Hopes that the solar power industry will finally expand to residential homes throughout the world remain uncertain. Despite the pursuit of tax benefits to solar energy users, many companies continue to struggle. For example, after First Solar (NASDAQ:FSLR) reported third-quarter results, while the company managed to generate earnings that were a hair better than expectations (EPS of $1.79 vs. the average analyst call of $1.74), sales came in decidedly below what analysts had been looking for ($481 million vs. $529 million) and gross margin guidance for the final quarter indicated that a sharp downturn in profitability was in the cards. Margins were expected to fall to the 41-44% range from the 50.9 level reported in the previous quarter.
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The stock sold off sharply on the news, tumbling more than 16%, echoing a similar plunge that rival SunPower (NASDAQ:SPWRA) experienced the previous week when it revealed that weaker panel prices would put pressure on margins well into 2010.

Lots of Supply, Not Enough Demand
These disappointing numbers pretty much confirmed that the problems of excess supply, weak demand and falling prices are unlikely to be resolved anytime soon. With Asian panel makers still ramping up capacity and production, further aggravating the excess supply problem, analysts generally agree that the downward spiral in panel prices could extend into 2011.

European Subsidy Cuts Dampen Demand
Since the end of 2008, panel prices have tumbled due to falling demand from the world's number one panel market, Spain, as the Spanish government pulled solar subsidies. A recent announcement from the government indicates that the door is now firmly shut to the idea of any new incentives. Germany, which has now moved into the number one market spot by default, is also mulling over its own plan for cutting solar subsidies by as much as 25%.

U.S. Demand Remains Firm
In contrast, solar subsidies in California were recently enhanced in an effort to meet the state's ambitious goal of producing a third of its electricity from renewable sources by 2020. Despite the recession, Californians have been keen to go solar with record numbers of residential and commercial subsidy applications filed in recent months. A new state law that allows the sale of surplus power generated by a solar system back to the utility will likely add further positive momentum to this trend. And the prospect of further significant cuts in the price of installed systems could further add to demand growth there.

China: A Key Emerging Market For Solar Power
Another market that solar panel makers have focused their hopes for future growth is China, where government stimulus spending combined with low-cost loans from state-owned banks has kickstarted a slew of new green energy projects. Much of that business is likely to go to China-based companies like Suntech Power (NYSE:STP), Yingli Green Energy (NYSE:YGE) and Trina Solar (NYSE:TSL) whose local production facilities have the benefit of lower labor costs vis-a-vis their European and American rivals. But that advantage is likely to be short-lived, as both European and U.S. companies have been scrambling to set up manufacturing facilities in China and cut deals with its government. Clearly, the key players are trying to position themselves as being among the lowest cost producers in order to survive the protracted price war that's likely to dominate the industry over the next couple of years.

The Bottom Line
Up until this point, the solar industry has owed its existence to the public purse; without generous subsidies, it's unlikely that the current level of industry capacity would have emerged. As this subsidization benefit is now in the process of being withdrawn, the hope has to be that a natural level of market demand will emerge to sustain it. Economic theory teaches us that this is inevitable, but we don't know what the market clearing price will be.

My own calculations suggest that that number is an end user price point about 25% below where we are today. For the average American homeowner that would translate into a total cost of around $25,000 to go completely off grid; something comparable to building a detached garage. In the longer term, that could stir up quite a bit of demand. (To learn more about solar, check out Spotlight On The Solar Industry.)

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