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Supply chain woes won't stop solar industry expansion - Reuters

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December 1, 2021 - Allegations of forced labor in Xinjiang province in China led to the June 24 announcement by the U.S. Customs and Border Protection of a prohibition on import of products made with materials from Hoshine Silicon Industry Company, pursuant to Section 307 of the Tariff Act of 1930. Five months later, we have seen the effects of this order play out in real time.

Hoshine is a significant silicon manufacturer in Xinjiang. While modules made with silicon from Hoshine historically represent a relatively small fraction of the total solar modules imported to the U.S., almost all manufacturers that import to the U.S. use silicon from Hoshine in at least some of their modules.

This has resulted in two immediate problems — first, there is a direct impact on supply by removing a major supplier. Second, there is an indirect impact caused by complexities in determining just which import modules are made with Hoshine silicon. There are reports of modules from major manufacturers being held up in ports for extended periods, only to finally be cleared for import.

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This is hardly surprising. Since 2012 there have been a complex and changing set of tariffs applicable to the import of solar modules and components manufactured in China or Taiwan (and, more recently, elsewhere). We all recall confusion and delays at the ports over the past decade as CBP agents attempt to determine the correct application of these tariffs to imported modules. The sheer complexity of the rules and the underlying supply chain became its own problem. We have already seen some of these same delays with the Hoshine prohibition.

There is also a potentially greater third impact lurking in the shadows: the threat of more Hoshines, and prohibitions on more silicon sources. There may also be retaliatory actions by China, which could result in a re-escalation into a broader trade war. This threat has led to concern about the sustainability of the current module/silicon supply chain, and efforts to manage the associated costs and risks.

In particular, we are seeing provisions added to project contracts and financing documents that expressly prohibit any equipment made with forced labor. In their simplest form, these contract provisions do not change much, as equipment made with forced labor is already illegal to import to the U.S., but these provisions do place an extra burden on developers to investigate their supply chain.

In a few unfortunate cases we have seen contract provisions that prohibit equipment or materials from Xinjiang generally. These broader provisions, by trying to safely avoid the forced labor problem, are actually aggravating the greater supply problem instead. Given that a large majority of current solar module manufacturing includes materials from Xinjiang, it is extraordinarily difficult (currently) to comply with any broad Xinjiang prohibition.

And, of course, this is all happening in the context of broader pandemic-related supply chain disruptions. Supply chains are disrupted across continents and across industries, and the solar energy industry is no exception, and solar module supply has faced a number of challenges and disruptions beyond Xinjiang-specific concerns.

The effects of these supply chain problems are found throughout the solar industry. Some suppliers are unable to fulfill contracts, other supplies are simply cancelling existing contracts to sell modules at higher prices. This is not surprising, as the module manufacturers have very narrow profit margins (when they are profitable at all). It would be unreasonable to expect the module manufacturers to absorb the sudden cost increases. Doing so would no doubt drive several of them directly into insolvency. Therefore, it ultimately has to be the projects that must absorb the extra costs.

Developers are attempting to manage this risk by introducing price adjustment provisions to PPAs (purchase power agreements), or by pushing the risk down to contractors. These efforts generally do not appear to be working, as counterparties are often unwilling to accept this risk allocation. That puts the price risk back with the developer, which in turn results in compressed project economics, or smaller profit margins for projects.

Compressed project economics in turn have led to projects getting cancelled. Project cancellations are a serious concern, but they are not the whole story. We have seen how the solar markets have responded to increased equipment costs due to tariffs, and it is projects in low-price markets without mandates that are most affected (Texas, we are looking at you). Markets with mandates (such as California and the Northeast) are less price-sensitive, as utilities are required to meet the mandates regardless of price. But in markets with narrow margins and no mandate, even a small price increase can make a project completely unviable.

As a result, increased equipment prices tend to principally shift efforts to the coastal markets rather than linearly reduce overall installations, and there is no reason to think it will be any different in the current circumstances. And, of course, this is mainly an issue for large projects, where the module cost can be half of the total project cost. Residential or commercial installations, on the other hand, can absorb some price increase on modules in most markets, as module cost is a smaller portion of the overall cost of these projects.

This is not to say that increased module prices will not cause a near-term dip in overall installations. But much of the U.S. solar market is either driven by mandate rather than price, or is not particularly price sensitive, so installations will continue. More important is that this is a near-term dip. There is every reason to expect that installations will continue to grow rapidly after this near-term dip.

Let us not forget our history. Almost 10 years ago, the solar module manufacturing industry relocated and reconfigured its entire U.S./Europe-bound manufacturing capabilities from China to Taiwan in response to tariffs. And then did it again a few years later, now moving (primarily) to Southeast Asia. This is not an industry that is locked in place. This is an industry that has a history of innovation, mobility, and determination. There is no reason to think that silicon manufacturing could not also be relocated to less troublesome regions. Silicon is not some esoteric rare-earth mineral, and manufacturing is not tied to specific geography.

We can look further back, to 2006, when there was a looming severe silicon shortage. Prices skyrocketed, and the press was full of doomsday predictions for the future of solar energy. A cursory review of headlines about silicon shortages from 2006 and 2021 would leave the reader unable to tell which headline came from which year.

The silicon shortage was real and devastating. And then, suddenly, the shortage ended. By 2009 polysilicon prices were below 2006 levels, and they kept on dropping. In three short years an entire silicon supply chain was built from the ground up. Would anyone today suggest that the solar energy industry suffered any long-term harm from the great polysilicon shortage of 2006? Yes, those were difficult years, but the shortage passed. And it passed not because of the patience of the solar energy industry, but because of the determination and resiliency of the solar energy industry.

The global solar energy industry has had tremendous growth in the past 15+ years, and it has done so not because there have been no obstacles, but by overcoming every obstacle. Raw materials shortages, tariffs, capital shortages, economic downturns, more tariffs, political opposition, trade wars, and pandemics. The ongoing success of the solar energy industry is a testament to triumph in the face of adversity.

If anything, the solar energy industry is in a stronger position now than ever before. At this point the political winds are in solar energy's back. We do not believe that solar will be allowed to fail. Solar energy will not be allowed to fail by California, not by the U.S., not by Europe, and not by China.

We are not suggesting that the silicon shortage should be treated casually. We are suggesting that this is not a crisis. It is not unrealistic to believe that the industry will survive this shortage just fine — it is unrealistic to believe that the solar industry growth curve would continue its upward trajectory without an occasional blip. This is a blip.

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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.

Seth Hilton is a partner at Stoel Rives LLP where his practice focuses on the California energy sector, representing clients before California's energy regulatory agencies including the California Public Utilities Commission and California Energy Commission, as well as in stakeholder proceedings at the California Independent System Operator. He is based in the San Francisco office and can be reached at seth.hilton@stoel.com.

Morten Lund is a partner in Stoel Rives' San Diego office. He is the current chair of the Energy Storage Initiative and former chair of the Solar Energy Initiative and can be reached at morten.lund@stoel.com.

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