‘I don’t get it’, one of our researchers, Ben, asked your editor last week.
‘For the past three years you’ve done nothing but criticise solar and wind energy, yet last month you tipped a solar power stock. What gives?’
‘There’s a simple reason we tipped a solar stock,’ we replied. ‘It’s due to the removal of one thing that’s held back alternative energy from reaching its full potential. It means a bad industry, could soon become the major growth industry of this century.’
‘If you’ve got 10 minutes I’ll explain everything in detail.’
And if you’ve got 10 minutes to spare, we’ll take you through everything we told Ben. It just may change your view on solar and alternative energy forever…
But before we go through that, here’s a story from today’s Financial Times that helps illustrate what we’ll explain today:
‘If all the proceeds of 30 years of global privatisations were put into one bank account, it would be almost wiped out by the price tag for rescuing the world’s crisis-hit banks.
‘National governments have invested about $1.7trn in financial institutions such as AIG, the New York based insurer, in the past four years, according to Privatisation Barometer, a research project. This compares with the $1.8tn in proceeds from the worldwide privatisation of assets that range from airports to telecoms and water networks in the decades since 1981.
‘The figures underscore that governments are nationalising assets, even as they privatise others.’ – Financial Times
But not only that, don’t forget that most privatised industries aren’t really private companies. They don’t really operate in a free and private market.
Most privatised utilities and transport firms still work under heavy government rules.
That means they aren’t private companies. Most of them are just quasi-government bodies that retain the government gift of monopoly or the government gift of regulated pricing.
And regulated pricing is bad news for consumers. It always means prices rise rather than fall. Utilities, transport and healthcare companies are perfect examples.
We came across a recent note from Medibank Private at the weekend. It said our health insurance premiums had to rise by $4.76 per fortnight due to – among other reasons – the ‘rising costs of technology’.
That came as a surprise to us. Because everywhere else we look, new technology tends to cause prices to fall not rise.
It was this example we used to explain to our researcher, Ben, why after bagging solar energy for three years, we’ve now decided to back it…
How Government Stifles Innovation
One of the biggest brakes you can put on innovation is to allow the government to interfere and set prices.
Governments interfere for many reasons. One reason is that they don’t like how free markets work. In a free market, consumers decide which businesses and products succeed or fail.
That process of success and failure can be random. It can lead to fortunes for some firms and bankruptcy for others.
It can mean one business creates a lot of jobs, while another business has to lay off a lot of jobs.
Of course, in a free market, with no government intervention, entrepreneurs can hire those who lose their jobs. Or they may even be hired by more successful businesses that need more labour for their growth.
Governments don’t like the fickle nature of the free market, because they can’t control it. They can’t promise jobs for people if they can’t control who creates the jobs. And if they can’t control that, there’s no reason for anyone to vote for them.
So, one of the major roles of government is to try to control market for jobs and prices. That’s why you see so many laws on industrial relations, business red tape, and price control (taxes, interest rates, subsidies, import and export tariffs and regulations, etc.).
But government interference has another bad impact on business and the market. It stifles innovation.
Why Green Energy Subsidies Stunted the Solar Industry
Take subsidies for the green energy industry. When an industry gets a subsidy or is gifted a government monopoly, the industry and business know that the government can remove the subsidy or monopoly at any time.
It could happen within weeks, months or years. But whatever the timeframe, businesses know they have to make the most of their gifted position while they’ve got it.
That means the business has to produce as many units of their product as possible and sell them as quickly as possible.
In the case of the solar industry it meant producing solar panels at a rapid rate and selling them quickly before the government subsidy ended.
The knock-on effect is that because the business (and industry) has a short-term focus to profit from the subsidy, they put any thoughts of product development on the back burner.
Why invest a billion dollars in research and development that may take two or three years to come to fruition, when the company could invest the billion dollars in producing more of its existing product to sell now?
After all, if the subsidy ends next year what use is the billion dollars spent on R&D?
But not only that, because of the subsidy, there’s no incentive for companies to reduce their costs. They set the price at the level they believe the customer will pay after deducting the subsidy.
For instance, if a company knows customers will pay $5,000 for solar panels, and the government offers a $2,000 subsidy, the company won’t drop the price to $3,000. Instead, the company will price the product at $7,000, knowing that the customer still only pays $5,000 after the subsidy.
