Holding strong in the face of losses

Swean Lin, Vice President for Taiwanese wafer maker Green Energy Technology (GET) has a simple solution for the travails facing the global solar manufacturing industry. To restore the balance between supply and demand and thereby stabilize prices, he proposes the major solar buying regions – the EU, the U.S. and other major markets – should mandate minimum standards, say 250 watts, on all panels installed at taxpayer expense. “Once this happens, the business environment will become healthier and quality will improve,” Lin claims.
Lin’s proposal hits a number of issues facing global solar energy. China’s alleged state support for its solar industry has long been controversial. State bank loans financed the development of the industry in the late 2000s and now provide the lifeline that Chinese solar manufacturers rely on to survive the very market conditions of overcapacity that they themselves created. The top Chinese solar makers hold an aggregate debt of US$17 billion and suffered US$4 billion in free cash flow losses in 2011. Many insiders contend that without government support, many of these manufacturers, especially Suntech Power Corp and LDK, would be insolvent.
In an attempt to restore fairness to the market, the U.S. Department of Commerce ruled in favor of preliminary anti-dumping tariffs of approximately 34% to 250% on top of countervailing duties of up to 4.7% on Chinese made cells. A final determination on tariffs is expected from the U.S. International Trade Commission in October.
Lin’s proposal is intriguing if unlikely, particularly in the contentious U.S., but points to the desperation that solar manufacturers around the world and especially in Taiwan are feeling as prices continue to drop and losses mount.
Despite being costlier than its mainland cousin, Taiwan has managed to remain competitive by controlling costs through strict attention to efficiency and the manufacturing process. Taiwanese PV makers boast that their costs are no higher than the costs of Chinese firms, despite higher payroll. “We are one of the best in mass production,” notes Gintech’s President Wen-Whe Pan. “Our costs are competitive with anybody. And also from a quality point of view, we are one of the best.” But in the current climate, even the best control over costs isn’t enough to maintain margins, and Fubon Securities analyst Daniel Tzeng observes that nearly all manufacturers are losing money. For solar firms to survive, something’s got to give.

