China Sneezes…

China Sneezes…

… and the PV world catches a cold.

In late May, the Government of China announced a major energy policy change. This new policy has substantial implications for the solar power market in China and across the world. It was a proverbial “China sneezes, and the world catches a cold” moment.

The new policy announcement has two major and interrelated elements: feed-in-tariffs will no longer be offered to new projects connecting to the grid, and all new utility scale solar projects must go through auctions. Wood Mackenzie, a consultancy, projects that as a result of the policy, and the effective wind-down of China’s FIT program, 2018 additions to solar capacity in China could be cut by nearly a half – from 48 to 29 Gigawatts.

This is big news for several reasons. A 20 gigawatt reduction in solar capacity? That is about equal to… the entire world’s solar generation capacity a decade ago. Another marker? There are only five countries in the world that have more solar generation capacity than 20 gigawatts. The difference between 20 gigawatts of solar operating for a year, and 20 gigawatts of coal-fired generation? About 120 billion tons of GHG emissions. A big deal.

The policy is also a big deal for a different – much more positive – reason. It will remove China from being in the unusual position, in the world of solar: the position of being a dinosaur. China has led the way in many aspects in recent years in solar, accounting for huge shares of global generating capacity, new investment, and solar panel production. This dominance has been a highly visible part of the government of China’s strategy to position the country as a technological leader. But in the increasingly important aspect of procurement, China has been the laggard, not the leader.

Procurement sounds like a completely boring topic. In the rise of renewable energy however, it has been an absolutely critical element. While technology has clearly played the starring role in the steep and continued price decline which have taken wind and solar power from expensive to THE low-cost option in market after market, procurement equally clearly deserves an Academy Award for Best Supporting Actor. Renewable Energy auctions, pioneered by Brazil and South Africa and then copied by an ever-growing list of countries, have been critical in translating declining technology costs into immediately declining power prices. Bloomberg New Energy Finance estimated, in a 2016 study, that the switch from other procurement approaches (Feed-in-Tariffs, direct negotiations, unsolicited proposals) to auctions led to drops in prices of wind and solar of over 20% in the first year, and 50% in the second year of auctions. That is a steeper decline than the – still impressive – declines in technology costs.

China, however, has not gone there. While almost all of Latin America, India, Pakistan, and now more countries in Africa have gone the auction route, China maintained its FIT program. Auctions have been run on a small scale, pilot basis. Prices offered to producers under the FIT program have been repeatedly adjusted, but still remain very high by the standards of solar tenders elsewhere in recent years. Current FIT prices for utility scale solar projects range from CNY 0.55 to 0.75 per kilowatt hour, or between 9 and 11 US cents/kWh. While that sounds pretty good compared to expected prices of solar power 5-6 years ago, it is now absurdly high compared to where prices of new solar capacity are today. Even Senegal has now tendered for solar at below 4 cents, as have the UAE, Chile, México, Saudi Arabia, South Africa and other countries. Unsurprisingly, China has found, as many European countries that maintained FIT programs over several years found, that renewable energy subsidies are expensive. China’s FIT program, which effectively subsidizes producer prices irrespective of declining technology costs, is expensive. 2017 subsidies for solar generation in China were estimated at $15.6 billion, and rising rapidly.

Now China will be a dinosaur no more. Let’s look at some of the impacts of this policy change.

1. In the short term, new solar capacity additions will slow down. If the drop in China is as large as is being projected, then global 2018 numbers will show a drop in the rate of new solar generation capacity, for the first time in two decades. As noted above, that drop is equal to all solar capacity worldwide a decade ago. This will be big news.
2. The shares of solar companies operating in China will fall. Indeed some share prices dropped by as much as 15% in the days after the announcement by GoC. The shares of probably all solar companies will fall, even if those not operating in China. India appears to be postponing plans for expanded domestic panel manufacturer given the glut that is coming.
3. Prices elsewhere in the world at solar auctions, notably in India, can be expected to fall farther, as companies look to replace the lost 2018 demand in China. What is bad news for companies is good news for governments and energy consumers everywhere.
4. Once the auction regime is up and running for solar projects in China, prices for new solar capacity will fall – a lot. From the current level of prices set by the FIT regime, around $0.10/KwH, prices are likely to fall a long way – probably to under two cents a kilowatt hour ($0.02/KwH). This will have major repercussions. Power prices on the grid (gradually) will begin to drop, and as auctions expand will begin to drop faster, reducing China’s energy costs. With the size of China’s market, it means global average prices of solar will now consistently be more than 50% lower than costs from greenfield coal-fired generation – which, only a few years ago, was thought of as the lowest cost energy available.
5. Dramatically lower power costs in China will in turn have their own implications. The visibility of two cent power in such a big economy, in a market which accounts for 50% of global renewable capacity, will be very high. From here one can expect an acceleration of new solar auctions throughout emerging markets, as few governments will want to feel left out of the party. So the bad news of lower 2018 solar capacity additions, due to China’s new solar policy, is likely to be offset by higher than expected 2019 and 2020 numbers. Good news for climate, good news for consumers, and with faster volume growth, good news for producers.
6. Infrastructure Ideas also believes that sharply lower prices in solar auctions in China will make negotiated contracts, as still being discussed across a number of Emerging Markets, politically untenable. Negotiated contracts for power capacity at 10, 8, even 6 cents will be ammunition for political opposition everywhere. In some countries, these prices will also make it very awkward for monopoly SOEs in generation. Monopoly providers will find it very difficult to follow, and will be unable to match anything resembling two cent prices, in turn making it increasingly difficult to justify building new solar capacity themselves when alternatives are so dramatically cheaper. Politicians backing solar plants for PLN in Indonesia, EVN in Vietnam, or EGC in Bangladesh, will find their position very uncomfortable, as will their financiers.

China’s sneeze is likely to become a global cold in 2018. But beyond then, the forecast is for more sun…