China’s “Silicon Bubble” Deflates at Early Stage

The Chinese government is seeking to rein in overinvestment in the nation's polysilicon industry. On August 26, the State Council, China's cabinet, sent out a warning that could raise the bar for market entry in the industry by tightening requirements for energy consumption, environmental standards, and technological capacity. 

Production of polysilicon, a key material in the production of solar cells, has expanded rapidly in China during the past two to three years. In 2005 and 2006, China produced only 60 tons and 287 tons of the material, respectively. In the first half of 2009, however, some 50 companies were building, expanding, and designing polysilicon production lines in more than 20 provinces.

The combined production capacity of these initiatives exceeds 170,000 tons, at a total investment of more than 100 billion Yuan (US$14 billion). Fully realized, this capacity would amount to twice the annual global polysilicon demand, indicating significant industry overinvestment.

Chinese manufacturers ramped up their production in response to a shortage of polysilicon worldwide that was triggered by the rising demand for solar cells in Europe and North America. The shortage caused the price of polysilicon to skyrocket, reaching as high as US$500 per kilogram in 2008. During the peak demand period, from 2005 to 2006, industry profits exceeded 100 percent.

The success of the Chinese solar-cell company Suntech, which raised millions of dollars on the U.S. stock market after going public in 2005, also galvanized Chinese companies to invest in solar cells and related industries. But this only exacerbated the polysilicon shortage and further raised investor interest in entering the industry.

Investors were also attracted by preferential tax measures, such as rebates and exemptions, being offered by local governments that were hoping to diversify their economies with polysilicon industries. But the rapid escalation ultimately led to a glut in capacity nationwide.

Li Junfeng, Deputy Director of the Energy Research Institute of China's National Development and Reform Commission, says the industry is not as overinflated as some presume, however. Noting that capacity is different from actual production, he explained that the country used 30,000 tons of polysilicon in 2008 but produced only 5,000 tons. This year, China will produce some 10,000-15,000 tons, while demand could reach 40,000 tons.

The worldwide financial crisis has affected the Chinese industry as well. As global demand for solar cells fell sharply, the price of polysilicon also plummeted, from around US$500 per kilogram last October to a low of US$50 per kilogram this year. This has affected profits in China and elsewhere.

Meanwhile, the recent government caution has put a much-needed spotlight on potential risks in China's polysilicon industry. Most of the nation's producers do not use advanced technologies, and their production processes tend to be energy-intensive and highly polluting. Both the government warning and the current market squeeze are helping to phase out smaller producers that use less sophisticated technologies and have higher operating costs.

In light of these setbacks, the industry is seeking its own solutions. Several large industry players have voluntarily formed a coalition that aims to develop a technological innovation system to combine research and production and to integrate resources for greater technological advancement. This industry reshuffling is likely to usher in stronger and better enterprises.

The excess capacity in recent years can be blamed in part on China's small domestic solar market. China produced 2,500 megawatts of solar cells in 2008, a third of the world total, but it installed less than 50 megawatts of solar photovoltaic (PV) systems domestically. An estimated 98 percent of the solar PV products that China produced were exported.

The situation will likely change in the coming years. The government is currently deliberating a new energy development plan that would raise the national target for solar energy production. By 2020, installed power generation from new energy sources in China is projected to reach 290 gigawatts (GW), or 17 percent of the country's total. Of this, wind power is projected to reach 150 GW, solar PV 20 GW, and biomass power 30 GW.  

Yingling Liu is director of the China Program at the Worldwatch Institute, an environmental research organization based in Washington, D.C.