What Is the Risk of Tariffs on Solar Panels? A Legal Analysis of Potential Outcomes of Suniva’s Section 201 Petition

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Eric Selmon Hugh Wynne

Office: +1-646-843-7200 Office: +1-917-999-8556

Email: eselmon@ssrllc.com Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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June 27, 2017

What Is the Risk of Tariffs on Solar Panels?

A Legal Analysis of Potential Outcomes of Suniva’s Section 201 Petition

In this note, we analyze the legal underpinnings of the U.S. International Trade Commission’s (USITC’s) review of Suniva’s Section 201 Safeguard filing, petitioning the U.S. government to impose restraints on imports of solar PV modules and cells. We believe the potential outcomes of this case to be more complex, and possibly more favorable to the solar energy industry, than the market appreciates. Indeed, although we estimate the probability of a positive determination of injury by the USITC to be 50-60%, we estimate the final probability of tariffs being imposed on imports of solar PV cells and modules to be only 33%-45% (see Exhibits 2 and 3 and the discussion below).

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Portfolio Manager’s Summary

  • In April 2017, Suniva Inc. filed a safeguard petition under Section 201 of the Trade Act of 1974. Accepted by the U.S. International Trade Commission (USITC) in May, the filing has the potential to materially increase the cost solar panels in the United States and, consequently, to disrupt the U.S. solar energy industry.
  • A manufacturer of crystalline silicon photovoltaic (CSPV) solar cells and solar modules, with manufacturing facilities in Georgia and Michigan, Suniva filed for bankruptcy in April 2017.
  • Section 201 provides a mechanism for the President to take action, including import relief, to facilitate efforts by a domestic industry that has been seriously injured by imports to make a “positive adjustment” to foreign competition.
  • First, however, the USITC must determine that an article (in this case, CSPV panels and solar modules) is being imported in such increased quantities as to be a substantial cause of serious injury to the domestic industry. The USITC is an independent commission whose members serve for nine years. The current members are all experienced international law jurists appointed by Presidents Bush and Obama. We expect them to conduct a professional and impartial investigation.
  • While Chinese and Taiwanese manufactured solar cells are currently subject to U.S. tariffs, solar cells manufactured elsewhere are not. Suniva’s filing has the potential to create barriers to the imports of solar cells and modules from any source.

    • If the USITC should make a positive determination that imports have caused significant injury to the U.S. CSPV module and cell manufacturing industry and the President should decide to impose restrictions on imports, the cost of CSPV panels, which comprise the vast majority of the U.S. solar market, could rise dramatically, forcing a decline in solar installations and slowing the growth of solar generation.
  • In evaluating Suniva’s safeguard filing, the USITC must determine that “an article is being imported into the United States in such increased quantities as to be a substantial cause of serious injury, or the threat thereof, to the domestic industry producing an article like or directly competitive with the imported article.” The USITC’s determination involves a three-part test to determine whether the imports have caused injury to the domestic industry. Specifically, the USITC must find that:

    • Imports have increased (generally analyzed over the prior five-year period).
    • The industry has been seriously injured or is threatened with serious injury. Serious injury is defined as a “significant overall impairment in the position of the domestic industry,” evidenced by idling of production facilities, losses across significant portion of the industry and significant unemployment in the domestic industry.
  • Increased imports are a “substantial cause” of the serious injury. A “substantial” cause is defined as one of equal or greater importance to any other cause of injury.
  • A determination of injury must be made by the USITC by September 22, with a report sent to the president with recommended remedies within 30 days, or October 22. If a positive determination is made, the President will have 60 days to make a determination as to which remedies to implement, if any. Those remedies are to take effect within 15 days of the President’s decision.
  • This puts the latest time for action by the President as December 21 and the latest date for implementation as January 5, 2018.
  • However, the implementation of remedies could be delayed by an additional 75 days (for a total of 90 days) if the President recommends negotiations with exporters of the modules and cells.
  • Should the USITC make a positive determination that results in trade restraints being imposed by the President, other countries can file complaints with the Dispute Settlement Body (DSB) of the World Trade Organization (WTO), initiating a process that would likely take about two years to complete.
    • In reviewing the USITC’s decision, the WTO will apply an additional test, specifically a requirement that the surge in imports has been caused by “unforeseen circumstances.” The WTO requires that the analysis of unforeseen circumstances must be included in the report issued by the national authority making the determination (i.e. the USITC).
      • If the USITC’s decision is deemed invalid by the WTO, countries adversely affected by the decision may retaliate with their own trade restraints of equal value on other areas of trade.
  • We see four potential outcomes at the USITC.
      • The first, which we believe has a 40% to 50% probability, is a positive determination of injury based solely on the tests included in Section 201.
        • We believe it is clear that imports have increased, there is serious injury to the industry as defined in the petition and that imports are the primary cause.
        • As will be discussed further below, however, should the USITC not explicitly consider in its determination and not include in its report an analysis of whether the surge in imports has been caused by unforeseen circumstances, as required by the WTO, the USITC almost guarantees that any trade restraints imposed by the President will be determined to be in violation of WTO rules, allowing for retaliation by other countries within two years.
      • A second outcome, which we think has significant probability, is that the USITC includes the WTO’s “unforeseen circumstances” test in its assessment. In this case, we believe it more likely than not that the USITC would make a negative determination, finding against Suniva.
        • We believe that there is strong argument to be made that the surge in imports should have been unforeseen.
  • The global CSPV industry has been suffering from overcapacity for many years.

