Weekly Insider (Lux on China Solar and Mexico Water)

From the brilliant global emerging technology team at Lux Research here are a few choice nuggets for you. First on Solar (remember my call that this will be a flight of Icarus with most US investors getting badly burned) and China’s deflationary forces. Then on Mexico’s water infrastructure woes.

**New entrants put on a brave face at Intersolar North America:

We recently attended the Intersolar North America Conference in San Francisco, CA. The conference was notable as much for the companies that did not attend as for those that did. Most major Japanese manufacturers – including Sharp, Sanyo, Kaneka, and Kyocera – did not present, while other industry heavyweights – including First Solar and Suntech Power – were also absent. The buzz remained focused on the size of the U.S. market, with all eyes set on the anticipated announcement of the Department of Energy loan guarantee program. Due to the slow drag of the stimulus package announcements in the U.S., module vendors and suppliers we spoke with were already focused on the U.S. market in 2H 2010. We wrote in the February 2009 report “Finding the Solar Market’s Nadir” that, for the U.S. market, “it’s unlikely that 2009 will be a breakout year.” Our outlook of 495 MW in the U.S. in 2010 continues to look accurate, while the greatest potential upside in the global market will come from China.

In contrast to the largely absent Japanese manufacturers, a host of Chinese firms – JA Solar, Canadian Solar, ENN Solar Energy, Best Solar, Trina Solar, and more – showed up in grand style, boasting huge displays. However, these large shells echoed with talk of still-slipping prices, with top-tier Chinese crystalline silicon manufacturers now selling at $2.30/W to $2.40/W according to our network. What’s more, one Chinese firm we spoke with expected prices to fall below $2.00/W by the end of 2009.

Chinese thin-film entrant ENN Solar Energy was on hand with a full 5.7 m2 tandem junction (microcrystalline silicon/amorphous silicon, or “micromorph”) thin-film panel on display. Since we last briefed the company in April 2009, ENN Solar received TÜV certification for its full panels, but the ramp-up has fallen behind schedule. According to the company, the ramp-up of its 60 MW Applied Materials line has been pushed out from the end of Q2 2009 to the end of Q4 2009 or Q1 2010, implying that full micromorph production with AMAT tools continues to drag down customers’ roadmaps. Nevertheless, the company, like many of its compatriots, was out to put on a bold and brave face throughout the show.

**Mexico City attempts to save water to avert sinking into the abyss:

On July 26, Mexico City authorities announced an emergency, 10-month water rationing plan in response to severe shortages resulting from an extended drought that has gripped the region since 1994. The National Water Commission, Conagua, warned in recent days that the seven reservoirs that make up the Cutzamala System, which supplies 24% of the Mexican capital were at dangerously low levels. (Over 70% is supplied by ground water, and the reservoirs are the sole source of water for 10 municipalities on the city’s outskirts.) Conagua, in response, plans to reduce the water flowing from Cutzamala’s dams in the southwestern state of Michoacan to 13 municipalities of Greater Mexico City by between up to 10% during the weekdays to 50% on the weekends; the goals is to reduce water use by 6.7 million m3/month, representing 3.5% of consumption. The 20 million residents of the giant metropolis were already hit with partial stoppages earlier this year, including a cutoff in April that affected roughly a quarter of Mexico City’s population.

Although the city’s mayor blames the crisis on global warming, demographics and ill-conceived management have played a far greater role in the local crisis – one that is now far too severe for temporary austerity measures to solve. The inhabitants of Mexico use on average 300 liters per day, roughly double that used in some water-conserving cities of Europe. Because the population is growing by 4% annually, water demand is expected to jump by 20% in the next four years to five years. The problem is further compounded by a self-reinforcing water withdrawal/leak cycle. Overdrawing groundwater has led to the land’s surface dropping by 10 centimeters per year. This causes the water distribution system to crack, which in turn has led to the loss of more than 40% of the water from water mains, yielding an equivalent demand for more groundwater.

The self-reinforcing nature of the problem makes it one that is particularly challenging and expensive to solve. Although the citizens of the city use a lot of water, nearly half of the “consumption” is in the form of leaks, so water restrictions on end use will be doubly painful. Those same leaks will also blunt the efficacy of water recycling. And because water withdrawal causes stresses that result in leaks, a slow piecemeal effort to replace pipes will not work. It seems that the only solution is to replace the entire distribution system within a few years; however, the Mexico City government has only allocated 770 million pesos ($57.8 million) to substitute water networks and capture systems and fix leaky pipes – a number orders of magnitude smaller than what’s required to rectify the problem. Given the political finger-pointing and token responses seen to date, it unfortunately seems unlikely that the needed investment will materialize. The city may very well have reached a tipping point where its only future is one of depopulation and decline.

Weekly Insider (Clever China Commodity Charge)

Everyone looks to explain things away. China buying commodities? It must be growth, they say. Maybe decoupling is real. I say not. Yesterday's NY Times headline, "China Fills its Pantry With Global Commodities". Commentators cheered on China's consumption. If this is the consensus view, it’s likely to be wrong. This isn't consumption. It's investment. It's diversification. Away from the US Dollar.

We have a debt overh ang. The options are simple: pay your debt or don't. You can pay it in cash or kind. Pay it in cash, you're clear. Pay it in kind (collateral—whether a house or a stock), you may be 'cleared out'. Since most debtors can't pay, lenders must either take debtor's stuff by seizing and selling their collateral or take their stuff by converting their debt to equity. Rule of law and bankruptcy allows for orderly procedure of this last option, unless the rule of law is suspended by government to prevent riots and revolutions from the working class that elected the government. The US government isn't really willing to let the prices of stuff (collateral) fall. So the other option is to let the value of the stuff that the stuff is valued in (ie. dollars), fall. We devalue our houses or we devalue our dollars. We do the dollar-devaluing thing by printing more of them. Many, many, more of them. More supply, less value. This is inflation. When there is a lot of money going around, it will eventually find itself into the prices of some other stuff. This way, the pain gets spread to those holding lots of dollars—like say China.

China officials have already jawboned the US publicly about maintaining a strong dollar, about finding alternative stores of currency reserves. And THAT dear reader is my opinion of what China is doing. They are doing what Dave Swensen did when he arrived at Yale as a 31-year-old. He looked at Yale's holdings, saw 50% of their equities in US Stocks and the rest in US bonds and thought that no matter how diversified Yale was within those two asset classes, having a total of 90% in US marketable securities was definitely NOT diversified. He embarked on, and others later emulated, the now famous endowment model—diversifying into commodities, real estate, private equity and active managers—that has outperformed and compounded Yale's endowment to be the envy of institutional money managers.

China may be diversifying its reserves into hard assets. If inflation comes, the value of those assets, especially in dollars will rise. If hyperinflation comes, the value, especially in dollars will skyrocket.

Clever. And what you might expect from the academic pedigree that comprises their government officials. In the US ours are mostly lawyers and career politicians. In China, theirs are mostly engineers, geologists and mineralogists. Who's got the edge?

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