Spwr Cvsr Image

Image source: SunPower.

Subsidies have been a huge help to the solar industry, with the 30% investment tax credit and accelerated depreciation providing installers with upfront financing that has allowed them to grow rapidly over the last few years. But the investment tax credit is set to fall to 10% in 2017, and even some of the industry's leading companies are ambivalent about its very existence, including First Solar (NASDAQ:FSLR) and SunPower (NASDAQ:SPWR)

If the ITC falls to 10%, there could be a huge impact on solar companies across the country. GTM Research, arguably the best predictor of the U.S. market, thinks installations will fall 55% from 2016 to 2017, leaving many companies out in the cold. Here's who I think will win even if that happens. 

Business models will have to change
The first thing to understand is how business models will need to change. In residential solar, tax credits have been sold to investors to fund most of the cost of installing solar. SolarCity (NASDAQ:SCTY) said that last quarter, 56.5% of the gross project cost was funded by tax equity investors. That figure will fall significantly in 2017 and that'll mean either more debt for SolarCity, or a new sales model.

Since it was difficult for residential customers to exploit these tax advantages and easy to sell them to investors, driving adoption of leases and power purchase agreements made sense in the past. But with a lower ITC and lower installation costs (meaning lower tax benefits for each homeowner to use) it would make sense that the dynamic will flip. The lower the tax credit goes, the more it will make sense for home homeowners to buy solar systems, use financing from a bank, and take any available state or local tax benefits for themselves.

This will cause companies like SolarCity, Vivint Solar (NYSE:VSLR), and Sunrun (NASDAQ:RUN) to shift their business models dramatically. They've relied primarily on selling solar for $0 down and a long-term lease or PPA to pay for systems, but now they will have to sell systems based on costs alone. This could even drive customers to look for the lowest-cost supplier, which in many cases is a local installer, not a national company. 

Long-term value will become even more important
The other dynamic shift is going to come in how solar energy is sold, both on large and small scales. Without subsidies driving leases, customers will have more choice in what solar products they go with. Rate changes in Hawaii, which provide for lower prices for electricity sent to the grid, and the changes to net metering coming in California mean self consumption will make more sense in some of the largest solar states. That means energy storage and energy management will become more important, and a suite of products will be important, not just solar panels and an inverter.

Spwr And Greenbotics

SunPower solar system with a robotic cleaner. Image source: SunPower.

SunPower (NASDAQ:SPWR) and SolarCity are leading the way, here, offering customers energy storage and energy management solutions alongside solar energy. As rates evolve and more customers become aware of how much monetary value they're creating by controlling their own energy, we'll see these offerings become more important. Companies with the right combination of solutions could take advantage of time of use rates, demand response, or even allow you to consume most of your own electricity.

On the utility side, similar offerings will start to become important. Better technology that generates more energy in future years will become more important to the financial model to create more energy long term, and that will drive utilities toward companies like First Solar (NASDAQ:FSLR) and SunPower, which have lower degradation than commodity solar panels. They may also start accompanying energy storage with solar as another way to create value to the grid. And with balance sheets that are the envy of most developers, they're already adding technology to take advantage of these changes.

Consolidation of power is coming to solar
Even a small reduction in installations could lead to a dramatic negative impact on the solar industry. And GTM Research's prediction of a 55% decline in installations could put a lot of highly leveraged developers in financial peril.

That will leave the stronger players to pick up the pieces, adding capability and market share in the process. SunPower is already doing some of that, buying low-cost manufacturing technology, a robotics company that builds panel cleaners, and project pipeline in the past year. But we can expect more in the future from the companies left standing.

Rough days could be ahead
2016 will be a phenomenal year for the U.S. solar industry, but if subsidies fall as expected in 2017, we could be in for a bumpy ride. The companies who will be hurt the most are those with highly leveraged balance sheets, low margins, little differentiation from competitors, and little international business. They'll be forced to compete solely on price, exacerbating the financial woes some companies are already seeing.

The changes will also force business model changes, particularly in residential solar where third-party financing will be less important than it was in the past. 

Companies like First Solar and SunPower will be able to leverage international operations and strong balance sheets to weather the storm, picking up strategic assets and cheap pipelines as they come available. They're the two I think will come out stronger as the industry recovers long term.

SolarCity could use this as an opportunity to add more capability in offering a full suite of solutions, and the manufacturing plant it's building in New York could add technology differentiation. There may be ups and downs on the financing front, but I think SolarCity will come out stronger by 2020 as well. It's higher risk than First Solar and SunPower, but it could be the third powerhouse left in solar a few years from now. 

What we know for sure is that there's a lot of uncertainty ahead for solar in the U.S., and those not ready for the industry shake-up will be left in the dust. 

Editor's Note: This article originally stated that "...the investment tax credit is set to fall to 10% in 2017, and even some of the industry's leading companies are asking for the tax credit not to be extended." This has since been corrected to acknowledge that while just one company (Sunnova) is asking for the tax credit to be eliminated, several players in the industry do not find it necessary to their business models. It now reads: "But the investment tax credit is set to fall to 10% in 2017, and even some of the industry's leading companies are ambivalent about its very existence, including First Solar (NASDAQ: FSLR) and SunPower (NASDAQ: SPWR)."

Travis Hoium owns shares of First Solar and SunPower. The Motley Fool owns shares of and recommends SolarCity. 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.