Solar Power Comes of Age: How Harnessing the Sun Got Cheap and Practical

Dickon Pinner & Matt Rogers. Foreign Affairs. Volume 94, Issue 2. March/April 2015.

Solar power has been declared a winner before, only to flounder. It’s easy to remain skeptical today, given that solar power accounts for less than one percent of the global energy supply. But it is also expanding faster than any other power source, with an average growth rate of 50 percent a year for the past six years. Annual installations of photovoltaic panels increased from a capacity of less than 0.3 gigawatts in 2000 to 45 gigawatts in 2014-enough to power more than 7.4 million American homes. This time really is different: solar power is ready to compete on its own terms.

The momentum behind solar power is a result of innovations in regulation, industry, technology, and financing. In a number of markets, it no longer needs public subsidies to compete on price with conventional power sources, such as coal, natural gas, and nuclear power. The International Energy Agency, which has historically taken a conservative approach to evaluating solar power’s prospects, has projected that by 2050, in the best-case scenario, solar energy could be the single biggest source of power, generating as much as 27 percent of electricity worldwide.

If that happens, the consequences will be profound. Electricity will reach places that have never known what it means to get light or heat on demand. The price of electricity could fall, and utilities will have to figure out how to adapt. But the environmental gains, in terms of lower emissions of particulates, sulphur, and greenhouse gases, would be profound.

The Power of Policy

Four factors lie behind the rise of solar power. The first is regulatory support. Around the world, governments have enacted a range of pro-solar policies, including requirements that utilities generate a given fraction of their electricity from solar power, feed-in tariffs (a guaranteed price per kilowatt of solar power), and subsidies to manufacturers of solar panels and the households that buy them. Policymakers have supported solar power for a number of reasons, including a desire to reduce emissions, diversify their countries’ energy supplies, and create jobs. Perhaps most important, they recognized the long-term potential of solar power and wanted to foster a market for it.

Germany, the country with among the most aggressive polices, added 35 gigawatts of solar-panel power in the last ten years, driving the majority of global demand for much of that time. In the United States, a set of mandates requiring utilities to produce a certain amount of electricity from renewable sources and a federal tax credit that allows taxpayers to write off 30 percent of the cost of installing solar power systems have helped the power source take off. From 2000 to 2013, solar-panel capacity in the country increased from 18 megawatts to more than 12,000 megawatts-enough to power almost two million homes.

Not surprisingly, regulatory support has not always been economically efficient, but it has been effective in creating enough demand for a large solar-panel industry to take shape and learn how to compete. Even as the industry has endured painful shakeouts- in the middle years of the last decade, in particular, dozens of solar-panel manufacturing companies went bankrupt-installations have continued to soar, and the industry has become much more competitive. Almost all solar installations in California, for example, took state subsidies in 2007. By the end of 2013, less than 40 percent did. Federal subsidies are still available, of course.

The second factor is industrialization, chiefly in China. Beginning around 2005, manufacturers there entered the solar-panel market to chase growing global demand, and they now account for nearly two-thirds of global production of solar panels. Chinese competition squeezed profit margins and drove many suppliers out of business, but it also led to improved production processes and new economies of scale, cutting costs substantially.

The last decade has seen technological innovations in manufacturing, low interest rates, leaner supply chains, and improved economies of scale; the price of polysilicon, the raw material used to make solar panels, fell by 90 percent over this period. The net result is that the cost of solar panels has fallen by 80 percent since 2005. Prices are still falling, by five to 12 percent in the first half of 2014, and there is room for them to fall further. So-called soft costs- meaning the cost of everything but the equipment, such as permits, installation, and maintenance-account for almost two-thirds of the total price tag for U.S. residential solar systems. Soft costs are about one-third of the price tag in Germany, where, among other factors, national standards have simplified installation and streamlined the permitting process.

The third factor behind the rise of solar power is technological innovation. Slowly but steadily, solar panels have become more efficient. Efficiency rates have peaked at about 20 percent- meaning that a panel is able to generate two watts of electricity for every ten watts of sunlight hitting it-but that figure could grow as the industry experiments with a number of new techniques and materials. If it does, the savings could be significant: every percentage point increase in efficiency can translate into a five percent cost reduction on the entire system. There is also room for greater efficiency after the electricity is generated, when power is lost as direct current (produced from the panels) is converted to alternating current (required for distribution by the electrical grid).

The fourth and final factor involves financing. Setting up a solar system entails high up-front costs. It takes about $15,000 to $20,000 to install rooftop panels on a typical house, and even though the investment can pay off over time, many households and businesses are wary of spending so much cash at once. New financing models are addressing this problem. Under thirdparty ownership systems, homeowners sign contracts with companies that install and maintain the solar panels. In return, consumers pay either a set monthly rate or a fixed price per unit of power-paying no cash out of pocket but still getting lower electricity bills. In 2012 and 2013, more than two-thirds of the installations in California used this financing approach, one reason the state is leading the country when it comes to solar power.

