TODAY’S STUDY: THE CHINA V U.S. SLUGOUT OVER SOLAR

A Duel in the Sun; The Solar Photovoltaics Technology Conflict between China and the United States

John Deutch And Edward Steinfeld (Massachusetts Institute of Technology)

Executive Summary

A debate is raging among government officials, industry members, technologists, and trade specialists about the nature of the competition between the United States and The People’s Republic of China (PRC) in developing, deploying domestically, and selling internationally solar photovoltaic (PV) electricitygenerating technology. Over the past three years, China has dramatically expanded its manufacturing capacity for crystalline silicon PV modules, 90% of which are exported at steadily declining prices to Europe and the United States.

One view characterizes Chinese behavior as a state-directed effort to dominate the global PV market by “dumping” product at below cost.2 In November 2012, the United States imposed an import tariff of up to 30% on certain Chinese PV manufacturers to compensate for unfair trade practice; the European Union (EU) has similar trade action under consideration. The alternative view is that Chinese new entrepreneurship, driven primarily by private equity investment, explains the rapid expansion of Chinese PV module production.

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However, overexpansion of production capacity combined with dampening of subsidized demand, mainly from Europe, has led in 2010–11 to an oversupply of product, a collapse in PV prices (in contrast to cost), and massive financial losses for Chinese companies. These different views need to be resolved to avoid a lengthy trade conflict, which is important if the United States and China wish to encourage cooperation in Research and Development (R&D), technology transfer, investment, and trade in renewable technologies, goals that both governments frequently state are in their common interest. In this paper, we consider the competition from three vantage points: (1) the structure of the PV industry in each country, (2) the recent trends in trade, and (3) the pattern of government assistance to the PV industry in each country. We expect that it will take several years for the global PV market to regain profitability and its forward momentum.

The recovery time will depend on some shrinking in worldwide PV device capacity, expansion in demand with subsidies for deployment (whether by feed in tariffs or renewable portfolio standards), and a firming of device prices to a level that is sustainable financially.

We conclude that the US–China PV competition is best understood not in terms of a bilateral clash between government-led policies, but instead in terms of a global PV industry structure within which US and Chinese firms play roles consistent with their strengths. Each country extends different assistance mechanisms and each country has conflicting purposes for such assistance. Both countries lack a transparent, quantitative evaluation methodology to assess the cost effectiveness of the assistance. We suggest some policy changes to make government assistance more consistent with the global character and long-term opportunity of this important technology.

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Differing Views of the Issues Informed observers in the United States hold two widely divergent views of the development of the Chinese PV industry. One view argues that Chinese PV development is best understood in terms of a deliberate central government decision to establish global dominance for this industry through a wide range of subsidies and unfair trade practices. The consequence of this policy is that Chinese PV module sales compete unfairly in the international market (importantly in Germany, Italy, and Spain), and have destroyed the prospects of domestic US PV manufacturers. The current collapse of PV module prices, attributable to overcapacity primarily in China, is seen as a tactic to accept short-term economic loss in order to drive out competition and establish long-term dominance.

A second view argues that Chinese PV development is the product of technology entrepreneurship under competitive market conditions. From this perspective, the industry’s advance has been driven not by top-down support from the central government, but instead by bottom-up actions by private entrepreneurs.

These entrepreneurs — mostly returnees from overseas with considerable experience in the global semiconductor industry — were able to establish and rapidly expand manufacturing facilities by accessing private capital and state-of-the-art production equipment in global markets. The public support they have received comes from municipalities and provinces rather than the central government, provided via the sort of tax concessions, loan guarantees, and land grants routinely used by local governments worldwide, including in the United States, to attract business. The industry boomed largely because of engineering and manufacturing competence — the ability to scale rapidly in the face of surging demand from European markets, while maintaining production quality, continuous product improvements, and steady cost reductions.3

However, in the face of plummeting European demand, the Chinese PV industry now faces overcapacity, negative margins, and a pending shakeout. It is only at this point that the Chinese central government, previously indifferent to the sector, has begun moving tentatively to bail out producers and stimulate domestic PV demand.

