The Hottest Solar Investment No One’s Talking About

The solar market has been one of the fastest growing markets, and we have seen companies in this sector jumping 60%, 80% and even 100% in just a couple of short months.

Renewable energy has been a hot political topic, but it has been just as hot as an investment. We have seen tremendous growth in wind, hydro and geothermal energy production, but one of the more recent markets to catch fire has been solar. To see just how explosive this market really is, there is no need to look any further than a couple of solar module producers, Trina Solar (TSL: NYSE) and First Solar (FSLR: NASDAQ). These two companies have recently signed some major deals, and it has shown in their stock prices.

These companies have seen huge run-ups in the past few months, but I have reason to believe there’s an even better way to play this market. More on that in a second…

Let’s first take a look at Trina Solar. It has recently signed contracts with a German company and three Italian companies. These contracts have TSL set to deliver solar modules that will produce approximately 88-99 megawatts of power over the next three years. Just on the news of these contracts, TSL stock jumped 16%, but this company was hot before these contracts even came out. TSL is up over 60% since the middle of June! But it isn’t the only one taking advantage of the solar boom. In fact, the story for First Solar is even more impressive.

First Solar, like Trina, produces solar modules. With the signing of its recent contracts, FSLR is set to manufacture and sell enough solar modules to create 658 megawatts of power by 2012. To make this number relevant to you, the total amount of solar energy produced in the U.S. amounts to approximately 400 megawatts. This is an enormous deal, and to help make good on its end, First Solar has announced the production of a manufacturing plant in Malaysia that will have an annual production of solar modules producing 120 megawatts of power. This plant is set to come online in the first half of 2009. I tell you that the stock market has really loved FSLR. After the news release of its most recent contracts, First Solar jumped 24%, but even more impressive is that it has more than doubled in price since the beginning of May.

These are two great stories in the solar market, and I can just see you sitting in front of your monitor saying to yourself, “Woulda, shoulda, coulda.” There was a time when I was saying the same thing to myself, but we can’t dwell on the past. We can learn from what has happened and use that knowledge to make profitable decisions in the future.

I KNOW that the solar market is still young, and there are still some amazing gains to be had. In fact, I have a totally different way to play this market and experience what might turn out to be the greatest gains of the solar market yet to come.

Commodities and Solar Energy

Commodities aren’t the first things that come to mind when you think of the solar market. Why should they be? The whole notion of renewable energy is based on the fact that it doesn’t use oil, coal, natural gas or other tangible assets to produce electricity.

My passion in life happens to be commodities investing. It’s what I do because I love to do it. I invest in commodities for two main reasons. The first is that I’m a simple guy who likes to read the supply-and-demand fundamentals of a market. What you see is what you get. The second reason I prefer commodities investments is that I believe in holding tangible assets with M3 money supply growing at around 13% per annum.

But back to the point at hand, I loved the market for solar energy, but I really wanted a way to play it with a commodities investment, because that’s what I do. It didn’t take much digging before I came across what traders were calling “gray gold.”

Gray gold, or silicon, is the base semiconductor used in the production of over 85% of solar cells. Rapid growth in the use of solar energy has led to a very large increase in the demand for silicon. The problem is that refiners are really having a hard time in keeping up with this sudden increase in demand. I will get into the supply and demand of silicon shortly, but I first need to cover an important notion.

Solar Technology

Don’t let this subhead fool you, because I’m not going to bore you with technological details. I just want to make one very important point that explains why there are no reasonable substitutes for silicon in the solar market.

The idea of substitutes is very important because it can act as a price cap for curtain items. For example, if the price of beef gets too high, people will start eating more poultry. If there is a feasible substitute, there is a limit to how high the price of an item can go before consumers switch to something else.

Here’s why there is no reasonable substitue for silicon. It is the same reason that silicon-based semiconductors make up over 85% of the solar cell market..

The preffered form of integrated circuit is called a complementary metal-oxide semiconductor (CMOS) logic circuit. The reason that producers use this circuit is because it has a much lower level of energy consumption than any other form of integrated circuit used in the solar industry.

In other words, it becomes much more economical in the production of electricity when the integrated circuit consumes less energy. The thing that is so great is that silicon-based semiconductors are the only way you can make a CMOS logic circuit.

This is a very important notion, because it will allow for the price of silicon to run up as long as supply-and-demand fundamentals favor a bull market.

Supply and Demand for Silicon

The supply and demand for silicon shows a very favorable outlook in producing a bull market. I would like to start this discussion with the supply side — more specifically, refineries.

Silicon is not exactly a rare element. In fact, silicon is the second most abundant metal on Earth. 25.7% of the earth’s crust is made of silicon. SiO2 is one of the most common ways that you find silicon. The coming shortage that I’m going to discuss is not a lack of silicon in the Earth; instead, it is the limited refining capacity.

The process of refining silicon is rather expensive. First, all impurities must be purged. As I said, SiO2 is one of the most common forms of silicon. The oxygen is removed from the silicon through a reaction with carbon. This process is usually done by adding some form of coal and then heating the product in a special furnace at temperatures of 2,700-3,600 degrees Fahrenheit. This grade of silicon is approximately 98% pure.

To make semiconductor-grade silicon, the metal needs to still undergo some processing. It needs to be combined with HCl, removing some additional impurities such as aluminum and iron. The final step takes the SiHCl3 and reacts it with hydrogen for 200-300 hours at 2,000 degrees Fahrenheit to produce a very pure form of silicon.

