Friday, December 2, 2011

The extent of Chinese solar subsidies and their implications

Chinese solar makers are facing a countervailing tariff case essentially arguing that the Chinese Government (through state controlled banks) are subsidizing them. The CEO of Trina Solar (Jifan Gao) was party to a statement (also made by three other solar CEOs) that:
China’s solar industry had to pay higher interest rates for bank loans than U.S. and European competitors, and paid market rates for loans. With the appreciation of the yuan, “the loan rate we are paying is probably equivalent to over 10 percent,”
Ok - lets see what the interest rate the market (as opposed to the Chinese banks are charging the solar makers):



(Unfortunately you need to click this image to see the axis)...

Suntech is at 78 percent. LDK is 53 percent. Trina is "only" at 22 percent - but the Trina debt piece is a convertible and was recently trading way above par as this bond price chart shows:


(Click the image to see the axis.)

Which shows the price of the Trina piece coming down from well over 100 as the "convertible" bit lost its value.

Trina has recently expanded its loans by several hundred million dollars at low rates. But Jifan Gao says those rates are not subsidized. He is wrong and the solar makers should and will lose their case. There is a robust market telling us what the "free market rate" is and it does not look like the subsidized rate the Chinese banks are providing.

The Solyandra case

The Chinese solar makers will - with righteous indignation - point at the subsidized loan that the US Government gave Solyandra - a loan that has now gone solidly into default. They have a point - but not a good one in a court. Their problem is that the WTO agreements have a specific exemption for government loans to develop new industries and new products. The most famous recipient of these loans is (of course) Airbus who gets subsidized loans to develop every new plane. Boeing can't win that trade case because the subsidy - like the Solyandra subsidy - is international trade law compliant. (If you want a decent history of that subsidy read John Newhouse's excellent book on Boeing versus Airbus.)

The reality for solar makers

The reality for the solar makers is bleak - maybe not for the solar business - but certainly for the shareholders and debt holders in the companies. The American solar makers will win the trade case. There will be a countervailing tariff. Europe will almost certainly follow. The products will have no markets at tariff included prices and the subsidized loans that the Chinese banks gave the solar companies will not be repaid.

The banks will wind up owning the companies anyway, selling products facing crippling countervailing tariffs. When the most potent argument that the Chinese solar CEOs can come up with is that their interest rates are high (almost 10 percent) but are really 30-60 percent below market their position is clearly weak.

There is an alternative. The alternative is for the Chinese to simply agree to provide no more subsidized loans and to roll all funding as it matures into long-dated non-subsidized loans. Then the whole countervailing tariff argument just evaporates.

Of course the solar companies - every single one of them - goes bust. And quite rapidly.

But it doesn't matter - after bankruptcy the Chinese government - through their banks - owns them. They become state owned enterprises and the Chinese Government can amalgamate them as they see fit. Indeed as SOEs they can seemingly subsidize them as they see fit too - because those subsidies are much harder to argue against in a trade case.

The losers are of course shareholders and western debt holders of the Chinese solar stocks. But I see no reason why should the Chinese government should give subsidies and enter into a crippling trade dispute to protect them.

It is time for Jifan Gao and the other CEOs to have their subsidies - and their businesses - removed from them just as the CEO of Solyandra had his business removed from him. The Chinese banks will learn - as people have been learning since the advent of capitalism - that when you lend a business too much you either own it or are going to spend a lot of time collecting.




John

PS. I do not wish to enter into the morality of the trade dispute. For instance I don't wish to argue that the loans to Solyandra were moral and the loans to the Chinese companies were immoral. I just want to argue what is - and why it is from an investment perspective. The loans to Solyandra were legal. The loans to the Chinese makers are not legal. Morality does not enter into it.

Moreover a countervailing tariff will hurt some people in the US (eg residential solar installers). That is a fact - but it won't enter into the legality of the dispute.


J

20 comments:

H.Z. said...

Bank loans are secured. Based on your logic, a consolidation of credit card debt (20+%) into mortgage (4% for first lien, higher for second lien) would be an illegal subsidy. You may get somewhere with your arguments but they clearly need to be refined as you ignored the issue of collateral and control contained in credit terms.

John Hempton said...

I have read the loan covenants. The short term funding is all unsecured and ranks next to the above mentioned corporate debt - in some instances parallel.

Also the incremental loans are effectively all unsecured and subordinate.

I am not as sloppy as you think. Lets call it a 2-3 percent not 30-50 percent differential.

John

Anonymous said...

This may make me look like an idiot, but it is better to find out: You should yield to worst instead of option adjusted spread in your comparison of rates. Wouldn't OAS clear out the convertible issue letting you not worry about how the TSL bond traded well over par?

John Hempton said...

Look at the top graph. It is yield to worst I think.

J

Jacob said...

Lending at a rate below an illiquidity-influenced market rate for existing debt is a benefit, to be sure, but it is not an illegal trade subsidy. It is something governments do in normal course; witness the Fed's emergency loans to US banks. In any case Chinese solar firms are borrowing at rates that would be reasonable in the absence of financial distress, 6-10% in RMB terms. That's only an unfair subsidy to those firms that should fail in the long run, not the more cost competitive Chinese players such as Trina or Yingli. Arguably their bonds (and equity) are mispriced, as they are viable concerns in the long run. It's a little unfair to use a market price that includes substantial implied default risk as a proxy for true economic borrowing costs.