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Importance of Resolving the Issues

Cooperation between the United States and China on energy technology has been a prominent part of the dialogue between the two countries in the context of common efforts on climate change and in the broader discussion of liberalized conditions for technology transfer, investment, and trade.4

In both countries, public officials and private firms see energy technology, especially “green” technologies such as PV, as an important opportunity for investment and sale of products into some part of the value chain. During the late 2000s, global PV installations grew at an annual rate of 50% to 100%, although a sharp decline in annual growth is projected, in the range of 10% to 20% to 2016.5

Global PV installation grew to 69.7 Gigawatts (GW) by the end of 2011.6

It is not surprising that the two countries contemplating such forecasts will be keen to encourage the growth and competitive success of their respective national industries. Acrimonious differences over the “fairness” of each other’s government subsidization and trade practices, if left unattended, will infect the entire technology and commercial relationship as both countries pursue growth and global competitiveness. The effects are likely to be felt far beyond just PV.

Shedding light on this issue must start with a clear and thorough side-by-side comparison of the circumstances of the PV industry in each country with regard to (1) technology focus, (2) the products and markets that are being addressed, and (3) the nature of public assistance for technology development and international trade. Such a comparison is not easy for several reasons.

The PV Industry Has Developed Differently in Each Country…Comparison Between the Two Countries is Difficult Because the Mechanisms that Each Country Uses to Support the Industry Are Quite Different…Perhaps the Most Important Barrier to a Successful Comparison is the Very Rapid Pace of Change in the PV Industry with Regard to Technology, (Supported) Demand, and Supply…Origin of the Conflict — the Trade Issue…US Trade Action…Chinese Response…Deeper Currents About Competitiveness…

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Public Assistance for PV in the United States

The Congressional Research Service (CRS) has recently presented a useful report on PV industry trends, global PV trade, and federal support.39 The report lists the following US mechanisms:

ADVANCED ENERGY MANUFACTURING TAX CREDIT (MTC) was aimed at supporting renewable energy manufacturers. It reached its funding cap of $2.3 billion in 2010.

LOAN GUARANTEE PROGRAM directs funds to manufacturing facilities that employ “new or significantly improved” technologies. Over $13 billion has gone to 13 solar production facilities.

INVESTMENT TAX CREDIT provides financial incentives for solar power at a rate of 30% effective through December 31, 2016, after which it will revert to a permanent rate of 10% for commercial investments and expire for residential investments.40

TREASURY CASH GRANT PROGRAM requires solar projects to begin construction by December 31, 2011, and be in service by December 31, 2012. Grants have exceeded $2.1 billion.

THE SUNSHOT INITIATIVE is one of several US DOE programs to support the solar industry and increase domestic PV manufacturing…

Public Assistance for PV in China

…Central government efforts to support domestic deployment of PV have been quite modest until recently. Funding for domestic deployment and demonstration projects began in 2009 with the central government’s Golden Sun program.50 The program, which supports deployment for rural areas, building-integrated PV (BIPV) systems, and large-scale grid connected projects, is viewed by industry insiders as an important contributor to the 4 GW of PV deployed in 2011.

More ambitious efforts to support domestic PV markets have come with the NDRC’s July 24, 2011 announcement of a national FIT for PV.51The FIT is consistent with the government’s increasing preference for market-based regulation. Because PV is more expensive than other conventional electricity generation, some mechanism is needed to finance its expansion especially since electricity prices are controlled.

After 2011, China like Europe has opted for a FIT, rather than RPS, to finance the cost of the more expensive PV.

