Solar power and geopolitical thunder

April 28, 2023

Pauls Miklasevics 

Chief Investment Officer (CIO) at BluOr Bank

4 trillion euros.

That is how much capital will be needed in order to achieve Europe’s clean energy goals over the next 10 years according to Goldman Sachs. Over the same period of time, it is forecast that the United States’ Inflation Reduction Act (IRA) will mobilize 2 trillion euros worth of clean energy investment. In the US, solar power generation will constitute 55% of new renewable energy capacity or approximately 400 gigawatts of new installations over the next 10 years.

In Europe, solar power generation is expected to play an even bigger role.

From 2019 to 2021 Europe averaged 15 gigawatts of new solar power installations per year. Going forwards, Europe’s solar installation capacity will have to scale to over 70 gigawatts of new installations per year from 2028-2030 in order to meet our ambitious renewable electricity targets - a total of around 600 gigawatts from now until 2030 (2/3 of new renewables).

Sounds great. What are we waiting for? Let’s build solar parks! I am happy to report that at long last, it seems as if the European Commission is finally ready to act. 

After getting massively upstaged by the Americans’ “Inflation Reduction Act” last August, on March 16th of this year the European Commission presented detailed legislation to support its Green Deal Net Zero Industry Act.

The legislation will encourage faster renewables development due to less burdensome permitting rules as well as a “Made in Europe” focus. If fact, the European Commission is ready to propose that at least 40% of clean energy equipment should be manufactured in Europe. 

Considering the fact that Europe only accounts for 2% of global solar component manufacturing, the EC’s “Made in Europe” mandate in the context of solar power installations is either woefully unrealistic or a spectacular opportunity for inspired European industrialists. 

However, what is clear is that in the short term, we will be heavily dependent on components from China. Currently, China’s share of the upstream solar supply chain is over 90% of the global market. This refers to the materials needed to enable the conversion of solar power into electricity such as polysilicon, wafers, cells, modules and solar glass.

According to the China Photovoltaic Industry Association (CPIA), China’s massive investments in the solar supply chain could enable them to add 95-120 gigawatts in solar generating capacity this year (Europe’s target this year is 23 gigawatts of solar capacity). However, geopolitical strife has made life difficult for China’s solar industry as the CPIA’s honorary chairman Wang Bohua stated at a recent industry conference that: "trade barriers are bringing increasing difficulties for Chinese solar firms seeking to expand in overseas markets, and the rapid development of local manufacturers in those countries will hit China's solar manufacturing industry." 

The US and Europe are prioritizing the growth of their own future solar supply chain capacity over cheaper Chinese components, which currently benefit from years of investment and economies of scale. Much of this productive capacity was built using cheap coal, and the dynamic of the world energy market has changed considerably over the past year.

It will be challenging for Europe to develop energy intensive production capacity under the current energy price environment. On the other hand, the US has a distinct advantage due to their access to abundant natural gas. 

Does it make sense to liquefy US natural gas, ship it over the Atlantic, convert it back to natural gas, fuel turbines to generate electricity and then build and power factories to make solar components in Europe? We shall see. The energy economics of this equation imply considerable subsidies. This in itself is not a bad thing. History has shown that nascent industries benefit from subsidies before reaching economies of scale, but Europe will have to be vigilant in ensuring that subsidies are not wasted and that the opportunity costs of this policy have been fully considered.

Europe failed to build out energy intensive solar supply chain capacity when it had access to cheap Russian gas and free money (the European Central Bank, through its negative interest rate policy, was literally paying people to borrow money…). Now energy is expensive and so is capital. If there was not an economic rationale to build out our solar industry then, surely those same economics are even more prohibitive now. But not everything is about money. This is clear.

At an American Chamber of Commerce luncheon last year Sadales Tikls CEO Sandis Jansons gave a very interesting presentation about planned solar generating capacity in Latvia. I was surprised to hear that the sum of Latvia’s planned solar energy production capacity was equivalent to over five times our average electricity demand. Of course not all of this capacity will be built, but let us keep in mind the economics of solar power: the more capacity you have, the more electricity you will generate when the sun shines, and the cheaper it will be. This creates a significant challenge for forecasting project economics because at a certain point the more solar capacity that is built the lower income from solar power generation on a unit basis. Electricity is similar to other commodities in that it is priced on the margin: supply one unit less than the market demands and prices move exponentially higher, supply one unit more than the market needs and the price plummets.

Yes, we will of course be theoretically able to export excess electricity to our neighbors, but no doubt they have similar plans that could lead to even more overcapacity and actually make a bad situation worse for solar investors. Low domestic energy prices on sunny days could be made even lower by excess capacity from our neighbors. We could theoretically be heading for a situation where we overpay for more solar capacity that we need, while failing to alleviate massive price swings that jeopardize our energy security. We cannot afford for this scenario to play out (again). 

Of course the best cure for overcapacity of intermittent renewable energy such as solar power is the ability to store it. This is the ultimate game changer because it enables you to store energy when it is cheap, and sell it when it is expensive. This would benefit producers, consumers, and regulators by lessening price fluctuations. It is also why many new solar projects in China must include an energy storage component in order to be permitted by local governments.

Sure, many solar projects might make perfect sense based on current elevated electricity rates, but the market dynamic is in constant flux. Uncertainty in terms of future cash flow for solar producers is compounded by possible difficulties in sourcing components from China or possibly having to pay dearly for those that are “Made in Europe”. That being said, Chinese components might not be all that cheap anymore – they too face higher energy costs and the Chinese economy is finally reopening after 3 years of zero Covid policy. This means that the demand for all factor inputs will increase – especially copper, which is the key material for electrical conductivity. Unfortunately, I have not heard any plans from the European Commission to procure copper supplies. This is troublesome since the current pace of demand could consume visible copper stocks by the end of this summer.

Grid-scale batteries and green hydrogen – which allows us to store electricity by converting it to molecules – are currently expensive.

It is one thing to produce renewable energy, keeping it is another. This is where the true opportunity lies.

That being said, I have met with some very bright and successful investors that are moving quickly to build solar capacity in Latvia and have put serious thought into all of the potential risks that I have outlined. With investors such as these leading the charge for renewable investment in Latvia, our future is indeed bright.

Now let’s go get our share of those 4 trillion euro!

The Latvian version of this article originally appeared in the April 2023 issue of Forbes Latvia.