More for the Money

Given these trends, it is not a stretch to assume that in many markets, the costs of solar power will continue to decline by eight to 12 percent a year. First Solar, an Arizona-based manufacturer, expects its solar-module production costs to fall from 63 cents per watt in 2014 to about 40 cents per watt in 2017. Utilities that rely on coal and natural gas-commodities whose prices are subject to market swings-could never be so confident of continuous year-on-year reductions.

The development of technologies to store electricity-in particular, batteries- will also help solar power’s development. Without storage, solar power can be harnessed only when the sun is shining; with storage, it can be used when power costs are highest. The costs of battery storage have declined by about 70 percent over the last five years, and already, companies such as SolarCity are packaging solar panels with batteries. The price could fall by another 70 percent in the next decade as the technology and manufacturing methods improve, thanks in part to battery research conducted by consumer electronics companies such as Panasonic and electric-vehicle companies such as Tesla.

It’s not safe to bank on great leaps forward in efficiency and storage. But even without such advances, solar power is making inroads into major markets.

In the United States, rooftop solar panels are already competitive in places with lots of sun and high power prices, such as Hawaii and parts of California. As the cost of solar power continues to fall over the next decade, it could make economic sense for consumers in a dozen U.S. states by 2020 and for specific customer segments-such as those with high electricity consumption and wellpositioned rooftops-in more than 25 states by 2030, even without government subsidies. In much of Australia and central and southern Europe, solar power is coming close to reaching an economic tipping point. And China, where many cities are so dirty that snow turns gray by the time it hits the ground, is pushing hard, with a goal of installing 70 gigawatts of solar power by 2017.

In the Middle East, solar power is competing against oil-fired electricity generation, which costs 12 cents per kilowatt-hour. In 2014, the Dubai Electricity and Water Authority agreed to purchase solar power at half that price. Solar power now accounts for less than 100 megawatts of capacity in sunny Saudi Arabia, chiefly because oilpowered generation is so cheap, with providers paying only a little more than the cost of production per barrel (about $5). As oil-producing countries turn away from burning oil domestically in order to sell it for higher prices on the international markets, the case for solar power will get stronger. Heeding that logic, the Saudi government has unveiled plans for two gigawatts of solar power by 2015 and 41 gigawatts by 2032.

Japan is not as sunny, but it is also betting big on solar power, as it seeks alternatives to the nuclear plants it closed in the wake of the 2011 Fukushima disaster. It has established generous feed-in tariffs for solar power and other alternative sources. Japan installed more than eight gigawatts of solar power in 2014 and has set an overall goal of having renewables account for 20 percent of its power by 2030, about double the figure before the disaster. There is also room for more solar power in Asian countries, such as China and South Korea, that rely heavily on liquefied natural gas, the price of which is linked to oil and can therefore swing up and down.

In places that are not yet electrified, such as much of South Asia and Africa, solar power is usually cheaper and easier to access than conventional energy sources. In India, where about 100,000 villages lack access to electricity, solar power is already less expensive than the likely alternatives, such as coal or diesel (and often more reliable). Solar power also eliminates the need to wait for transmission lines to reach a town. India’s new prime minister, Narendra Modi, appears to see the benefits, announcing in January the ambitious goal of building 100 gigawatts of solar power by 2022, which could make India the largest solar power producer in the world. For villages that aren’t connected to the electrical grid, the combination of solar panels, efficient lighting, cell-phone plugs, and electric water pumps could improve the quality of hundreds of millions of lives.

The Coming Disruption

As the rates for solar power begin to match the rates for traditional energy sources in more and more markets, the capacity of solar power installed each year could increase from about 45 gigawatts today to more than 200 gigawatts by 2025. That would fundamentally disrupt the electric power sector.

In Europe, the proliferation of solar panels, wind turbines, and other renewable sources is changing the composition of the electricity sector. The market share of renewables there rose from six percent of the total in 2006 to 12 percent by the end of 2013, and it has risen much more in some countries. That significant new supply, combined with low growth (or even shrinkage) in demand due to efficiency gains and slow economic growth, has helped push down the wholesale price of power. The price that consumers pay is still high, however, due to the cost of infrastructure plus various taxes. European consumers pay an average of roughly 26 cents per kilowatt-hour, compared with the 12 cents Americans pay.

High prices in Europe have made it easier for renewables to compete, as have requirements that utilities give priority to renewable power on the grid. But European utilities are suffering in part because of this growth in renewables. From a peak of $1.3 trillion in 2008 to the end of 2013, their market value declined by half. In 2014, Germany’s biggest utility, E.ON, announced a radical move: in order to focus on renewable power, it will spin off its nuclear and fossil fuel power plants into a separate company. Japan’s utilities, too, have found themselves unprepared for the solar surge, and are threatening to hold back on access to the grid.

Utilities in parts of the United States are beginning to face similar problems. Traditionally, U.S. utilities stayed profitable by capturing all new demand for electricity, but solar power is threatening that reliable revenue stream. In the first half of 2014, solar power accounted for a quarter of new capacity, and a house equipped with solar panels doesn’t buy as much power from the grid. The resulting drop in demand is shrinking the amount of new capital that utilities can invest, meaning that even if solar power continues to generate a relatively small fraction of electricity in the United States, it could have an outsized effect on the industry’s future. In a 2014 survey by the consulting company Accenture, 61 percent of utility executives said that they expected to see noticeable revenue losses as a result of the spread of distributed power sources, including solar power.