The pure silicon is formed into rods measuring two meters in length and 30 centimeters in diameter. These rods are then sliced 0.5 millimeters thick, and you have your silicon wafer, which is the final product used for PV cells.

It’s very easy to see why the energy input costs of creating semiconductor-grade silicon are very expensive. But not only is this process itself very expensive, it is also very expensive to increase refiner capacity.

Let’s take a German silicon refiner, Wacker Chemie, for example. It has undertaken a project to expand its refining capacity from 5,500 tonnes to 9,000 tonnes. The price tag on this project? Over $270 million. The high cost of refining and adding additional refining capacity can deter companies from embarking on new silicon ventures, and that is exactly what has happened.

It would take a large demand shock to push the prices of silicon to high enough levels to make it economical for refiners to bring more capacity online.

This is the fundamental idea behind a commodity supercycle. In a commodity supercycle, getting additional supply online to meet growing demand takes time and money. The market needs to be assessed, funds need to be raised, permits need to be obtained, and finally, the project needs to be started and finished. The time lag consists of a supply shortage met by higher prices. The shortage and price increase can also be judged or predicted by the size of the demand shock. And this particular demand shock is one of great significance.

The Power of Government Subsidies

The obvious question that follows is why is this demand shock going to be so noteworthy? It’s very simple. Where renewable energy goes, the footsteps of government subsidies can be heard close behind.

As proven with ethanol, government money can make a bull market out of nothing. But what happens when the market is actually economical on its own, but is then combined with taxpayer money? You get a huge, stinking demand shock.

Look at California, for example. California has recently announced the largest solar energy potential program in U.S. history. Its Public Utilities Commission has set up an 11-year plan that could supply up to 2.3 million Californians with solar power. I want to make myself very clear about the implications of this plan for the market for solar energy. Remember that I said the U.S. currently produces 400 megawatts of solar energy? With this increase in solar power, California alone will produce an estimated 3,000 megawatts of solar energy! That would make California alone the third largest user of solar energy in the world, behind Germany and Japan. There are many other similar forms of legislation that are either already passed or in the process right now. We are seeing the green wave take hold around the globe.

The United Nations recently passed an amendment to the international treaty on climate change called the Kyoto Protocol (KP).

As of 2006, 169 countries had agreed to the Kyoto Protocol. The idea of the KP is to reduce greenhouse gas (GHG) emissions. The 169 countries that agreed to the KP account for 55% of total GHG emissions. Annex 1, or developed, countries are expected to reduce their GHG emissions by 5% from their 1990 levels. The date set for the reduction standards varies from 2008-2012. Some countries, like those of the E.U., will have to reduce their emissions by 15% from their current levels, due to the growth in GHG emissions from 1990.

Although this amendment isn’t solar specific, those 169 countries will be using solar energy to meet the above-mentioned GHG emission standards.

Silicon is used in cell phones, computers, and MP3 players, but its greatest use is definitely in the solar market. Solar energy currently makes up approximately 50% of the demand for silicon, and that number is rapidly increasing.

Let’s look at some numbers regarding the growth in solar energy. From 2000-2004, the number of annual PV installations nearly quadrupled. In that same period, the price of silicon went from $9 per kilogram to nearly $30 per kilogram.

The market for solar-grade silicon currently is estimated to be around $2.3 billion. By 2010, PV installations are expected to quadruple again and the market for solar-grade silicon is expected to rise to $10.4 billion. With solar taking up a higher and higher percentage of the silicon market, you can expect to see an even stronger correlation between the growth in the solar market and the price increase in silicon.

I would like to look at a hypothetical situation regarding the market for silicon. PV installations quadrupled from 2000-2004. The price increase in silicon over that same period was 230%. The interesting thing is that in 2000, there was excess refiner capacity. The increase in demand was met by spare refiner capacity, and still a 230% increase in price followed. What happens when PV installations quadruple again, but this time spare refiner capacity isn’t able meet the growing demand? I think that a 200%-plus increase would be a modest guess.

Your guess is as good as mine as to what the actual price will bring. But I can promise that the shortage in silicon due to a skyrocketing demand in the solar market and a refining capacity with minimum wiggle room will result in some spectacular price action in the silicon market.

It is my opinion that silicon refiners are set to experience the greatest gains in the solar market. PV producers will be forced to pay higher input costs to produce their modules because of silicon shortages. With government subsidies and tax breaks, they will be more than willing to pay these higher prices, allowing for the price of silicon to continue its bull run. Although the profit for solar producers will be hurt by higher silicon prices, the refiners will be in a position to experience tremendous gains. Playing the solar market from a commodities perspective is the best and safest way to profit off the solar energy boom.

One of the refiners producing solar-grade silicon that I think is set to profit off the coming bull market for silicon is Tokuyama. Tokuyama is mainly traded on foreign exchanges, but you can also trade it here in the U.S. under the symbol TKYMF (Other OTC). These guys have experienced increased revenue from their sales of silicon, and as the price of gray gold continues to push up, look for Tokuyama’s stock price to also experience large gains. But it isn’t the only one set to profit from this market. As I come across more silicon refineries that seem poised to grow with the silicon market, I will be sure to send them your way.

Nick “Child Prodigy” Jones

August 20, 2007