The FIT system for solar is in principle supposed to be applied at the provincial level with allowance for balancing FIT payments between provinces that had produced more and less renewable generation. The new FITs for both open and non-competitive PV project tenders are slated to be above those accepted previously. Electricity grid operators are to pay solar developers 1.15 Yuan (US $0.18) per Kilowatt hour (kWh) on projects approved before July 1, 2011, or to be completed by the end of 2011 and 1 Yuan/kWh on projects approved after July 1st…

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Key Focus Areas in the Five-Year Plan Are:

HIGH PURITY POLYSILICON PRODUCTION /INGOTS/WAFERS /CRYSTALLINE SILICON CELLS /THIN FlLM CELLS/ HIGHCONCENTRATION SOLAR CELLS/MODULES /SPECIALIZED PRODUCTION EQUIPMENT/ANCILLARY MATERIALS /GRID AND ENERGY STORAGE SYSTEMS/PUBLIC SERVICE PLATFORMS

The plan states specific objectives for cost objective and market shares. The plan targets that by 2015 the cost of PV modules installed will drop to 7 Yuan per watt and the cost of PV power generation will be 0.8 Yuan/kWh. By 2020, the cost of PV modules will drop to 5 Yuan per kilowatt (kW) and that of power generation to 0.6 Yuan/kWh. The plan also includes a number of specific policy measures, but without any indication of the resources that will be applied to each…

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Conclusions

…[I]n three key areas…

OBSERVATIONS ABOUT THE PV INDUSTRY

1. The structure of the PV industry should be seen in global terms with demand coming from many countries and with many international suppliers involved in the various stages of the supply chain. PV is not a bipolar competition between China and the United States for manufacturing of crystalline silicon cells and modules. There is strong supply chain linkage and mutual dependence between technology generation and deployment in the United States and manufacturing of cells and modules in China.

2. The respective PV sectors of China and the United States are developing in different ways that reflect the strength of each nation’s industrial base and each nation’s government policies. The United States has relative strength in the creation of new technologies that are potentially of lower cost and meet end-use needs in different ways (whether distributed or central generation). China has demonstrated its relative strength in rapidly introducing high-quality, low-cost manufacturing. The situation is not static: China certainly is interested in moving up the food chain and the United States is interested in improving domestic manufacturing performance generally.

3. Technology generation is one important factor determining economic competitiveness and this motivates countries, especially the United States, to support research, development, and demonstration of new technologies. The PV story is that the technology is pretty well globally available and innovation depends more on rapid and low-cost application than on technology creation.

4. Accordingly, the risk for US-based industry is that firms cannot execute large-scale manufacturing (either in the United States or abroad) as well as China (either in China or abroad, including, potentially the United States). The risk for China-based industry is that firms will miss new technologies that have more desirable performance/cost characteristics than traditional crystalline silicon, and in missing these technologies, will continue to make premature investments, resulting in large financial loss.

5. There is no credible data that permits one to establish whether the sum of all public subsidies for PV in the United States, both state and federal, are larger than the sum of all Chinese subsides for the domestic and exporting PV industry, but it is possible. Up to the present, the balance of deployment assistance to production assistance is likely greater in the United States than in China. With regard to subsidies to capital, China appears to favor subsidizing debt through easy bank loans while the United States appears to favor subsidizing equity through tax credits or direct assistance, although loan guarantees are also used.57 We are unable to conclude whether government assistance to capital is greater in China or the United States.

6. We have not uncovered evidence that government subsidies, low labor costs, or stolen technology are sufficient factors to explain the apparent Chinese advantage in manufacturing. If American firms cannot meet and exceed Chinese cell and module manufacturing competence, US firms should focus on the many other attractive parts of the PV supply chain, especially those with higher profit margins. The outcome of the PV manufacturing competition may well foretell how successfully the United States will compete with China and other Asian economies in manufacturing other products.

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OBSERVATIONS ABOUT RECOVERY IN THE GLOBAL PV MARKET

Unquestionably, the combination of decline in demand for PV modules and the cutback of generous FITs from European countries, primarily Germany, Italy, and Spain, and the enormous increase in supply capacity, primarily from China, has fundamentally disrupted the global PV market.