        • During this period prices have frequently dropped to near the cash cost of production.
        • The capital cost of new module and cell manufacturing plants are very low (~$0.10/W of manufacturing capacity for modules and ~$0.25/W for cells) and the time to bring new plants online is very short (three to six months), allowing for rapid responses to changes in demand and trade policy.
        • The rapid move of module and cell capacity from China to Taiwan in 2012 after the US placed anti-dumping/countervailing duties on Chinese imports was evidence that such a response would be likely after additional tariffs were applied to Taiwanese imports in 2014.
        • The only aspect of the surge in imports to the U.S. that likely could not have been foreseen is how quickly the underlying cost of production would drop over the past few years. However, this, alone, is not enough to make the surge in imports unforeseen because, even if prices were higher in 2016, imports were still lower cost than domestic production and would have jumped in order to meet the demand for projects that had been planned when the solar investment tax credit was expected to expire at the end of 2016. .
        • We note, moreover, that some international lawyers have interpreted the “unforeseen circumstances” test as requiring that the increase in imports be due to unforeseen circumstances resulting from tariff concessions granted on the product, i.e. the last set of tariff reductions under GATT in 1994. This has not been the case in respect of the domestic CSPV industry. Should the USITC adopt this interpretation, therefore, it would almost certainly make a negative determination, finding against Suniva.
        • Should the USITC apply the “unforeseen circumstances” test, therefore, we believe that the probability that it makes a negative determination rises modestly above 50%.
      • A third potential outcome, the probability of which is difficult to determine, is the separation of CSPV modules and cells into separate products.
        • In the China and Taiwan anti-dumping/countervailing duty decisions in 2012 and 2014, the USITC defined modules and cells as a single product, but our understanding is that there was some discussion among commissioners in 2014 as to whether there should be distinction between the two. That distinction could be made in the Suniva case.
        • Distinguishing between CPSV modules and cells would require a separate injury analysis for each product, which could result in different outcomes.
        • The decline in module manufacturing in the U.S. could be determined to be of greater import as a cause of injury to domestic cell manufacturing than cell imports, resulting in a finding of injury for modules, but not for cells.
        • Seen from this perspective, a remedy for modules could serve as a remedy for cells. There is only one significant CSPV cell manufacturer remaining in the U.S., SolarWorld. As it uses its cells internally for its module production, improving the ability of SolarWorld to sell modules by placing tariffs on modules should result in increased domestic manufacturing of cells as well.
        • This outcome would have a much more benign on impact on the U.S. market for solar energy. It would likely increase solar panel prices only moderately, as foreign module manufacturers would rapidly build module assembly plants in the U.S. The impact on costs would thus be limited to the difference between module assembly cost in the U.S. and abroad.
        • The capital cost to construct module assembly plants is <$0.10/W of production capacity and takes only three to six months to complete.
      • A final, and we believe highly unlikely outcome, is that the USITC determines based solely on the tests included in Section 201 that the domestic CSPV manufacturing industry has not suffered injury from imports. Such a determination by the USITC would end the case, and the President would have no opportunity to impose any trade restraints.
        • This outcome would likely be due to a determination that actions taken by the companies in the U.S. industry were a more important cause of the decline suffered over the past few years.
  • In the event of a positive determination, USITC will recommend appropriate courses of action to the President. These may take the form of trade restraints, including import quotas or tariffs, as well as assistance to the affected industry to adjust to the imports.
      • Rather than curtail the absolute level of imports through a quota, we expect the USITC to recommend a tariff. Moreover, since the purpose of the remedy is to help the domestic industry to adjust to the imports, we expect the tariff to be a declining one, initially set to achieve an average price on imports of ~$0.60/Watt, similar to pricing prevailing in 2014-2015 and a >50% increase over current prices, but then declining over three to four years to a level that would achieve an average import price of $0.40/Watt.
      • We do not expect the USITC to recommend minimum import pricing, which was requested in the petition, as this generally has not been used in prior safeguard cases.
      • Finally, it is equally probable that the USITC would not recommend a tariff but rather assistance to transition the industry, reflecting a view that the domestic CSPV industry will be unable to reduce its costs rapidly enough to be competitive even after four years of protection.
  • Should a positive determination be made by the USITC, the President has the authority to decide whether to impose a remedy and if so, which one.
      • While we hesitate to predict the actions of President Trump, the first possibility is that he may choose to enact no remedies, declaring that it is in the public interest to allow the current situation to continue.
        • Viewed from the perspective of the impact on employment, this is arguably true. The U.S. solar installation industry employs, by some estimates, as many as 250,000 people, or 100x as many people as are employed by the U.S. CSPV manufacturing industry.
        • Furthermore, as noted in the discussion of potential USITC remedy recommendations, it can be argued that the gap between the US CSPV manufacturing industry and foreign competition is too great for the domestic industry to catch up, thus rendering tariffs ineffective.
        • A further consideration may be the impact that imposing trade sanctions on China’s CPSV manufacturers may have on relations with China, on which the administration depends to contain the risk of a nuclear armed North Korea.
      • A second possibility is that President Trump imposes tariffs on solar module and cell imports in order to support U.S. manufacturing.
        • Trump may decide that this approach is more consistent with his campaign promises and is more likely to be perceived as winning on trade.
      • Finally, the President could choose to treat modules and cells differently, even if the USITC did not make that distinction, and impose tariffs on modules, but not cells.
        • This would allow him a victory in supporting U.S. manufacturing and manufacturing employment while not materially hurting the U.S. solar installation industry.

Exhibit 1: Decision Tree Analysis of Suniva’s Section 201 Petition

Source: SSR analysis and estimates

  • In summary, we believe the potential outcomes of Suniva’s Section 201 petition to be more complex, and possibly more favorable to the solar energy industry, than the market appreciates.
    • First, as illustrated in Exhibit 2 below, we estimate the probability of a positive finding by the USITC in Suniva’s case to be only 50%-60%. If the USITC were to apply only the three-part test required by Section 201, we would place this probability in a range of 90%-95%. However, it is our view that the USITC is quite likely to apply not just the three-part test required by Section 201, but also the test of “unforeseen circumstances” that will be applied by the WTO if the case is appealed. As we believe the demise of the U.S. CSPV industry was foreseeable, we do not expect the USITC to make a positive finding if this fourth criterion is applied.

