Silicon is not exactly a rare element. In fact, silicon is the second most abundant metal on Earth. 25.7% of the Earth’s crust is made of silicon. SiO2 is one of the most common ways that you find silicon. The coming shortage that I’m going to discuss is not a lack of silicon in the Earth; instead, it is the limited refining capacity.

The process of refining silicon is rather expensive. First, all impurities must be purged. The oxygen is removed from the silicon through a reaction with carbon. This process is usually done by adding some form of coal and then heating the product in a special furnace at temperatures of 2,700-3,600 degrees Fahrenheit. This grade of silicon is approximately 98% pure.

To make semiconductor-grade silicon, the metal needs to still undergo some processing. It needs to be combined with HCl, removing some additional impurities such as aluminum and iron. The final step takes the SiHCl3 and reacts it with hydrogen for 200-300 hours at 2,000 degrees Fahrenheit to produce a very pure form of silicon.

The pure silicon is formed into rods measuring two meters in length and 30 centimeters in diameter. These rods are then sliced 0.5 millimeters thick, and you have your silicon wafer, which is the final product used for PV cells.

It’s very easy to see why the energy input costs of creating semiconductor-grade silicon are very expensive. But not only is this process itself very expensive, it is also very expensive to increase refiner capacity.

Let’s take the German silicon refiner, Wacker Chemie, for example. It has undertaken a project to expand its refining capacity from 5,500 tons to 9,000 tons. The price tag on this project? Over $270 million. The high cost of refining and adding additional refining capacity can deter companies from embarking on new silicon ventures, and that is exactly what has happened.

It would take a large demand shock to push the prices of silicon to high enough levels to make it economical for refiners to bring more capacity online.

This is the fundamental idea behind a commodity supercycle. In a commodity supercycle, getting additional supply online to meet growing demand takes time and money. The market needs to be assessed, funds need to be raised, permits need to be obtained, and finally, the project needs to be started and finished. The time lag consists of a supply shortage met by higher prices. The shortage and price increase can also be judged or predicted by the size of the demand shock. And this particular demand shock is one of great significance.

The Power of Government Subsidies

The obvious question that follows is why is this demand shock going to be so noteworthy? It’s very simple. Where renewable energy goes, the footsteps of government subsidies can be heard close behind.

As proven with ethanol, government money can make a bull market out of nothing. But what happens when the market is actually economical on its own, but is then combined with taxpayer money? You get a huge, stinking demand shock.

Look at California, for example. California has recently announced the largest solar energy potential program in U.S. history. Its Public Utilities Commission has set up an 11-year plan that could supply up to 2.3 million Californians with solar power. With this increase in solar power, California alone will produce an estimated 3,000 megawatts of solar energy! That would make California alone the third largest user of solar energy in the world, behind Germany and Japan. There are many other similar forms of legislation that are either already passed or in the process right now. We are seeing the green wave take hold around the globe.

The United Nations recently passed an amendment to the international treaty on climate change called the Kyoto Protocol (KP).

As of 2006, 169 countries had agreed to the Kyoto Protocol. The idea of the KP is to reduce greenhouse gas (GHG) emissions. The 169 countries that agreed to the KP account for 55% of total GHG emissions. Annex 1, or developed, countries are expected to reduce their GHG emissions by 5% from their 1990 levels. The date set for the reduction standards varies from 2008-2012. Some countries, like those in the European Union, will have to reduce their emissions by 15% from their current levels, due to the growth in GHG emissions from 1990.

Although this amendment isn’t solar specific, those 169 countries will be using solar energy to meet the above-mentioned GHG emission standards.

Silicon is used in cell phones, computers, and MP3 players, but its greatest use is definitely in the solar market. Solar energy currently makes up approximately 50% of the demand for silicon, and that number is rapidly increasing.

Let’s look at some numbers regarding the growth in solar energy. From 2000-2004, the number of annual PV cell installations nearly quadrupled. In that same period, the price of silicon went from $9 per kilogram to nearly $30 per kilogram.

The market for solar-grade silicon currently is estimated to be around $2.3 billion. By 2010, PV installations are expected to quadruple again and the market for solar-grade silicon is expected to rise to $10.4 billion. With solar taking up a higher and higher percentage of the silicon market, you can expect to see an even stronger correlation between the growth in the solar market and the price increase in silicon.

I would like to look at a hypothetical situation regarding the market for silicon: PV installations quadrupled from 2000-2004. The price increase in silicon over that same period was 230%. The interesting thing is that in 2000, there was excess refiner capacity. The increase in demand was met by spare refiner capacity, and still a 230% increase in price followed. What happens when PV installations quadruple again, but this time spare refiner capacity isn’t able meet the growing demand?

Your guess is as good as mine as to what the actual price will bring. But I can promise that the shortage in silicon due to a skyrocketing demand in the solar market and a refining capacity with minimum wiggle room will result in some spectacular price action in the silicon market.

Silicon refiners are set to experience the greatest gains in the solar market. PV producers will be forced to pay higher input costs to produce their modules because of silicon shortages. With government subsidies and tax breaks, they will be more than willing to pay these higher prices, allowing for the price of silicon to continue its bull run. Although the profit for solar producers will be hurt by higher silicon prices, the refiners will be in a position to experience tremendous gains. Playing the solar market from a commodities perspective is the best and safest way to profit off the solar energy boom.

One of the refiners producing solar-grade silicon that I think is set to profit off the coming bull market for silicon is Tokuyama Corporation (Tokyo: 4043). Tokuyama is mainly traded on foreign exchanges, but you can also trade it here in the U.S. over the counter under the symbol TKYMF. These guys have experienced increased revenue from their sales of silicon, and as the price of gray gold continues to push up, look for Tokuyama’s stock price to also experience large gains. But it isn’t the only one set to profit from this market. We will follow this trend and bring you profit opportunities as they come…

Regards,
Nick Jones
November 6, 2007

Editor’s Note: Our fellow Sleuth editor, Greg Guenthner, has stumbled on to something that quite possibly could change everything you know about investing.

Investing in Silicon was originally featured in the Penny Sleuth.