The most serious reflection of market disruption is the disparity between PV module prices and cost. PV module prices in 2011–2012 were in the range of $1 per Wp, and even lower in some cases, at the end of a long period of price reductions.58 The evidence from 2011–2013 is that some of the recent reduction of the price of PV modules does not properly reflect full cost-reduction experience but simply a squeeze on profit margins from selling products at low prices to reduce excess capacity. Market recovery to certain PV producers certainly means an increase in module price in order to achieve higher margins and the “minimum sustainable price,”16 required to sustain growth. The Center for American Progress has clearly explained the dilemma posed by the need for higher prices required to sustain supply but that will dampen demand.59

Restoring order to the PV market also requires some adjustment in demand and supply. On the demand side, it is likely that at least out to 2016, the European countries that have been an engine for demand will not maintain policies that have previously encouraged rapid growth. The European Photovoltaic Industry Association projects two scenarios for future PV installations reflecting a “moderate” scenario in which the expected phase-out of generous FITs in Spain, Italy, and Germany occurs and a “policy-driven” scenario in which these incentives are retained.

The spread in European cumulative deployment in these two scenarios is between 155 GW (policy driven) and 96 GW (moderate) in 2016 relative to 51 GW at the end of 2011.60 If global PV demand is to maintain its past pace of growth, European demand will need to be replaced by demand from Asia (primarily China) and the United States. There are also important uncertainties on the supply side. Will the Chinese continue to allow their excess capacity to diminish or will policies be adopted to encourage production? How rapidly will new PV technologies be introduced and will these new technologies be of lower cost? Finally, general economic conditions, such as fiscal constraints, the availability of low-cost natural gas, and the cost of capital will influence the economic competitiveness of PV as an electricity-generating technology option. The net result is that large uncertainties confront the PV industry for at least the next several years.

General economic conditions, such as fiscal constraints, the availability of low-cost natural gas, and the cost of capital will influence the economic competitiveness of PV as an electricity-generating technology option.20 We stress that our work is restricted to PV and we do not suggest and we do not believe that our findings should be extended to other industries in which the United States and China compete. Nor do we suggest that generalizations can be drawn about the outlook for US manufacturing competitiveness from this US–China case study.

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ADVICE TO GOVERNMENT

The natural temptation for governments when faced with a popular and promising new industry opportunity that faces international competition is to quarrel with competitors and adopt policies that are perceived to give domestic industry advantage — consider the examples of commercial air transport, computers and electronics, pharmaceuticals, nuclear power, and space. We should not expect all folly to be avoided, but the effort should be made to avoid the greatest excesses.

1. The most immediate risks are (a) that the Chinese will continue to push sharp commercial practices that sell unprofitable products on global markets at below prices that recover full costs and (b) the United States will adopt protectionist trade practices in response to this Chinese action, e.g. adopt domestic content requirements for PV systems. The net result will be that the Chinese industry will continue to lose money and the US PV industry will be shielded from the reality of competitive manufacturing.

2. Both China and the United States need to reassess their portfolios of assistance measures for PV from two points of view: what are the goals of the subsidies (development, deployment, employment, reducing greenhouse gas emissions, competitiveness) and are the subsidies achieving these goals in a cost-effective manner?

3. To the extent government-assisted PV technology programs in the United States and China have the objective of achieving innovations that improve competitiveness, the assistance programs need to address both technology creation and adoption. Public support of technology is justified when individual firms do not undertake R&D because they cannot appropriate the benefits to lowering their production costs, and the R&D knowledge is spread to many firms. The intent is to benefit US firms and workers, but the PV example shows the difficulty of applying this principle in an industry that has a complex supply chain and a global character.

4. The prospect of carbon-free electricity generation from PV means there is a global public good in subsidizing PV technology development. The tight linkage between US and Chinese PV firms raises the question of whether there are practical mechanisms of public support that could advance the global PV enterprise better than the separate efforts of each country. Such integration could have three aspects: cross investment, technology transfer, and joint development or production projects in either country. Integration would blur outcomes of jobs, revenue, and technology advances from national firms to the results of the global enterprises. Of course, much detailed analysis and negotiation would be required before the United States and China could decide if they wished to encourage or discourage greater integration between their PV industry sectors. This is a report for the MIT Future of Solar Energy study and several of the key issues that are raised in this paper — PV manufacturing private and public costs, PV technologies, supply chain relationships, and the rationale and choices of different public assistance mechanisms — will be analyzed further in the study effort.

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