor.
Take a look at the gross margin trends over the past year for these companies. Margins are improving rapidly as a result of better pricing and cost reductions that were put in place when the industry was in a worse position.
If demand grows to 46 GW in 2014, these margins should continue to improve. There's little new capacity coming online next year, and even SunPower's 350 MW expansion won't be ready until 2015.
Chinese manufacturers won't likely start expanding or upgrading plants until at least 2015. Even the best manufacturers are still dealing with bloated balance sheets, and Chinese banks have a lower appetite for solar risk after the past three years. That should keep supply stable for the foreseeable future.
Foolish bottom line
2013 was a great year for solar companies, both operationally and on the stock market. If demand continues to grow, I think 2014 could be even better. Japan and the U.S. should see steady, growth and China will likely install more than 10 GW by itself. 46 GW is an aggressive target for the industry, but one I think it can reach.
The highest quality suppliers have seen the biggest benefit so far and I think that's where the gains will be next year as well. I'd rather be betting on a profitable company making even more money as the industry improved than a high risk debt ridden company turning things around, something Suntech Power and LDK Solar couldn't do despite strong demand in 2013.
Fool contributor Travis Hoium manages an account that owns shares of SunPower and personally owns shares and has the following options: long January 2015 $5 calls on SunPower, long January 2015 $7 calls on SunPower, long January 2015 $15 calls on SunPower, long January 2015 $25 calls on SunPower, and long January 2015 $40 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 may not 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.