Survive the solar shakeout and reap substantial rewards

The study, "Solar Power: Darkest Before Dawn," predicts that, despite changes to the regulatory environment and dwindling financing options, photovoltaic installations could increase 50-fold by 2020, compared with 2005; rivaling gas, wind, and hydro power for capacity. Indeed, McKinsey expects installed solar capacity to increase by as much as 400 to 600 gigawatts (GW) within the next eight years.

For the industry players – downstream and upstream – to survive the shakeout, however, they will have to "dramatically" reduce costs, and deliver distinctive products and services, says McKinsey. Specifically, solar manufactures must develop capacity. "A few years ago, manufacturers needed to have 50 to 100 MW of solar capacity to compete … today they need two to three GW," it said. Developing proprietary technologies can also help to capture "significant" cost advantages – something that many players, like Hanwha TechM or MEMC are focusing on.

In terms of the downstream players, McKinsey advises that you should focus on getting to know your customers. It writes, "Since the bulk of the market in the next five to 10 years is expected to be in distributed generation, we focus here on downstream distributed-generation companies. These companies should focus on serving high-value customers at low cost. To do so, companies must know their customers well."

Light years: 2020 – 2030

Overall, McKinsey’s predicted that photovoltaic growth will stem largely from demand in five customer segments – four of which are likely to expand significantly by 2020; while the fifth is expected to surge from 2020 to 2030:

1. Off-grid areas

Solar power is ideal for far-flung, off-grid applications. The study identifies significant potential in areas where, to date, diesel generators have provided uninterrupted power supply (for example, India’s remote telecommunications towers). Off-grid applications have been economically practicable in some locations for several years, but have been deterred by the high credit risk involved in financing such isolated initiatives, as well as a by a scarcity of local distribution partners. Nonetheless, the analysts believe that demand in this segment could reach 15 to 20 GW by 2020.

2a. Residential and commercial retail customers in sunny areas

Many businesses located in sun-soaked regions such as California, Hawaii, Italy, and Spain, where power prices rise steeply at times of peak demand, already generate their own solar power. In the near term, this segment’s growth will depend on customer-acquisition costs, as well as the availability of low-cost financing and support from regulated utilities.

For example, in the United States and European Union, utilities might be tempted to modify their rate structures, in order to make switching to distributed generation less attractive for customers. In Hawaii, regulations require anyone located in a region where distributed generation represents 50 percent of peak demand to undergo a long and costly review before adding solar capacity. McKinsey forecasts that the demand in this segment is likely to be about 150 to 250 GW by 2020.

2b. Residential and commercial retail customers in partly sunny areas with high retail electricity prices

Parts of Europe and the United States, Japan, Canada, and some countries in Latin America fall into this segment. As in segment 2a, barriers to growth include access to low-cost financing and the ability to dramatically reduce customer-acquisition costs. New entrants from the security, cable, or broadband industries could leverage their existing customer relationships to acquire customers at a significantly lower cost than existing players. If the barriers are addressed, ballpark demand could be 65 to 120 GW by 2020.

3. Isolated grids

In the remote villages of Africa, India, Southeast Asia, and parts of the Middle East, where microgrids fueled by diesel generators provide power, the break-even cost of energy (also known as the levelized cost of energy, or LCOE) is between $0.32 and $0.40 per kilowatt hour (kWh). The analysts estimate that demand in this segment is already 25 to 30 GW. The current barrier to deployment is the limited availability of reasonable financing options in nations that are not working with the Organization for Economic Cooperation and Development (OECD).

4. Peak capacity in growth markets

The largest potential for this segment lies in emerging markets where major electric-power infrastructure already is in the planning stages (for instance, in India, Brazil, the Middle East, and China) or in nations that rely heavily on imports of liquefied natural gas (such as Japan). In these currently undeveloped areas, new solar-power plants that will be operational during periods of peak capacity will require an LCOE of $0.12 to $0.14 per kWh for economic justification. Greater access to inexpensive natural gas from shale could pose an obstacle to solar deployment, but demand may be about 150 to 170 GW by 2020.

5. New, utility-scale power plants

New solar-generation plants must reach an LCOE of $0.06 to $0.08 per kWh to compete head-to-head with new conventional plants (coal, natural gas, and nuclear). Like the smaller peak-capacity plants, utility-scale solar plants are most likely to get the go-ahead in emerging markets that are expanding their infrastructure aggressively, but again, the cost of solar will be compared with the cost of a new coal, natural-gas, or nuclear plant.

To reach this cost threshold, companies must achieve breakthroughs in manufacturing techniques; and, once they do, it will take time to scale-up any technological advances. Extensive use of solar as an alternative to traditional base-load generation is not likely before 2020, but the segment could reach 110 to 130 GW by 2030, representing only 15 percent of the cumulative new solar build in the same period. Margins probably will be set by the wholesale power price, however, and may be slim as a result.

The researchers found that, across these five segments, distributed rooftop generation is likely to be the dominant source of solar demand in OECD countries; distributed ground-mounted generation is likely to prevail in non-OECD countries.

Healthier margins

In addition to these segments, many entrepreneurial opportunities will arise for new players and investors. Large commercial customers are likely to prefer suppliers that can install and operate solar systems across a global network of sites. For example, a global developer could help big retailers such as Wal-Mart and Staples to deploy solar and energy-efficiency approaches in their stores.

Providers also will increasingly be asked to develop specialist solar applications, for example, IBM uses solar applications to power its high-voltage, direct-current data center in Bangalore.

As mentioned earlier, companies could partner with local vendors that already deliver products and services. For example, Eight19, a photovoltaic start-up, partnered with SolarAid, a nonprofit, to provide Kenyans with bundled products and services that include solar-powered LED lighting and phone-charging options. Customers pay for the services as they use them via scratch cards validated through a text-message service. These products are inexpensive to manufacture, and the innovative pay-as-you-go approach enables partners to address some of the financing challenges that might otherwise stymie their efforts to serve poor communities.

Given the emergence of these pools of demand, McKinsey & Company predicts that leading solar companies could have healthier margins by 2015. Prices paid for solar are likely to continue to fall, but sales should rise as solar power becomes economically justifiable for an increasing number of customers. What’s more, because prices for solar-based power are likely to be set by prices for fossil fuels instead of subsidies (which have been falling annually), margins for leading solar players should increase, even as their costs continue to decline.

As McKinsey succinctly summed up, "The solar industry is undergoing a critical transition. The rules of the game are changing, and many current players could face significant challenges as the industry restructures. But those who believe the solar industry has run its course may be surprised. Solar companies that reduce their costs, develop value propositions to target the needs of particular segments, and strategically navigate the evolving regulatory landscape can position themselves to reap significant rewards in the coming years."

Edited by Becky Stuart.