The solar PV industry is not as mature as some advocates believe.

Once upon a time, there was a theory of efficient market behaviour. This theory held that markets self-correct, and over time behave efficiently. The theory held that since markets are essentially rational and self-correcting, intervention is harmful.

The invisible hand, said Adam Smith, would take care of any inefficiency in the market. Essentially, if there was a ‘zig’ in the market, a ‘zag’ would eventually come along, bringing with it some form of equilibrium. And trust in this theory was high - until the financial crash.

In theory, the law of supply and demand is a beautiful thing. Supply is, of course, a good or service, offered to the market at a price that adds value to the supplier. Demand refers to the buyers, who purchase a good or service at a price that reflects the value of the good or service to the buyer.

This good or service could be anything from a paper clip to a haircut, to a solar panel, or the electricity generated by a solar panel. A price is an agreement between a seller and a buyer that reflects the value of the relationship to the two (or more) parties.

Though this seems neat and tidy, in reality it is neither neat, nor tidy, and is often messy - with one or the other parties feeling hard done by in some way. In the case of PV there are two different products being sold:

• A system (appliance), where the buyer is engaged with the technology;
• Electricity through a contract, in which case the source of the electricity is anonymous, and the buyer is not emotionally engaged. Since the buyer is not emotionally engaged, the lowest price is the desirable value – in other words a commodity’s primary value is its cheapness.

A perfect market, in theory

One reason that buyers and sellers in a market feel hard done by, is because prices can be manipulated by aggressive pricing for share or entry. In other words, an entity offers a good or product at an artificially low price in order to gain market share. Such aggressive and/or entry pricing is not nefarious; it is simply a business strategy. However, since it gives a false picture of costs, when prices start to rise, buyers typically become angry.

In very simplistic terms, the law of demand holds that the higher the price of a good, the lower the demand. In equally simplistic terms, the law of supply means that the higher the price, the higher quantity of goods a suppliers will bring to market because … no surprise here … they can achieve a higher margin. Shocking, but true.

Theoretically, equilibrium occurs when the price of a good intersects perfectly with the value the buyer places on a good or service. At this point, again, theoretically, there should be enough product available at an efficient price point to serve an orderly group of buyers.

In the case of disequilibrium, the price is set too high for a good or service, leading to low demand and overcapacity. In a perfect world, or that of a product in a market place without incentives, a situation of overcapacity drives the price down to the level where demand is stimulated. And so forth, and so on.

In a nutshell: in perfect market theory, everything runs smoothly over time with naturally efficient markets self-correcting when necessary.

PV: an artificial market

Aside from the fact that there are no perfect worlds or markets, (if you know of one, please tell me about it, and direct me post haste to it) the solar industry does not run smoothly over time.

Grid-connected applications represent 98% of demand for the PV industry. Demand into this application (commercial, utility, and residential) is 100% driven by ‘incentives’ in various markets (and regulation in other markets).

Prices are forced down, and held down, by decreasing incentive levels. As capacity is high, and frankly even when it is not high, the solar PV industry will continue selling against its own self-interest. That is, industry participants will choose to lose money. It could be argued that with today’s low prices for technology, grid parity has been achieved. If so, this is hardly worthy of celebration as it has been achieved with highly-subsidised conventional energy, and at price levels that are too low to be sustainable over time.

Markets and industries are not always efficient because they are filled with people who often act irrationally, fearfully, bravely, naively and either for or against their best interests. Just as companies have cultures, industries do too, and in the case of the solar PV industry, it is a culture of pioneers dedicated to changing the way the people of the world get their energy.

All major changes from the settling of the American West to the industrial revolution, to the telegraph, telephone, and indoor toilets have been subsidised to a certain extent, often for a very long time. All conventional energy technologies receive subsidies, and these subsidies are difficult to untangle.

The PV industry has been struggling to compete with subsidised conventional energy for about 40 years. The PV industry has also been fighting since its inception for a share of the global energy market. To win its current share it promised to become incentive free - and yet at parity - with subsidised conventional energy.

Unfortunately, this may mean that it will also be unprofitable. Not rational or orderly market behaviour, but no market is entirely rational or always orderly.

The law of supply and demand applies imperfectly to most industries, and it applies with complete imperfection to the PV industry. For the PV industry, supply is the group that develops technology, while demand is the first point in the sale that buys the technology. It is, of course, even more complicated than this because the end user is the buyer of either a system, or, the electricity from a system. The farther a customer gets from the actual product, the more disconnected that customer is from feeling an attachment, or assessing a meaningful value, to that product. In this way utility scale solar (multi-MegaWatt) pushes more solar into markets, while disconnecting the electricity buying-public from the value of distributed generation, and the power of owning the meaning of electricity generation.

Subsidy-reliant

The PV industry remains incentive driven. It does not matter that other energy technologies also have subsides, because PV is still viewed as non-mainstream, and, the switching costs from conventional energy to PV are high. Forget about the environment for the moment, this is a hardware discussion. Since PV requires incentives of some type for 98% of its demand, the industry’s basic behaviour does not fit classic economic theory, simply because there is no equilibrium price at which suppliers and buyers both receive value.

During the PV industry’s brief period of positive margins, (2004 through 2008), prices increased, and suppliers took margin. Prices for buyers (essentially the first point of sale in the market) increased along with angst over higher prices. Economic theory would hold that buyers should have backed off until equilibrium was restored. Instead, driven by healthy incentives, buyers continued to participate in the market.

In 2009, aggressive pricing for share drove prices down as manufacturing capacities continued to rise. Buyers were happy and suppliers suffered, but continued their selling behaviour.

Nothing's perfect

For the perfect market to exist, no energy technology (conventional or renewable) would receive subsidies. However, in this perfect market world, the end users of electricity would not be able to afford it, unless they belonged to the now famous 1% (referring to the US Take Back Wall-Street movement.)

Pure economic theory should not be applied currently to the PV industry, which is at this point in its adolescence. The PV industry needs time to mature, and, as it decreases its costs and incorporates new business models incentives can, and may, slowly subside. At the same time, conventional energy should be weaned from incentives. At some point in the future, when the playing field is truly even … well, at that point a discussion about market behaviour and economic theory will make real sense.

In Part 4 - thin film technology.

About the author: Paula Mints is the principal analyst for Navigant's PV Service Market Research Program, and executive editor of the Solar Outlook Newsletter. She is widely recognised as an industry expert on photovoltaic (PV) technologies and markets.