Anonymous said...

Can you clarify exactly what your yield to worst graph is showing? I am not used to reading Bloomberg (is that what it is?) screens.

Finster said...

John, I suggest you visit

http://mpettis.com/

For China financial macro take. As Prof. Pettis analysis shows, the entire Chinese economy developes and rests on negative real interest rates, which shift wealth from savers to borrowers.

Incidentally we have a similar environment now in the UK and in Germany, as well as the US, where interest rates are effectively below inflation due to central bank policies.

It will be hard to take the Solar Panel companies to task over the interest rate regime of the PBoC, especially as the FED is effectively doing the same.

John Hempton said...

I am aware of Pettis view - the slowly declining Chinese inflation rate is one of those puzzles I have and do not understand.

J

H.Z. said...

John,
I am impressed by the quality of your work so I apologize if I sounded abrasive in my first post. For the sake of argument (it is probably safe to assume that Chinese banks subsidize firms favored by the State):
1) Do you read loan covenants from translated copies provided by the filers? Chinese contracts tend to be short and do not spell out a lot of details and contingencies. So seniority would probably largely depend on the local legal practice that I am not familiar with. There could also be structural subordination (loaning to a subsidiary with real assets instead of the holding company). Short maturity could also effectively subordinate other longer maturity debt.
2) One could lend at reasonable rate against reliable collaterals (inventory, receivables, real estate) to a company in financial trouble.
3) USG DIP financing to GM/Chrysler and cramming down of creditors was also a form of subsidy, probably not consistent with WTO. Indeed a Chapter 11 bankruptcy is generally a form of subsidy to the operating entity when competitors would be happier if the entity is liquidated.

Nemo Incognito said...

H.Z. yes you are abrasive.

1) I read contracts in Chinese. If we want to talk credit, lets talk about yields over swaps. Chinese loans are 200-300bps over risk free vs 3000 bps over for USD bonds.
2) Think John has more to say on this point - if you get a default the whole capital structure defaults so spread differentials imply different recoveries.
3) No you are wrong do some research and read the actual trade law.

Anonymous said...

A lot of the polysilicon / materials provided for the manufacturing of the Chinese panels come from companies like MEMC / Wacker Chemie / Dupont...so I am not so sure that it will be that easy for the americans/europeans to justify a complaint against Chinese Solar panel companies because you will see lobbying from these companies on behalf of the Chinese. Secondly, you could say the Germans are subsidising q-cells with cheap loans (ever seen where their bonds are trading)....at the end of the day, the solar industry is a nascant industry which benifits from subsidies from both sides and in my opinion the Americans need cheap panels from the Chinese in order to reach closer to grid parity. The jobs that will eventually created in the USA will be on the installation side.

Nemo Incognito said...

It amuses me that people presume its cheaper on a fundamental basis in China. One of the major inputs in polysilicon is power which China does not have on the cheap, REC does. Labor is frankly a rounding error in much of this business ex installation - and that labor is not tradable in the sense that you can't use Chinese people to install panels in Cali.

And while China may have historically imported a lot of polysilicon they produce a lot more themselves now from companies like GCL Polysilicon.

Q cells bonds may be cheap here - but they may go under before this policy shift saves them. For 10-15c its an okish punt I guess.

Anonymous said...

So solar is a "new industry" to the US, but not the same to China? What a BS! Those who try to fool around with double standard shall be punished severely.

John Hempton said...

Dear last anon.

Polysil is not a new technology

Solyandra panels (which were cigs panels - look it up) were a new and hopeful (and failed) technology.

If China wanted to subsidize a CIGS panel of a new design then they could do that via government guaranteed loans and still be WTO compliant.

John

ECD Fan said...

John,

There is no such thing as Solyandra. It is Solyndra. Solyndra was an actual scam (and a fraud) since the beginning - cost of manufacturing (on efficiency-adjusted basis) was not competitive and management knew that it will never be competitive.

John Hempton said...

Maybe Solyandra was a fraud from inception - maybe it was NEVER going to be competitive.

Whatever - it was a new technology so the subsidized loan to it was WTO compliant.

There is nothing in the WTO that stops a government subsidizing a new technology. Come to think of it - I don't think there is anything in international trade law that stops the government subsidizing a fraudulent new technology.

I do not need to express a view on whether Solyandra was real or fraudulent to have my view on the trade dispute with China about coventional polysil.

J

Anonymous said...

It is possible, by fixing your eye relentlessly on a single sharp landmark, to find your way free and clear even in the midst of a heavy snowstorm. But it really takes an exhausting effort to avoid less distinct distractions which may lead you astray along the path.

Anonymous said...

I wouldn't argue that the technology is new but you could make a strong case that the industry is.

Anonymous said...

I wouldn't argue that the technology is new but you could make a strong case that the industry is.

H.Z. said...

http://www.tirereview.com/Article/95164/another_court_tosses_china_countervailing_duties.aspx

Subsidy is probably a moot issue anyhow until after 2016 when China will be deemed a "market economy" based on WTO-accession agreement.

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