Solar power could shake up other sectors, too. In the housing industry, for example, the spread of rooftop solar panels could transform construction and design practices. In manufacturing, factories could relocate to areas with favorable conditions for low-cost solar power. In agriculture, hot countries that lack fresh water could harness solar power for desalinating and pumping water, enabling farmers to work previously infertile land. History suggests that when a commodity gets cheaper and cheaper, it gets used in new, unforeseen ways.

Risks and Resiliency

Amid all the optimism, it’s worth considering what might set back solar power. One possibility is that govern- ments might dismantle or weaken their supportive policies. That could hurt, as it did when Spain cut subsidies in the wake of the financial crisis and when Germany lowered its feed-in tariffs.

In both markets, the adoption of solar power slowed down, but the industry as a whole kept rolling. Indeed, the solar industry has proved resilient, coming back leaner and stronger from its painful shakeout a decade ago.

The biggest risk in many markets is not that government support will go away but that long-standing regulatory issues will fester. In the United States, for example, utilities are concerned that solar consumers get a nearly free ride, since they rely on the grid on cloudy days and when the sun goes down yet no longer cover the grid’s fixed costs. And in some states, when consumers sell electricity back to the grid, they get paid the retail rate for it rather than the lower wholesale rate, a practice known as ” net metering.”

In response, some utilities want to charge households with rooftop panels for access to the grid, imposing fees known as “demand,” or ” capacity,” charges. That would change the economics of solar power substantially, depending on how high the fees went. Some utilities in the United States would like to recover the full fixed costs of distribution from solar customers and also end net metering. Regulators may not go that far, however. In 2013, for example, Arizona allowed its largest utility to impose a fixed charge on households with solar power, but the fee was much lower than what it wanted, and the state preserved net metering.

How and when the debate over recovering fixed costs is resolved in country after country will be one of the most important factors determining how fast solar power will scale up and how much of it will be centralized (in the form of large, faraway solar plants) and how much decentralized (on rooftops). Both sides could take their cues from the telecommunications industry. When the monopoly in that industry was broken up in the United States in the 1980s, new market entrants were guaranteed access to the existing infrastructure but had to pay reasonable fees that compensated existing providers for their services, while also leaving room for new competition. And it is worth remembering that an unprofitable utility sector benefits no one; a reliable grid is a national necessity. As SolarCity’s ceo, Lyndon Rive, told the Financial Times, “It is important that there is a grid.”

Compared with the regulatory dispute, other challenges look easy to deal with. One possible risk is the inevitability of higher interest rates (interest rates have nowhere to go but up), which would raise the costs of financing solar power. But there is strong demand among institutional investors for “yield cos”-publicly traded companies that package the cash flow from renewable energy. These low-risk investments should help moderate financing costs. Besides, higher interest rates would also affect other capital-intensive alternatives for generating power.

Another risk is that lower-cost power sources, such as natural gas from shale deposits, could undercut the economics of solar power. In the short term, that may happen. In the long term, however, natural gas is more friend than foe to solar power. Natural gas tends to be a cheap and reliable source of flexible power that can complement solar-generated electricity by providing 24-hour backup. This reduces the costs of integrating solar power into the grid. Indeed, solar power is going strong in the place with the world’s lowest natural gas prices: North America.

A third possible risk is that nuclear fusion or some other breakthrough will finally take hold. Perhaps, but that is a hypothetical. Better to bet on a proven technology that is seeing its sales booming and its costs falling.

Here Comes the Sun

Coal, natural gas, and nuclear power, which today supply two-thirds or more of global power, are not about to disappear. But even at its currently low rates of market penetration, solar power has begun to shift the economics of electricity. This is the dawn of the solar age.

If that sounds overly optimistic, consider another technology that went from curiosity to commonplace in a matter of decades: the automobile. When the first car hit the American street in the 1890s, skeptics sneered that the “horseless carriage” had no future. In 1900, there was only one car for every 10,000 Americans. In 1908, however, the Model T hit the market, making cars more affordable for many more people. By 1920, there were almost 900 cars per every 10,000 Americans. The global solar industry is at an analogous stage to where the auto industry was in 1920. Just as it was not yet the norm for Americans to have a car in 1920, it was becoming normal. And norms can change quickly. Between 1920 and 1930, the rate of car ownership shot up to 2,170 cars per every 10,000 Americans. The United States was now a car country.

The next ten years could see something similar with solar power, but on a global scale. It would not be at all surprising, for example, if most new housing developments, particularly in the sunnier parts of Europe and the United States, came with solar power, or if most of those 100,000 Indian villages without power were lit up at night thanks to solar energy. Even without a great leap forward in efficiency and batteries, and even with halting and sometimes contradictory government policies, the momentum behind solar power has become unstoppable.