Former Fed chairman Alan Greenspan recently rattled financial markets by saying there is a one-in-three chance of a recession this year. Greenspan might be considered an optimist. Several models created by research firms place the probability of a U.S. recession during the next year at 50%. The market is still jittery over the subprime sector, and investors are starting to get full-blown concerns over a bleed in the larger subprime mortgage market. Crude prices have dropped after the recent moves in global equity markets, as a global slowdown could reduce the demand for oil. Crude oil has dropped from about $62/barrel on Feb 27 (the day of the big sell-off in China) to current levels of $57.25/barrel, a 7.6% decline over less than a month.

There has traditionally been a positive correlation between oil prices and solar stocks. When oil prices go up, investors tend to put money into renewable energy sources such as solar, hydroelectric and wind power to hedge against the price of crude. During 2006, high oil prices sparked a rally in solar stocks during the first half. Now that we face an increasing probability of a U.S. recession, crude oil prices are expected to drop. With lower oil prices, will solar shares also take a nosedive?  

I believe that the historic pattern between crude and solar stocks is about to change. The main driver of solar stocks in the medium term should be governmental concerns about global warming, not the price of oil. I believe that solar stocks could remain well supported by subsidies, even if we had to see crude prices tumble ahead of a possible recession.

Government subsidies have been so significant that it is masking a long-term problem in the solar industry: Solar power isn't yet a cost-effective energy source because of the high price for panels. For this reason, I would only get involved with solar stocks over a long term horizon, focusing on cost per watt and low-cost technologies. Solar companies with lower cost per watt will have greater pricing power in the long term, and should be successful if the demand for solar eventually picks up.

That is why I like First Solar (FSLR – $52.69) as a long-term play. Recent data showed that FSLR modules were the lowest-cost in commercial production during 4Q06 at $1.25/W to manufacture (approximately 50% below the industry average). FSLR is already displaying significant pricing power. The company's average selling price to customers in 4Q06 was 35%-45% below competitors. FSLR is also immune to the polysilicon shortage, as their manufacturing process doesn't need the material. In addition, they have excellent sales visibility after signing contracts for 75% of their planned production until 2012. These contracts are for fixed volumes with pricing negotiated annually.

Another strong long-term play is MEMC Electronic Materials (WFR – Last trade $55.13). WFR is one of the leading polysilicon producers in the world. The solar company with the lowest cost process wins, and WFR has already demonstrated its ability to grow its revenues and margins and earnings through the inventory correction in the semiconductor industry. The company currently trades at a discount to the semiconductor industry because it has had extreme earnings volatility through up and down cycles. Now seems to be a good time to buy, since WFR now has a lot less cyclicality than it has had historically. Citigroup has also mentioned the stock as a LBO candidate.

Perhaps the saddest-but-true Wall Street maxim is to buy "when there’s blood in the streets." WFR and FSLR look like solid bets for long-term investors, even if oil prices had to fall dramatically on recession fears.

Disclaimer:  I do not own any of the stock mentioned in this article. 

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