The Economics of Solar Power

A new era for solar power is approaching. Long derided as uneconomic, it is gaining ground as technologies improve and the cost of traditional energy sources rises. Within three to seven years, unsubsidized solar power could cost no more to end customers in many markets, such as California and Italy, than electricity generated by fossil fuels or by renewable alternatives to solar. By 2020, global installed solar capacity could be 20 to 40 times its level today.

But make no mistake, the sector is still in its infancy. Even if all of the forecast growth occurs, solar energy will represent only about 3 to 6 percent of installed electricity generation capacity, or 1.5 to 3 percent of output in 2020. While solar power can certainly help to satisfy the desire for more electricity and lower carbon emissions, it is just one piece of the puzzle.

What’s more, solar power faces challenges that are common in emerging sectors. Several technologies are competing to win the lowest-cost laurels, and it’s not yet clear which is going to win. Rapid growth has created shortages and high margins for early players, such as the silicon refiners Dow Corning, REC Solar, and Wacker, as well as the component manufacturers First Solar, Q-Cells, and SunPower. Fueled by ever-increasing flows of new equity from venture capital and private-equity firms—$3.2 billion in 2007—innovative new competitors are entering the sector, and with them the potential for excess supply, falling prices, and deteriorating financial performance for some time.

With competition heating up, the companies building the equipment that generates solar power must relentlessly cut their costs by improving the processes they use to manufacture solar cells, investing in research and development, and moving production to low-cost countries. At the same time, they must secure access to raw materials without tying themselves to the wrong technology or partner.

The evolution of technology looms large for utilities as well. If they hesitate to undertake large long-term investments until the dust clears, they risk losing customers to players such as panel installers willing to put up and finance solar units on the roofs of buildings in return for a share of the savings the owners enjoy. As always in the utility sector, it will be essential to deploy smart regulatory strategies, which in some regions might mean including solar investments in the capital base used to set rates for consumers. Government policies will also continue to influence the sector’s development heavily. Deciding when and how to phase out subsidies will be critical for creating a vibrant, cost-competitive sector.

Even in the most favorable regions, solar power is still a few years away from true “grid parity”—the point when the price of solar electricity is on par with that of conventional sources of electricity on the power grid. The time frame is considerably longer in countries such as China and India, whose electricity needs will require large amounts of new generating capacity in the years ahead and whose cheap power from coal makes grid parity a more elusive goal.

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