How long until the solar industry revives?

December 16, 2011, 4:22 PM UTC

By Kevin Kelleher, contributor

FORTUNE — Back in 2007, solar energy was one of the hottest stock sectors around. Oil prices were soaring to record highs, solar IPOs were winning warm welcomes and some stocks were rising exponentially. First Solar (FSLR) and Ascent Solar Technologies (ASTI) both rose 800% throughout the year.

Then in 2008, a few months after oil prices peaked at $145 a barrel, the credit crisis hit, leaving few banks willing to lend money to finance costly solar-manufacturing plants. Demand for solar panels softened as European governments began eliminating solar subsidies. At the same time, China invested aggressively to expand the production capacity of its solar companies. The result was a rapid decline in solar-module prices.

In recent months, the lean times began to take their toll. Solyndra, famously, filed for bankruptcy in September. A few weeks earlier, Evergreen Solar, a 17-year old solar company that had been struggling for years, also filed for bankruptcy. Last week, MEMC Electronic Materials (WFR) laid off 20% of its staff, cut production at a solar plant in Oregon and said it may close another plant in Italy. And today, First Solar is trading 89% below its May 2008 high, while Ascent Solar’s stock has lost 98% of its peak value, currently trading at 58 cents a share.

In other words, investors in solar stocks went from manic enthusiasm in 2007 to noble patience in 2009 to a complete spirit of capitulation in 2011.

So far this year, most of the big names in solar manufacturing have lost more than two thirds of their value, including Trina Solar (TSL), Suntech Power (STP), JA Solar (JASO) and First Solar, which fell 21% on Wednesday alone after lowering its 2011 sales forecasts. The declines have been so severe that some are wondering if solar stocks are finally nearing a bottom.

That’s not to say the next year or so will be easy. The subsidies that gave utilities and other companies an incentive to buy solar panels, are growing scarcer. Europe is in no condition to offer new subsidies. And as First Solar’s CEO told investors recently, “There have been no significant new state-level solar programs in several years, and the solar industry is feeding mostly off of legacy subsidies in California.” Companies that grew dependent on government subsidies may need to transition to the private markets.

If there’s a silver lining to this grim scenario, it’s this: solar panel prices have fallen so far they are finally reaching “grid parity” — the point where solar power is at least as cheap as conventional electric power. A new report from Queen’s University found that solar panels are already cheaper than conventional power sources in some areas (though certainly not everywhere). As energy on the grid gets higher, the report said, solar power “will become an increasingly economically advantageous source of electricity over expanding geographical regions.”

Unfortunately, that doesn’t mean solar power will go mainstream next year. But in the meantime, prices will keep falling. The spot market price for polysilicone, the material used by most solar manufacturers, is trading around $25 per kilogram — that’s down from $475 per kilogram in early 2008. And next year, the industry is expected to once again produce more polysilicon that there is demand for. “Polysilicon costs have fallen more than 40% year to date and will fall more until capacity comes in line with demand but this may not happen for years,” wrote Wunderlich Securities’ Theodore O’Neill last week in a report discussing MEMC’s cutbacks.

In the meantime, the gap between the strong solar manufacturers and the weak is likely to widen. Banks won’t lend to the troubled companies, so they will have difficulty reaching the economies of scale necessary to compete against falling prices. Consolidation in the industry is sure to follow. “This is the decade of mergers and acquisitions,” Jifan Gao, CEO of Trina Solar, told Bloomberg News in an interview last month. “From now until 2015 is the first phase, when about two-thirds of the players will be shaken out.”

In short, the end of the lean times for the solar industry is finally in sight. But many of the companies that have weathered the downturn so far may not be around to enjoy the good times if they do roll in.