Of Solar Shoes and Ships and Sealing Wax
Or if that's too obscure, then let's just go with "Hello, World."
Welcome to the first post of Renewable Energy Analysis. The goal of this newsletter is to provide clear and succinct information for those interested in learning about some of the most important issues facing the renewable energy industry in the United States, particularly with respect to solar and energy storage. I aim to tackle issues in an interdisciplinary fashion – and to translate current issues into practical considerations that you can use when transacting.
In other words, I don’t want to just report what is going on, I want to help answer: “How does this concretely impact deal negotiations?”
The first two topics I hope to cover are both trade-related issues impacting renewable energy equipment supply, which has been my area of daily professional practice for over ten years. These are: (i) current state of U.S. import tariff issues, and (ii) concerns regarding potential forced labor in the manufacture of equipment, and the risks of delayed and/or blocked equipment from importation into the United States.
In the past year or so, questions regarding use of forced labor in supply chains has been mostly focused on polysilicon in solar modules, but this is broadening – including to energy storage (see, for example, this New York Times article discussing forced labor concerns in battery supply chains).
We’ll get to forced labor in future posts – I think that could be the most important issue for the second half of 2022 in solar. But first let’s cover tariff issues.
Import Tariff Solar-Coaster
The industry moves fast, and I’ve had to re-write this first post a few times before publishing it. As everyone has now seen, the Biden administration announced an executive order waiving tariffs for up to two years from Malaysia, Vietnam, Thailand, and Cambodia. That is critical, as imports from these countries comprise in the vicinity of ~80% of U.S. imports.
Since the executive order, and particularly in the past few weeks since we saw the implementing regulations come out, I’ve seen transaction volume for solar module supply deals pick up substantially. Transactions aren’t generally in fire drill mode, but people are definitely negotiating deals again.
In the medium-term, many developers will obviously want their modules imported before the end of the tariff waiver in June 2024. If you run that backwards to when you need to transact for larger projects, that means negotiations starting now through year-end/Q1 2023. Demand will be even higher in this period if the ITC extension does not pass (probably of which seems rapidly changing), and people will consider Safe Harboring modules (among other methods) for the ITC step-down from 22% to 10% in 2023-2024. Finally, there is pent-up demand for modules for projects that were pushed out from 2021/2022 due to recent module pricing (owing to tariff risk/Auxin, elevated container shipping costs, etc.).
All of this is to say, I think the second half of 2022 is going to be busy with module supply negotiations and people locking supply down.
As we enter that phase, here are some important things to consider: the waiver of tariffs announced by the Biden administration is an adrenaline shot to the U.S. solar industry. As the industry comes off the initial celebration of that tariff waiver, however, there are still risks and unknowns. This means that sellers and buyers will still need to contractually allocate certain tariff risks going forward.
Unfortunately, Biden’s executive order does not mean that sellers and buyers can completely forget about import tariff risk. Tariff change clauses will still need to be a fixture in US module supply deals. Among the risks that must still be considered in new supply agreements:
Tariff Waiver “Up to” Two Years
The executive order does not waive the tariff for “two years,” as widely reported in much of the media; the executive order waived the tariff for “up to two years.” When you are contracting to buy or sell modules for importation in the US market, that is a big distinction. There is a risk that this tariff waiver could theoretically be terminated any time between now and June 2024.
I am not a trade law specialist, but from my synthesis and discussions with trade lawyers and others, I suspect that the “up to” two years language in the executive order was partially meant to help insulate the executive order from court challenge. By not specifying a guaranteed (and arbitrary) period of “two years”, and instead allowing for at least the possibility that the conditions giving rise to the waiver might theoretically dissipate in less than two years (although realistically I think they won’t change), the President seems to be acknowledging that the authority granted to waive tariffs depends on certain external factors persisting, and those factors are not necessarily arbitrary in time duration.