The result is prices tend to flat line at best…or rise at worst.
What the Solar Energy Industry Could Learn from TVs
Compare that to the free market for most other technology. The television industry is a great example. 10 years ago you wouldn’t get much change out of $10,000 for a 40-inch plasma TV.
Today, you can buy a cheap 40-inch plasma TV for less than $500.
But plasma isn’t even the latest technology. Now you’ve got LCD, LED, HD, and 3D. Sharp has even released a 70-inch LED TV that’s infinitely better quality than the 40-inch plasma TVs of 10 years ago…and yet it costs less than half the price (about $4,000).
But how is that possible? After all, according to Medibank Private, new technology should have caused prices to rise, not fall.
The answer is simple – it’s all thanks to competition and a lack of government interference.
In the TV market there isn’t a government-gifted monopoly on the provision of TVs. There isn’t any government mandated price control. The TV manufacturers don’t have to submit pricing to the government to get approval to index a price rise.
No. What happens is that firms invest millions of dollars in research and development to produce the best product possible. They’re looking for anything that can give them an edge over the competition.
Not so long ago, you couldn’t buy an LCD TV larger than 30 inches…because it wasn’t technologically possible.
Well, telling an entrepreneur that something isn’t possible is like waving a red rag to a bull. So today LCD TVs are pushing out the cheaper plasma TVs due to new innovation. And LCD TVs are now the same size as plasmas.
All this is possible because TV manufacturers don’t have to worry about the subsidy cuts. So rather than pushing out the same product quickly, they focus on developing new products to gain market share. And that leads to a better product for consumers.
Could Solar Energy be 100-Times Better
for One-Tenth of the Price?
for One-Tenth of the Price?
But it doesn’t stop there. As soon as one firm does something, other firms are quick to copy. That drives down prices and encourages more innovation.
The end result is a product that’s 100-times better but priced at just one-tenth of the cost.
This brings us back to solar power. The best thing that could have happened to the green energy industry is the global financial meltdown in 2008. As governments attempted to cut costs, green energy subsidies have been a major casualty.
In the short term, that’s bad for the industry, because it dries up the demand. But in the longer term it’s great news.
Why? Because without the stimulus of government handouts, solar companies will need to improve their products. They’ll need to invest in research and development for the long term – just like TV manufacturers.
And while it could mean that some solar firms go out of business, it will also mean that more firms will enter the business. They’ll see the chance to profit from high prices.
But as competition increases, that’s when consumers will start to see the benefit…prices will fall and the product quality will improve.
The Solar Energy Advantage
As we explained to our researcher, Ben, solar energy has one major advantage over every other conventional and alternative energy source – it’s local.
You can’t install a coal-fired or gas-fired power plant on the roof of your house. And you’ll have a tough time getting approval to build a nuclear power plant in your backyard.
Even wind turbines have to be pretty big to generate enough electricity to power your home. But solar power? Well, that’s different.
Solar panels are inoffensive. They don’t take up any extra space (you just stick them on the roof). They aren’t an eyesore. And they don’t emit anything that could annoy the neighbours. Solar power is the perfect localised energy solution.
And at the right price (assuming governments can keep their big fat noses out) we don’t see a single reason why every household and every business in Australia shouldn’t have solar panels on the roof.
Given time, and with technological advances, we believe this is possible. Of course, it won’t happen overnight. It’ll take time.
Now, don’t get us wrong. That isn’t to say solar will be the only energy source, because it probably won’t. It’s not efficient enough. But as a complement to gas- or coal-fired power stations, solar energy makes a lot of sense.
And as an investor, we believe now is the best time to buy, with solar stocks hitting all-time lows.
Make no mistake, investing in solar energy is a high-risk punt. But at these prices it’s a punt worth making for any speculator.
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Written by Kris Sayce
Kris Sayce is Editor in Chief of Australia’s biggest circulation daily financial email — Money Morning. (You can subscribe to Money Morning for free here).
Kris is also editor of Australian Small-Cap Investigator, his small-cap stock research service, where he provides detailed analysis on some the brightest, smallest listed companies on the ASX.
If you’re already a subscriber to these publications, or want to follow his financial world view more closely, then we recommend you join Kris on Google+. It’s where he shares investment insight, commentary and ideas that he can’t always fit into his regular Money Morning essays.