On December 18th, METI has come up with new rules, which are going to solve suspensions of review of grid access applications by 5 out of 10 utilities in Japan. METI also published a review of what can be connected to the grid as the solar power and what has been approved for a grid access, in comparison to what METI certified for connection and what was the amount of total applications for each utility.
The review numbers show that what has been given a grid access versus the availability of grid has been mostly used up. METI gave an designated power provider system (DPP) status to some power companies that generate or are expected to generate more electricity than the capacity of a grid based on the current FIT policy, so that the amount of power generation can be limited without compensation for 30 days or more by those utilities. Out of the ten utilities, after December 22nd, seven are having such a status. Having the status allows utilities to apply own rules to management of energy provided from solar plants. Under those rules, utilities will be able to shut off an energy flow, action called curtailment, for an unlimited amount of time, based on the perception of the overload. The new rule for the rest of utilities (3) will change the curtailment formula from 30 days in a year to 360 hours in a year. Since solar plants provide energy during daylight, and an average sunny hours in a day for Japan are around 5 hours, it means worst case scenario is now about 71 days per year. Further, curtailment will be executed by the hour and not a by the day, which seem as very laborious format, and certainly is more debilitating to operations of solar plants. Lastly remote control of PV inverters will be made as a requirement for suspended and future applications. METI offered number of improvements to increase size of the grid, but for purpose of this review we are not considering them as material.
From 69GW certified by METI, around 51GW are awarded grid access. DDPS status utilities have around 23GW grid approved capacity. While some of the utilities do not have space, in a couple of instances there is about 1.5GW left in total, with Chugoku EPCO having 1.3GW. The remainder or some 17GW certified by METI only (balance of 69GW minus 51GW approved), is falling under new rules and based on information, utilities will resume the application process if the developers are willing to connect their plants with possibility of unlimited curtailment. Kyushu EPCO found around 20MW still available between grid availability and what has been grid approved, thus for this amount, Kyushu will use old rules for connection. Suspended applicants upon resumption are asked to install remote controls over PV inverters. METI considers this request as complex, and still needing operational, unified infrastructure, thus promise by a developer to install such equipment should suffice to get approval at this time.
All the new rules are not retroactive and already approved projects are not affected by any of the proposed changes.
Kyushu in its own release noted that it has connected about 4GW by December out of 8.1GW grid approved. This is why we believe the module demand in Japan will remain robust for at least 2 to 3 years as we think out of 51GW grid approved projects there is at least 31GW demand left. However, we see difficulty for new developments take place beyond what has been grid approved already. Unlimited curtailment is a tough proposition in particular with extra equipment requirements, and also faced with FiT changes coming in March 2015. It must be noted that grid available to solar is limited by the portion of existing grid allocated to nuclear energy, while nuclear plants have not been running. We see METI not to enforce changes, since the government has a desire to restart nuclear plants. Exception could be the decommissioning of old plants, but this does not equal to immediate reallocation of space to solar.
There is potentially room for more growth for utilities without DPP status, but the available space may quickly run into similar problems. Those utilities will have 360 hours rule for new applications, but this alone may pose problems for profitability for development with expensive infrastructure.
What does this mean to Canadian Solar?
As a supplier, the company should not have issues since with 31GW demand potential, and roughly 7.5GW delivered to Japan by Chinese suppliers in 2014, this looks like at least three years of the same busy pace. One issue to a demand can be coincidentally a benefit to Canadian Solar. Many believe that a large amount of the 51GW approved for grid connection is not in a position for development. If such projects become canceled, existing applications could be considered, where CSIQ could win new connection with its currently suspended application or even a completely new plant development. We suspect that new rules render additional projects not attractive, so if that reclaimed space is offered with new rules, it may not be developed. However, Kyushu's 20MW available is going to be offered to suspended applications with old rules by adding request for remote controlled inverters only. METI stated that only new applications will follow new policy, so seems logical that existing database of applications will be considered as a replacement for canceled projects, but there is no confirmation of this approach. If old rules are used, and old applications can get canceled projects' space, Canadian is bound to benefit.
Canadian Solar had 490.5MW of projects on October 6th, when company issued an update based on news of suspension. Out of 490.5MW projects, 150MW had a grid approval. Those were on a track to obtain construction permits. Since this update, Canadian added 48MW of projects totalling 538.5MW as of November 12th, and also updated investors that 95.6MW is ready for or being constructed.
In October update, the company identified 137.3MW as suspended, having 2.3MW for Kyushu and 135MW for Tohoku utilities. Based on METI analysis of the grid, Tohoku has no grid available creating a potential risk for the company not being able to develop that set of projects. Kyushu has 20MW available so there is a chance, but slim, for approval.
We also know that Canadian did not have projects with other three utilities named to have temporary suspensions, meaning that 203MW was not having grid approval, but was not suspended. Since then, two more utilities are qualified as DPPS, but one of them has at least 1.3GW space available for connection, which improves dramatically chances of grid approval, if Canadian had in fact those projects with this utility. We also do not know where the 48MW acquired from October to November is located. We assumed it has to be outside of areas managed by utilities with suspensions. So the potential risk for non-development to Canadian plant portfolio in Japan is about 137.5MW, of course assuming that new rules are something that the company would not consider as economic.
While we await the company's take on new rules, investors should once more consider facts, instead of rumor mongering by short-side analysts. Despite the fear tactics used, facts are that Japan remains as an attractive point of delivery with estimated 31GW of demand, and we consider the number as conservative. Development of solar plants may not be as attractive going forward, and new rules certainly will be reviewed by each company, but even If Canadian is left with 400MW of projects, this is still an excellent portfolio, as lucrative in gross margins and as large as the one the company had in Canada. In the event of bogus applications with grid access becoming canceled, in-waiting applications may get approval for connection to the grid, situation which could benefit Canadian. In light of the changes, Canadian's Japan business remains as an attractive component of the overall business strategy.