I personally think that it is most likely that the “up to” two years language may not be an undue concern for the industry. Supply chains may shift a lot in the years ahead in response to policy incentives, potential tariff risk, and broader geopolitics. But the high-level supply chain conditions that exist right now in solar (e.g., concentration in Southeast Asia) will still substantially exist two years from now – these things can change, but not completely in a matter of months or even a year or two.
That said, when signing contracts for millions of dollars, sellers and buyers have to consider the risk that my theory, that “up to two years” in the executive order realistically means “two years” is wrong, and this could lead to the executive tariff waiver terminating early. Supply agreements will need to have language addressing risk allocation if the tariff waiver is terminated sooner than expected/hoped.
Court Challenge to Executive Order
The executive order waiving tariffs may be challenged in court. My synthesis to date from trade lawyers about this is as follows: The President has very broad authority under the statute that was invoked. That said, this portion of the statute allowing for the tariff waiver is not often used. In addition, the tariff waiver provisions have been invoked more directly in war-time than in circumstances 100% analogous to the solar industry’s present circumstances. I expect deeper analyses of this issue from trade law experts to emerge if a lawsuit is filed, although the initial thought seems to be that the likelihood of a court challenge actually succeeding is low, but non-zero.
In other words, the risk seems low — but not to the point that you can just forget about it. Also, if such a challenge did succeed, it could have major implications for supply contracts, and perhaps even risk of retroactive application of a tariff.
A lawsuit is possible — Auxin would not have much to lose by at least trying, and that in itself would make headlines and inject some uncertainty into the market, as the market synthesizes if such a lawsuit would have any chance of succeeding.
So, a court challenge to the tariff waiver represents a “long-tail” risk – meaning it has a low probability of occurring (hopefully low probability, but I want to hear more detailed analyses on this before getting too comfortable) but if it happened, it could be quite high impact. Solar module buyer and sellers must contractually consider that, for up to the next two years, cells and modules imported into the U.S. from Southeast Asia may be free of tariffs upon importation. That is, no cash will have to be paid to U.S. Customs at that time.
To summarize, the long-tail risk is that all of the following events happen:
(i) a court challenge is launched against the Biden executive order waiving tariffs, asserting that Biden did not have the authority to waive the tariffs;
(ii) that court challenge eventually succeeds; and
(iii) during the pendency of such challenge, a tariff is announced, either because of the Auxin investigation (which will still continue to proceed despite the executive order, with a preliminary ruling expected in late August) or any other new tariff investigation (which I don’t think are blocked from being at least being brought as a result of the executive order, even if a tariff is not imposed due to the waiver. More on this below).
If those three things all happen, then there may be risk of a retroactively applied tariff. I’ve not yet heard any analyses from trade law experts saying that it is completely impossible for a court challenge to result in retroactive application of tariffs. This could occur years from now, making the period of retroactively application of tariffs quite large, since it may take a long time for a definitive court challenge to wind its way through the court system, including all possible appeals, and we do not yet have any tariffs announced as a result of the Auxin investigation (if any are ever announced).
Much more can and will be said, especially if there is a challenge, but I want to focus on what all of this means for sellers and buyers contracting for supply of modules right now.
Module vendors and buyers will have to consider that at least some non-zero probability of retroactive tariff risk, even with the tariff waiver in place. This is surprising to some buyers who may have thought that the tariff waiver executive order means that everything is 100% settled re: tariffs.
How does this risk resolve in contract negotiations? The good news is that, unlike when the Auxin petition was initiated and we had no tariff waiver, the risks presented right now seem “transactable” — meaning this risk appears to be low enough that it can be allocated in a contract and new large deals can get signed despite this risk.