      • Second, if the USITC makes a positive finding, we believe there is some significant probability (estimated at 25%-35%) that President Trump will chose not to impose tariffs in response. In part this reflects our view that USITC may not recommend that tariffs be imposed; as illustrated in Exhibit 3, we believe it quite likely (~40% probability) that the USITC will deem the U.S. CSPV industry to be too small and uncompetitive to make a meaningful recovery, and will choose therefore to recommend transition assistance to the industry rather than tariff protection. A further consideration that may sway the administration against tariffs is the fact that the number of U.S. jobs in the construction of solar power plants, and the installation of distributed solar arrays, is estimated to be 100x that in the U.S. CSPV industry. Were tariffs to have even a small adverse impact on the deployment of solar PV in the U.S., therefore, the net impact on domestic employment would be negative. Finally, the administration may decide that, whatever the merits of Suniva’s case, the imposition of tariffs could damage Sino-U.S. relations at a time when the U.S. is heavily reliant on Chinese cooperation to contain the North Korean nuclear threat.
      • If indeed the probability of a positive finding by the USITC were only 50%-60%, and the probability that the Trump administration imposes tariffs in response to such a finding were 65%-75%, then the probability that Suniva’s Section 201 petition will result in tariffs being imposed on CSPV imports can be estimated at only 33%-45%.

Exhibit 2: Estimated Probabilities of Key Exhibit 3: If ITC Finding is Positive, Estimated

Outcomes in Suniva’s Section 201 Petition Probabilities of Alternative Recommendations

Source: SSR analysis and estimates Source: SSR analysis and estimates

    • Which firms would be most affected were the administration to impose tariffs or other restraints on imports?
      • FirstSolar (FSLR) would be the primary beneficiary of tariffs on CSPV modules and cells because it is the sole large scale producer of non-CSPV modules and it would be, therefore, exempt from any tariffs imposed.

        • This does not imply, however, that we are adding FSLR to our list of preferred renewable companies. The risks of its transition to Series 6 and the likely limited long-run margins on its PV modules even if Series 6 is successful lead us to conclude that FSLR is currently fairly valued.
      • Solar installers, particularly, the residential installers Sunrun (RUN) and Vivint Solar (VSLR), would be hurt by tariffs as it will either reduce sales or reduce margins.
      • Foreign solar manufacturers, such as JA Solar (JASO) and Jinko Solar (JKS) would be hurt by the reduction in U.S. sales that tariffs would likely cause.
      • Consumers of solar power, including utilities and their customers as well as large corporations such as Google and Amazon, will suffer from higher prices for new solar projects.
  • We are also adding JASO and JKS to our list of least preferred renewable companies, in part due to the risks posed by section 201, but primarily due to the impact of lower sales volumes and lower pricing in China, their biggest market, going forward.
      • Looking forward, after a surge in installations in China to meet the deadline for the current feed-in tariff (FIT) on June 30, we expect installations to be lower than they have been the past few years as the 2020 target in China has been reduced and the pricing of solar power under the new green certificate program should be materially lower.
      • The long-term lower level of solar installations in China, combined with a natural fall in U.S. demand after the surge in 2016 means that global overcapacity in 2018 will be even greater than 2017, pushing average selling prices and margins down even further without the impact of Section 201 on US imports. Should tariffs be imposed on US imports that would only exacerbate the problem
      • As pure manufacturers, unlike Canadian Solar (CSIQ), which also has a project development business, JASO and JKS will face continual pressure on average selling prices and margins over the next several years as global capacity far exceeds global demand and manufacturers continue to drive costs and prices down.

Exhibit 4: Heat Map: Preferences Among Utilities, IPP and Clean Technology


Source: SSR analysis

©2017, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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