Impact of the anti-dumping tariffs

Taiwanese solar manufacturers initially greeted the U.S. antidumping tariffs of 31%-250% imposed last May with guarded optimism.
Gintech’s Pan complained that Chinese vertically integrated behemoths wanted to dominate every segment of the industry and could do so on a seemingly endless source of funding from state-owned banks. “A few companies dominate the market based on support from the government – it’s not fair,” Pan says.
Smaller Taiwanese firms, on the other hand, were exposed to the same market forces that had taken down larger firms – low prices and major losses. “So we fully understand the antidumping and countervailing tariffs,” Pan says.
Fairness aside, the tariffs also meant opportunities to steal market share. In a market as tight as solar, a 34% premium on Chinese cells would likely prompt module makers to seek out other sources. Low cost, high quality Taiwan is the obvious alternative. Taiwanese solar firms have over eight gigawatts of manufacturing capacity and three Taiwanese companies – Motech, Gintech and Neo Solar Power (NSP) are already among the Top 10 solar firms in the world. Cell orders are naturally being rerouted from state-subsidized Chinese solar firms to free-market Taiwan.
Daniel Tzeng says orders surged 21% in Q2 (compared to Q1) on U.S. tariffs. So why is Taiwan trying to attract suitors from China just as it has gained market advantage precisely by not being tied to China? The Taiwan External Trade Development Council (TAITRA) for instance, sponsor of PV Taiwan 2012 (along with SEMI Taiwan), touts the expo’s role for showcasing Taiwan’s advantages to attract “China’s PV manufacturers planning to make investments in Taiwan.” This comes even as Chinese solar firms are facing serious questions about debt loads, weak earnings and corruption. Some are even suggesting that the change of the government in October 2012 might call into doubt the Chinese solar industry’s seemingly never-ending lifeline of state-backed loans.
With China in the cross-hairs, wouldn’t it be wiser for Taiwan to edge away from China, rather than lean farther in?
For many Taiwanese firms, the question of investing in China sometimes comes down to patriotism. Taiwan and China share a long complicated history; the two split at the end of the Chinese Civil War in 1949, and China still claims Taiwan as its own. Taiwan/China relations remain passionate and controversial, and questions of economic integration get to the heart of this divide. While most Taiwanese manufacturers also have substantial capacity in China, some proudly wear a “Taiwan only” identity, including Gintech and NSP.
Gintech and Neo Solar Power stress their Taiwanese origins and boast of Taiwan’s many advantages over China – higher efficiency, greater expertise and even better financing and lower interest rates. These allow Taiwanese manufacturers to compete cost-wise with Chinese manufacturers despite higher labor costs while delivering better products. The tariffs highlight ‘Brand Taiwan,’ and Taiwanese players that straddled the straits, such as Motech, have taken to conspicuously marking products manufactured in Taiwan to prevent cases of mistaken identity (and tariff levying).
The tariffs worked as expected, too. Now, the EU is also considering similar tariffs on Chinese made cells, another boost to Made in Taiwan.
However, despite an increase in orders, the U.S. tariffs are not seen as having had a significant impact on the underlying industry fundamentals. Taiwan’s solar makers continue to face an extremely tight market that seemingly grows worse by the day. It is true that Taiwanese cell makers did see orders go up on U.S. tariffs, but the impact on the bottom line was negligible. Even with tariffs, global solar prices continue their steep descent, touching new floors at US$0.43 per watt for cells and US$0.739 for modules. With costs coming down far more slowly, just breaking even looks like success.
Maxim analyst Aaron Chew notes that Taiwanese cell makers’ revenue declined 13% month-on-month in July for the second consecutive month due to low prices but also fewer overall orders. While orders had picked up in the weeks and months immediately following the Department of Commerce’s decision on tariffs, the April FIT cuts and expiration of the June 30 extension for small projects in Germany led to softening demand. Chew writes, “We believe demand began to taper off significantly in July, weighing on Taiwanese utilization rates.” Taiwanese solar firms made over NT$4 billion (US$134 million) in July, a decline of 16%, while wafer makers earnings only declined 0.5% in the same period, to over NT$1.5 billion (US$50 million).
The nature of the orders Taiwan is seeing more of is also an issue. Daniel Tzeng of Fubon Securities notes that Chinese vertically integrated manufacturers are increasingly outsourcing their wafers to Taiwanese firms for cell fabrication, and then bringing the cells back to China for module assembly. Tzeng says that with solar prices continuing to plunge in Q3, “most domestic solar cell manufacturers don’t want to do [outsourcing] anymore.” The picture is no less grim in other solar manufacturing markets, casting doubt on the efficacy of the tariffs. Solar’s dark ages continue, what Gintech’s Pan describes as solar’s “Age of Competition” – with only the strongest competitors surviving.
The fundamentals of the industry – too much manufacturing capacity making too many solar products for too few customers – remain unchanged. And with China’s perennial support for its solar industry so far preventing what would otherwise be insolvent firms from failing, little capacity has come offline, despite widely publicized solar bankruptcies in other markets.
That might explain why cross strait investment is being actively courted by Taiwan as a good opportunity to leverage China’s deep pockets. The Taiwan External Trade Development Council notes that trade agreements such as the Economic Co-operation Framework Agreement (ECFA) between the two sides of the strait reduced corporate tax rates, improved diplomatic ties, and made the investment environment more attractive for China’s PV manufacturers planning to make investments in Taiwan.
Differentiation has not been much of a boost after all. Perhaps further integration, then, is the answer?

