Solar Power: Still a Stellar Investment
More than 20 years ago, I made an investment decision that worked out really well. Based on a confluence of economic and demographic trends, I believed that the health care sector would likely outperform the broader market over the long term. Consequently, I began to invest disproportionately in the sector.
My hypothesis turned out to be correct. Although there have been a few corrections over time, the health care sector has outperformed the S&P 500 by a large margin over the past couple of decades.
If I were making a decision today for the next 20 years, I would invest disproportionately in the solar power sector. I strongly feel that solar power is destined to become our most important source of energy.
I’m confident that my solar bet will pay off, just as my bet paid off on health care.
Since January 1999, the Health Care Select Sector SPDR Fund (XLV) has nearly doubled the performance of the S&P 500:
Over this time frame, there have been booms and busts in the health care sector, as well as long periods of flat performance. But the patient investor was amply rewarded.
Solar power is poised for a similar trajectory.
Solar stocks have boomed over the past year. Solaredge Technologies (NSDQ: SEDG), a manufacturer of inverters, rose by more than 200%. First Solar (NSDQ: FSLR) more than doubled in price.
But the solar sector will experience its own booms and busts. Just last week the solar sector sold off sharply. What happened, and is it a reason to now avoid the sector?
China Taps the Brakes
The trigger for the sell-off was an announcement by the Chinese government that it would take measures that would likely curb the astronomical growth of its solar industry. The South China Morning Post reported:
“A joint statement put out on Friday by the National Development and Reform Commission, Ministry of Finance and National Energy Administration said the allocation of quotas for new projects had been halted until further notice, and tariffs on electricity generated from clean energy will be lowered by 0.05 yuan per kilowatt hour, a cut of 6.7% to 9% depending on the region, effective June 1.”
The Chinese government indicated that the curtailment was aimed at “promoting the solar energy sector’s sustainable development, enhancing its development quality and speeding up reduction of subsidies.”
The entire solar sector sold off, but Chinese companies were hit especially hard. Analysts lowered estimates for new solar photovoltaic (PV) installations in China this year from 45 gigawatts (GW) down to 30 GW. Multiple analysts downgraded the sector, declaring it to be in a downturn.
Of course, China wasn’t the first country to slash subsidies for renewable energy, but it’s in a different position than other countries that have cut subsidies. In Germany and Spain, for example, power demand was relatively stable and renewables were helping to replace power derived from fossil fuels and nuclear power.
China’s energy consumption, on the other hand, is growing rapidly. As a result, the country has had an aggressive “all of the above” energy strategy. China has added solar PV capacity faster than any other energy source and has done so at a rate faster than any other major country.
A primary motivation for China’s solar PV investments is the country’s need to curb pollution. But China also faces a future in which oil supplies are depleting while electric vehicles are proliferating. Thus, China sees renewable energy — and solar PV in particular — as a critical area of focus.
To put China’s growth in perspective, in 2017 alone China added 53 GW of new solar PV capacity. That addition was greater than the total solar PV capacity of any country at the beginning of 2017:
Source: REN21 2018 Global Status Report
Given China’s growing need for clean power, its decision to curb subsidies caught many, including me, by surprise. Why would China make such a decision?
A Trade War Casualty
The decision may be rooted in actions of the Trump administration. Earlier this year, President Trump announced a 30% tariff on imported solar equipment that would last at least the next four years. The decision was a response to a couple of U.S. solar companies charging that China’s solar subsidies were allowing Chinese solar companies to undercut U.S. solar manufacturers.
Reuters reported last week that these tariffs have already resulted in the cancellation of more than $2.5 billion in large installation projects in the U.S. — more than double the $1 billion in new spending plans announced to take advantage of the tariffs.
Because China is the world’s leading consumer of solar power by far, I didn’t expect this decision to have a huge impact on China’s solar industry. But now that a larger trade war looms, China may be signalling to the U.S. that it will stop allowing Chinese solar panel makers to substantially undercut U.S. manufacturers.
Although the overall growth rate of the solar industry may suffer, in the long run, solar PV is still all-but-certain to outgrow every other energy category. In the short term this decision will create a lot of uncertainty around the industry, but we will look back on it as just a minor bump in the road.
I decided to take advantage of the sell-off. Given the sudden change in outlook, I sold some cash-covered puts on one of the leading solar power companies at an attractive price. I got an annualized yield of 22% on the cash I risked, and if I “lose” on the trade I will end up with shares of this high-quality company at a 10% discount to the price after what has already been a steep sell-off. In the long run, that’s a trade that I expect to work out well.
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