One resolution to that risk is simply that module vendors bear such risk, and it is “priced in” to the upfront price of modules to be sold. I think we will see this in some deals – I don’t think the price premium we are talking about is the same level as what vendors wanted while Auxin was pending and there was no tariff waiver executive order. But there likely would be a price premium for the vendor taking retroactive risk (and all vendors will want a tariff change clause of some sort for anything to be delivered going forward, however). Otherwise, this risk will likely be put on the buyer, as it is a seller’s market for modules right now. Buyers that want the lowest price may have to take this risk (which is another price itself, of sorts.)
I think this issue will remain a bit fluid for the next month or two, until there is a preliminary decision announced in the Auxin proceeding. Also, I think it may ultimately be handled differently in different contracts. The reason I say that is because a unique aspect of the Auxin petition and AD/CVD tariffs generally is that different specific module sellers have different specific risks of tariffs here, depending upon their specific supply chains.
In addition, different vendors can end up with different AD/CVD tariff amounts assigned to them as a result of Auxin. So there may not be a “one size fits all” approach that results in contracting around this risk. I think there may also be other transaction structures that are optimal in this circumstance, after some initial ideas can actually be tested in transaction negotiations.
Either way, one bottom line is that supply agreements will still contain tariff change language in case the tariff waiver is terminated earlier than two years, and/or litigation alters the expected path of tariffs.
Tariff Waiver Implementation by Commerce
The proposed rules implementing the tariff waiver have been announced by Commerce for public comment. I personally don’t see any surprises in it. One item I was wondering about was whether this waiver would cover what I call a “regular” AD/CVD case against Vietnam/Malaysia/Thailand/Cambodia. The Auxin petition seeks to apply Chinese AD/CVD tariffs to those countries – but what about a separate investigation seeking to apply AD/CVD to any or all of those four countries independently? I think the proposed tariff waiver implementing regulations prevents application of those duties during the period of the waiver. That is an important nuance that I have not seen largely discussed within the industry. Without that nuance, I think the waiver would not have the desired impact.
There is much more to be said about tariff issues, and I will write further posts as information develops.
Final Thought - Solar Modules are Not “Pure” Commodities
When I completed an MBA I had a marketing professor at UC Berkeley who would “fine” any of his students (request a $20 donation to charity) if such student ever described any product as a “commodity” in his class. His point was that even municipal tap water could be marketed as differentiated — if you developed the right marketing strategy.
Still, I’ve often considered solar modules to be “commodity-like” (and I’ll make a $10 donation for that statement). There is increasing technological differentiation in solar modules, to be sure. But zooming out, the electricity produced by modules is fungible, module characteristics are often somewhat similar compared to other products (e.g., 90%+ market share for crystalline silicon), and most tellingly, price is often the determining factor in a choice between two “Tier 1” module suppliers.
But import tariff and forced labor investigations are now drilling very deep into the entire supply chain for each module — deeper than we’ve ever seen before. Issues now get into polysilicon (even quartzite), ingots and wafers, not just the location cell manufacture and module assembly. As such, different modules and module vendors now have different risk profiles associated with their differing originating supply chains.
Modules will increasingly be differentiated on these features, and not just the specific cell technology used, or other technical characteristics. That’s a new era, and also a new vector of differentiation.
Even the team within any particular module vendor is differentiated – has their team (both in the U.S. and their overseas headquarters) ever dealt with a U.S. Customs inquiry before? Can they speak intelligently about the UFLPA? Do they have U.S. trade counsel lined up?
Related to some of those questions, in future posts I will cover the looming topic for solar modules and potentially energy storage: supply chain traceability to ensure that no forced labor is used in the product supply chain, and proving that to U.S. Customs.
The teaser here: as a whole, the industry as a whole is not ready for what is probably coming.
I hope that you found this first post and subsequent ones useful. All feedback and suggestions are welcome.
Len Conapinski
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Len Conapinski is a partner at DuFour Conapinski Ha LLP. Please note that all views here are my own personal thoughts, are not intended to be taken as legal advice, and are not reflective of the views of my law firm colleagues, or our firm as an organization, or any client of our firm.