Cash is tight on both sides

GET’s Swean Lin notes that his company already has significant production in China and is considering investing in more Chinese capacity, but notes a number of difficulties. Intellectual property is reputedly not secure in the Chinese market. He notes that GET has proprietary processes that allow them to “push impurities out” of their poly wafers, giving them a distinct quality advantage over rivals. But he fears that if they take this know-how to China, their partner might walk away from the project with that know-how in tow, becoming a rival rather than a partner.
Considering the turbulent solar market and relentless slide of prices, cross-strait tie-ups might not even be an option anyway, says Daniel Tzeng. Cash is tight on both sides and few have the financial means to raise money on the market. Whether or not firms might welcome Chinese money or manufacturing capacity, “they just don’t have the money anyway,” says Tzeng.
He also notes that cross-strait mergers and acquisitions would do nothing to address the basic problem of overcapacity. Combining production capacity would only compound overcapacity problems, not alleviate them. “I don’t think this will help domestic solar makers to become profitable,” he says.
The poor financial condition of solar players is a clear indication of the terrible state of margins in the industry. But could there be a ray of hope in all this financial gloom? In a darkest before the dawn moment, does the dismal state of solar manufacturing – so bad even China’s state support is called into question – indicate the market is at a tipping point? Has the game advanced to the point where mass failures – even in China – of weaker competitors are imminent? Getting rid of excess capacity alongside forecasts for rising demand would hopefully lead to more balance between supply and demand and more stable, and viable, pricing; a state of equilibrium for solar makers. In short, has the culling begun?
Gintech’s Pan thinks so. He sees 80% of today’s players falling out over the next few years, leaving the market in the hands of the strongest 20%.
The wildcard in this war of attrition is China’s support for its domestic industry.
Recent Taiwanese news reports and several market analysts’ reports indicate that even in China market forces might yet prevail. China’s solar industry has faced a year and a half of losses and survives by mostly reckoning on life support provided by state-run banks. But with a new government being installed in China between October 2012 and March 2013, does this perhaps herald deep changes in how China’s government will view solar energy?
This is the idea put out by Aaron Chew of Maxim, NYC. In his market report of July 25, Chew says that China’s new government, set to be installed between October 2012 and March 2013, might have a different take on the solar industry. Chew writes that while Chinese solar firms have survived the extreme market conditions of the past year and half, “we believe investors may have grown too complacent that this support may be perpetual.” Market forces might mean that even the deep-pocketed Chinese government will ultimately reconsider continuously investing in a money-burning industry. “While influence with the provincial governments and banks runs deep, cash reigns supreme,” observes Chew.
While support for the solar industry is enshrined in China’s 12th five-year plan, Chew believes support for individual companies remains the purview of local government and banks. With even tighter market conditions on the horizon, solar firms might even face trouble meeting payrolls. That would certainly create doubts in provincial leaders charged with growing their local economies and possibly causing some to seek better returns elsewhere. Chew writes, “Provincial governments ultimately recognize their need to allocate their limited resources to industries with brighter outlooks for cash flow to invest in growth and employment.” Debt loads for Chinese manufacturers are also crushing. On top of a combined debt load of US$17 billion, advances in technology would require massive and continual investments in R&D and equipment just to maintain market share in a market promising razor thin margins at best. Chew writes, “We believe it is only a matter of time before banks realize the only prudent move is to curtail future capital contributions, even if it is at the expense of its original investment.” What would this mean for the industry? Would massive insolvencies in the Chinese solar industry lead to an improved supply and demand situation?
Business failures in China “would definitely help the oversupply situation by removing excess capacity,” forecasts Daniel Tseng. Unfortunately, the present looks quite different. Taiwanese companies have suffered the current economics of solar alongside everyone else, with most either losing money or breaking even. It’s no wonder then that Taiwan is seeking outside investors. Forecasters see more of the same poor financial situation through the end of the year: capacity outstripping demand and ever more downward pressure on prices. Subsidy declines in Germany and Italy are also putting a damper on global demand, with emerging solar markets such as Japan, China and the US not yet making up the difference.
Still, Taiwanese firms are holding strong in the face of losses. While Andy Shen, Senior Vice President of NSP, acknowledges the short-term challenges, he expresses confidence in his company’s survival. He cites key qualities of those that will survive the Age of Competition: most cost-effective operations and highest quality product with highest efficiency and longest life. “These are the business fundamentals of this industry,” he observes. “In the long run, solar is inevitable.”