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The Sun'll Come Out Tomorrow for First Solar in the U.S.

First Solar (FSLR) has become a developer of utility-scale solar projects in the U.S. to ensure a captive market for its own solar modules. Construction delays, however, could drive up overall systems' costs and lessen the economic attractiveness of this strategy.

In second-quarter 2010, First Solar shipped 344 megawatts (MW) of cadmium-telluride (CdTe) thin-film solar modules, up 19 percent from last year. Germany contributed about 50 percent of this total, followed by deliveries to the U.S., France and Italy, according to Chief Executive Rob Gillette. Demand could slow in key European markets next year, however, due to photovoltaic (PV) incentive cutbacks and continued capacity ramp-ups way above anticipated market growth, especially from Chinese crystalline-silicon (c-Si) module manufacturers. Market imbalances are expected to reverse recent gains witnessed in average selling prices, too.

The sale of solar modules from its components division has historically been viewed as the engine driving profitability, return on assets, and cash flow; whereas, systems' sales were always the disrespected younger brother in the organization, due to lower-returns: gross margin for component sales of 52 percent for the second quarter were double the gross profitability of system installation-related activities, according to second-quarter 2010 regulatory filings.

Despite less attractive economics, the Tempe, Arizona-based firm is pushing forward to reduce exposure to module-only competition. Management told analysts on the second-quarter earnings call the company was scaling up scope and size of PV systems' activities, including design and management of utility-scale power systems -- a strategic decision centered in their belief that wearing of two hats, builder and manufacturer, would help mitigate certain challenges plaguing even its c-Si solar module rivals:

  • Visible and More Predictable Demand. To date, a "gold rush" mentality has characterized solar panel markets in Europe -- as epitomized by Spain and then Germany: suppliers flood market with product simultaneously, looking to beat subsidy expiry dates -- overwhelming demand. By developing its own projects, First Solar hopes to better regulate demand and supply imbalances (and regain control over pricing).
  • Better Inventory Management. At June 30, the company had 2.2 GW in backlog for PV systems in North America (57 percent more than its current annual global manufacturing capacity of 1.4 GW). Owning this captive distribution channel for its supply of modules and panels should help the company increase operating margins -- via improved manufacturing efficiencies, like lower raw material costs (e.g. cost-related savings from economies of scale in bulk purchases) and construction expenses (shorter lead times and shipping distances).
First Solar anticipates starting construction of up to 700 MW in solar farm-related projects next year from its contracted pipeline. This is an ambitious agenda, as the entire nameplate PV capacity currently installed and sold to power sellers in the U.S. is only about 610 MW -- most of which are concentrated in dissimilar PV-based technologies, such as thermal projects.

Product performance and warranty-related issues aside, of three ambitious solar farms planned for the southwestern corridor in the U.S., only the 290 MW Agua Caliente PV project -- on 2,400 acres located about 65 miles east of Yuma, Arizona -- is "shovel-ready," having cleared regulatory hurdles, like permits and zoning.

Construction is scheduled to begin before year's end, according to CEO Gillette, and panels could be readied for installation come first-half 2011.

First Solar has never built a solar plant of this size, but the company inherited experienced teams of engineering, procurement, and construction (EPC) experts from its frenzied buying of utility-scale (EPC) developers during the last three years. Management stands firm with a scheduled completion date by year-end 2013.

Pacific Gas & Electric (PGE) has contracted to purchase deliveries from the project for 25 years, estimated -- when connected to the grid -- to be able to meet the power demands for up to 100,000 households annually.

Two other potentially lucrative utility-scale deals working their way through the regulatory process are:

  • The 550 MW Topaz Solar Farm, to be located on 4,500 acres of farmland in San Louis Obispo County, an area along the Pacific Coast between Los Angeles and San Francisco, will generate enough electricity to power about 165,000 annually.
  • The Desert Sunlight project, set to be built near Desert Center in eastern Riverside County, California, with an anticipated total installed capacity of 550 MW: PG&E -- signed power purchase agreement (PPA) for 300 MW and Southern California Edison (SCE), a signed PPA for the remaining 250 MW.
First half of 2011, the aforementioned 2.2 GW in systems backlog won't buffer top-line growth from weakening demand in EU markets. Revenue received from modules sold to utility-scale systems are recognized according to an accounting method known as "percentage of completion" method: According to generally accepted accounting principles (GAAP), PV products for the Aqua Caliente project can only be recognized and booked as revenue in the quarters in which they are shipped and installed.
Suspect each moment, for it is a thief, tiptoeing away with more than it brings. ~ American novelist John Updike, A Month of Sundays (1975)
Less a slippery pickpocket, more like a noisy Tom Sawyer-like rapscallion, Father Time is ready to wreak havoc on First Solar's plans to ramp up its utility-scale ambitions. Specifically, momentum in U.S. PV markets could stall due to expiring federal tax incentives:

A key provision of the American Recovery and Reinvestment Act of 2009 (ARRA 2009), which subsidized up to 30 percent of construction costs for PV plants (through Investment Tax and Production Credits), will no longer be available for pipeline projects that don't start construction by year-end 2010. Consequently, First Solar's Topaz Solar and Desert Sunlight won't be eligible for these tax incentives, as both initiatives are still hung up in Dante-like circles of regulatory hell.

First Solar spokesperson Alan Bernheimer confirmed in an e-mail response "groundbreaking isn't likely for either Sunlight or Topaz before 2010 year-end." However, Bernheimer insisted both irradiation projects may still qualify for Treasury grants (instead of ITC) -- if "certain expenditures are made before the year-end deadline."

The "certain expenditures" Bernheimer has referenced is a gaping loophole with ARRA 2009: First Solar could still qualify for cash in lieu of tax credits -- as long as they start "construction," which by the Fed's definition includes just some solar panel shipments.

The alt-energy federal funding program, however, is running out of cash. At August 16, of the $6 billion allocated by Congress to a loan guarantee program (backed by Dept. of Energy) for solar and other renewable programs, $3.5 billion had already been spent -- and President Obama recently dipped into the fund and "borrowed $1.6 billion" for other appropriations -- leaving just $1.9 billion in the register.

In racing to get all its permits signed before the application grant deadline set for October 2011, First Solar needs to sidestep another inconvenient obstacle -- desert dwellers: Last month, a tiny rodent temporarily derailed a 250 MW solar project proposed by c-Si solar module challenger SunPower (SPRWA), to be built near First Solar's Topaz project. The San Luis Obispo county Planning Department released a report also recommending that the project's electrical output be reduced 40 percent to protect the habitat of the giant Kangaroo rat, an endangered species local to the region.
In an e-mail response, First Solar's Bernheimer stressed his company is working with scientists to mitigate any risks to indigenous species:

The only threatened or endangered listed species that Topaz may impact is the San Joaquin Kit Fox (we are avoiding habitats of two species of fairy shrimp that are also listed). We are working with leading Kit Fox biologists so that the project design may ultimately improve the site as Kit Fox habitat.

About 85 percent of the power price received from a large-scale solar power plant goes to repay the capital (investors) lent to build the project, according to Kathleen Weiss, VP - Government Affairs, First Solar.

Elimination of tax incentives will increase payback periods (time needed to recoup initial investment) and levelized costs of energy (revenue stream over life of project that meets minimally accepted equity rate of return and covers debt servicing of project).
Venture partners will require even higher interest rates commensurate with perceived or actual increases in construction risks or delays, further squeezing First Solar's profit margins: a 200 basis point increase to investors from seven to 9 percent would increased levelized revenue costs on the project by roughly 7 cents/kWh, according to energy analyst Mark Bolinger.

First Solar just got stung from fresh black smoke -- and not from Santa Ana wind-fueled brush fires: a natural gas pipeline owned by PG&E exploded in a suburb of San Francisco last week, resulting in the deaths of at least four people. If found negligent, California's largest utility -- and the company's biggest domestic (utility) partner -- could face a "challenging regulatory environment," according to an analyst at Morgan Stanley (MS).

Absent stimulus extensions, First Solar will likely need to scale-back its solar park construction schedule, likely leading to inventory write-downs next year as module selling prices continue to decline.

The sun'll come out
So ya' gotta' hang on
'Till tomorrow ~ Broadway musical "Annie"
In addition to having a 15 - 20 percent cost structure advantage over most c-Si challengers, this global leader in thin-film module manufacturing has an enviable balance sheet -- net cash balance of more than $800 million. I suspect the company will use any weakness in domestic demand to swallow additional systems projects from struggling, poorly capitalized competitor for its utility-scale portfolio.

Longer-term trends still favor manufacturing costs trending lower and demand higher. Come what may, tomorrow in America still looks pretty good for First Solar.


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