Is It Time To Buy The Solar Sector?

Is It Time To Buy The Solar Sector?

Solar energy production is booming but sector stocks haven’t performed well in 2015, caught in the downward spiral affecting the entire commodity complex. Despite broad selling pressure, traders and investors will be taking a fresh look at the industry at the start of 2016 to see if it’s the right time to step back in and build long exposure.

2015 will mark another record year for solar power installation, in a dramatic growth curve that’s accelerated since 2010. The industry is expected to install nearly 8000 mw (megawatts) during the year, bringing the installation base to 28,000 mw. Residential and utility markets show the highest growth rates, with 40% of new electric generating capacity coming from solar energy.

Meanwhile, solar pricing has gone the other way in the last decade. The Blended Average Solar PV Price ($/Watt) fell gradually from $8.00/watt in 2005 to $7.50/watt in 2009 and then plunged in a major downtrend, cutting through $3.00/watt in 2013. This decline has raised affordability for consumers but generated broad competition for business that’s cut into industry profitability.

Rapid declines in crude oil, heating oil and natural gas have also impacted the sector, with fewer potential consumers willing to cross over to solar because fossil fuel energy bills have dropped dramatically. The industry also faces major headwinds from the scheduled expiration and reduction of the Investment Tax Credit, which is expected to trigger a 55% decline in installed solar capacity in 2017.

Finally, utility companies are raising challenges to net metering policies that allow homeowners to sell unused capacity back to utilities. The industry impact could be devastating, as evidenced when Arizona’s Salt River Project added a fee that repealed the practice in 2015, triggering a reported 95% decline in installations. Solar homeowners can pay $15,000 or more for installations, which only makes sense if they can recoup costs through net metering.

Guggenheim Solar ETF

Guggenheim Solar ETF (TAN) provides the industry’s primary trading vehicle and market barometer. It tracks an index of companies that focus to varying degrees on solar production. The fund holds 25 securities, overweighting pure industry plays while underweighting non-pure plays. First Solar (FSLR) currently holds the highest weighting at 10.37% while Enphase Energy (ENPH) brings up the rear with a 1.08% weighting.

Components are drawn from all over the world, with a heavy weighting in Chinese stocks. This lowers the impact of U.S. government and utility subsidies while raising the impact of China’s economy. This is an important consideration because growth in BRIC countries has stalled in recent years, dampening economic outlooks of U.S. and European trading partners.

TAN came public near 280 (recalculated for February, 2012 1: 10 reverse stock split) in April 2008 and entered an immediate downtrend, aggravated by that year’s bear market. It bottomed out in March 2009 at 46.52 and more than doubled in price in just three months, peaking at 117 in June. Two years of sideways action gave way to a 2011breakdown to an all-time low, with the downtrend continuing into the 2012 low at 12.60. The breakdown roughly corresponds with lower GDP growth in the Chinese economy.

The fund bounced back to new resistance at the broken 2009 low in 2014, with that level ending the recovery effort. A June 2015 test failed to yield a breakout, with price rolling over into a new downtrend three months later, at the same time that crude oil was engaged in a ferocious decline into the 30s. It’s was trading near a 2-year low at the end of 2015.

Solar Sector Outlook

TAN’s failure to rally into the mid-30s during the fourth quarter of 2015 suggests lower prices in the first half of 2016. Danger levels for long positions will rise geometrically if the fund breaks the 2015 low near 25. If that happens, short sellers can look at new positions because the downtrend could reach the 2012 low in the low teens. That would mark a 50% decline from late 2015 levels.

Longs should stand aside in early 2016 and let this bearish scenario play out. Support may hold but it will still take a rally into the mid-30s to improve the deteriorating technical outlook. Even then, the fund will still trade under the 2011 breakdown in the upper 40s, limiting 2016 profit potential. Given this unfavorable reward: risk profile, opportunities look tightly skewed to the short side.

The outlook will significantly improve if Congress renews expiring subsidies and the Chinese economy gets back on track. Congressional action isn’t likely to happen until late in 2016, when the expiration date gets closer. Even then, the presidential election is likely to a major barrier to legislation, with highly partisan conditions inhibiting all sorts of rulemaking.

The Bottom Line

The solar industry has grown rapidly in the last decade but faces major roadblocks that have dropped industry securities into long term declines. The potential elimination of residential and utility subsidies stands at the top of this list, threatening to substantially reduce future production. As a result, short sales may offer better short and long-term opportunities than long positions.