The solar market is on track to break growth records this year, but analysts say the numbers may paper over some emerging market challenges for installers.

A joint report from GTM Research and the Solar Energy Industries Association (SEIA) said the solar industry is projected to add 14.5 GW of capacity this year, a 94% increase over the 7.5 GW installed in 2015. In the first quarter alone, solar developers installed 1,665 MW of solar PV nationwide, adding more new capacity than coal, natural gas and nuclear combined.

Typically, first quarter growth is the weakest of the year, but it appears the growth is building off momentum from 2015, largely due to declining system prices and an 11th-hour extension of the investment tax credit for solar installations.

Price declines for solar systems were about as impressive as installation growth last year, according to another GTM report: The price of non-residential solar installations dropped 8.3% to $1.88/watt in the first half of 2016. Residential installations dropped 8.8%, to $3.00/watt.

If continued, these drops in prices could help the solar sector hit the U.S. Department of Energy’s “impossible dream” price target of $1.00/watt by 2020, GTM noted.

Even so, the recent bankruptcy of SunEdison and declining stock prices for other leading installers raise questions among investors about the sector’s long-term health, according according to a recent research note from Deutsche Bank Securities.

The sector “has still not completely emerged from the shadows of the SunEdison bankruptcy and balance sheet quality remains the biggest source of investor concern,” the bank’s Vishal Shah wrote. “Complicating the investment process is the complexity of solar business models and difficulty in modeling a path for sustainable cash flow generation.”

The extension of the ITC, while a boon to the solar industry, could also lead to oversupply in the module market, the Deutsche report noted. Investors are also warily watching the heated net metering battles taking place in key states like Nevada and Arizona, casting doubt over the sustainability of the lease financing model of many solar developers.

Building on 2016 growth: the challenges ahead

“Without question, the extension of the federal investment tax credit [ITC] ranks as the most important policy development for U.S. solar in almost a decade,” the GTM installation report noted. “The wheels are already in motion for U.S. solar to benefit in 2016 from a double-digit-gigawatt pipeline of late-stage utility PV projects that rushed through development last year.”

Benjamin Gallagher, the author of the GTM report on pricing, said utility-scale solar systems are expected to compose nearly 75% of the new capacity.

“With the extension of the ITC, the utility-scale developer is back in the driver’s seat,” Gallagher said.

But the Deutsche Bank note doesn’t paint an entirely happy picture for the solar market in the second half of 2016. Shah wrote the fundamentals of the solar market will be “challenging in 2H16,” though it may not alter pricing forecasts.

Two important factors could combine to produce slower demand in the upcoming six months, Shah suggested. The first is the absence of a rush to meet the year-end ITC reversion. The second is a drop in demand from China’s market when it lowers its feed-in tariff at the end of June.

As a result, “investors are rightly concerned about the risk of oversupply from 2H16,” Shah noted. “Moreover, a significant amount of new supply is expected to come online in 2017, raising concerns over potential pricing/margin pressure for module manufacturers.”

Before the U.S. investment tax credit extension occurred at the end of 2015, developers were racing to get their projects online by the end of 2016 to qualify for it. Module suppliers knew developers needed their product and “looked to get as much margin as possible,” Gallagher said.

“Now developers are asking their suppliers to rebid projects or come back with better pricing or they will wait until next year to build,” he said. “That shifts the pressure to suppliers to drive down costs.”

Impact on markets, module manufacturers

Falling demand for modules built by companies like SunPower and First Solar could compromise their bottom lines. But it could also lead to a drop in price for modules as suppliers look to clear the market. Since both companies are vertically integrated, such a situation could lead to a “pickup in business momentum,” Shah noted.

“It is also possible this price reduction forecast is high," GTM’s Gallagher added. "If the global solar market is flatter than we expect due to reduced demand in China, we may see the price of modules decline more and more rapidly.”

It’s uncertain whether Shah's concerns about a decrease in global demand due to China’s FIT reforms will pan out, said Mohit Anand, senior analyst at GTM. That big demand drop, he said, "is only for the second half of this year … Our estimate for next year for China is 19 GW to 20 GW installed despite the reduction in the FIT this year.”

Back in the U.S., solar prices have already dropped so low in some regions that it can both “compete with and complement new natural gas plants,” the GTM report noted. If this trend continues to spread, it could spark a “wave of geographic demand diffusion.” Already, grid operators in markets like SPP are noting many utilities adding utility-scale solar investments when they had bet on wind and natural gas before.

Even so, the residential solar market segment could struggle since “investors are generally concerned about the net metering policy changes in a few states such as Arizona and Nevada, and implications for policy decisions in other states,” Shah wrote.

In January, Nevada regulators scaled back the retail rate remuneration for net metering and increased fixed charges. And Arizona, which has been in the national spotlight for its rancorous debates over the net metering policy, is now experiencing another resurgence as major utility Arizona Public Service is now asking its regulators to approve a $0.0299/kWh credit for 2017.

If these net metering debates over how to compensate rooftop solar proliferate in other states, it could severely challenge the value proposition of residential solar, and it’s unclear if

most residential solar installers have the fundamentals and financing to weather such challenges, Shah argued.

Companies like SolarCity and Vivint must demonstrate “improving bookings momentum and execution on the financing front,” Shah says. And resolving the “net metering policy overhang” will also be necessary for installation company values to stabilize, he added.

Beyond 2020, the future is hazy

Despite the potential financial risks, especially in the residential solar market, the ITC extension will “will serve as a long-term policy bridge to help transform solar PV into an increasingly mainstream source of power generation in the U.S. electricity market,” the GTM installation report asserted   

But the future for rooftop solar beyond 2019 is hazy.

A tax credit will remain available past 2019 but steps down to 26% in 2020, 22% in 2021, and 10% for third-party-owned residential, non-residential, and utility PV projects in 2022. A “commence construction” provision will also allow projects that go online through the end of 2023 to qualify for the credit.

This is a major achievement for the industry, Gallagher stressed. “Solar at below $1/wattdc is a strong message to people who are skeptical about solar power,” he said. “A lot of market dynamics affect solar’s competitiveness with fossil fuel-generated electricity, but reduced capital costs are a major element.”

Even so, there are too many variables to make a reliable forecast for beyond 2020, Gallagher said. “Once the industry gets past 2016 and 2017 and the shakeup that followed the ITC extension, it will begin shifting its attention to 2021. But this is what solar looks like when it is at scale and being installed with lean and efficient business models.”