A Slowing Economy Could Cast a Shadow on Solar Energy

On July 4, President Barack Obama unleashed a $2 billion torrent of solar subsidies that went to two companies. One, Abengoa Solar, will use $1.45 billion to build a massive solar power plant in Gila Bend, Ariz.. Another slug will help Abound Solar Manufacturing build high-tech panels at factories in Colorado and Indiana (in a shuttered Chrysler plant, no less). This is the latest good new for solar companies, which keep garnering the greatest percentage of clean-tech venture capital, private equity and public offering dollars.

All may not be sunny, however. Signs of a second-half slowdown could put a chill on the sector. According to the latest numbers collected by Cleantech Group and Deloitte, solar companies got $881 million in investments during the second quarter of 2010. That's more than one-third of global investments in clean tech for the period, far outstripping any other sector. However, this outperformance could flag in the very near term for several key reasons.

A Key Index Is in Free Fall

First of all, coal and natural gas prices almost never go up during slow economic times, and appetite for solar energy and investments in it are, at least perceptually, closely linked to the price of other energy products. With the all-important Baltic Dry Index, which tracks shipments of commodities that are precursors to economic activity, in free fall (as pointed out by ZeroHedge) and Asian economies showing signs of slowing, lots of economists are now saying that global economic growth will slide in the fall of 2010 and into 2011. That won't be good for solar start-ups because low energy costs remove political pressures to build out alternative energy infrastructures.

Second, not only are energy costs likely to be lower but governments around the globe, from Athens to Albany, will have less money to spend on alternative energy projects due to fiscal problems. Overall, the solar industry has benefited tremendously from tax credits to large-scale project developers and from special electricity prices that allow solar projects to sell their juice back to the grid at a premium.

This was particularly true in the European Union, where Spain and Germany pushed agressive programs to expand their alternative energy grids. The Spainish government is now looking desperately for ways to cut costs, and Germany is ready to slash once-sacred spending items (like university education) to digest the fiscal reality of the Greece bailout. That means the two biggest solar guns in Europe are likely to even further throttle back programs aimed at encouraging alternative energy projects that are costly in the short term.

The third reason is an unspoken wariness of big capital-intensive start-ups in Silicon Valley and other centers of early-stage capital formation. Sure, corporate investments in those types of young businesses remain strong. But super-VC Vinod Khosla voiced in public recently what all too many VCs in the U.S. are now saying in private: that most of the big solar energy start-ups today will likely hit the wall in the next year or so unless they can dramatically improve their power output or reduce production costs to compete with solar juggernaut First Solar (FSLR).

What Could Go Right

There are some exceptions. Concentrated solar-thermal power start-ups appear to be gaining steam, in part because they tend to be more energy-efficient than photovoltaic-based solar energy and because the thermal energy they produce can be used for multiple purposes, including industrial processes and solar-powered air conditioning. And of course, lots of solar start-ups are rolling out new technologies with eye-popping potential that, if proven in field trials, could restoke investment demand. Then there's Uncle Sam, doling out money for solar.

Alas, history hasn't looked kindly on past U.S. government direct involvement in industrial policy, and unlike China and Japan, such forays have failed to yield significant benefits, particularly in comparison with subsidies aimed at improving the economics of a sector rather than a direct reward to a specific player.

Silicon Valley VCs are concerned that government selection will replace natural selection and stomp out innovation. This is a case where huge capital-equipment-intensive start-ups could just as easily be hurt by the subsidies that may create an uneven playing field and scare private money out of the market.

The bottom line? Solar remains the bright light in alternative energy, but it could be staring down some dark alleys in the next few quarters.