Chinese competition and subsidy cuts mean that Europe's solar industry will face tough conditions until better technology and carbon-emission charges on other forms of electricity generation make costs more competitive, Fitch Ratings said on Monday.
In order to prevent an investment bubble from growing out of control and to cut government spending, several European governments – including Britain and Germany – have cut solar power subsidies this year.
Other countries, like Italy, are imposing limits on the maximum solar capacity that can be installed under its subsidy programme.
"The solar power sector is likely to face tough trading conditions for the next two or three years," Fitch said.
"The impact of a supply glut in photovoltaic panels from Chinese manufacturers combined with potentially weakening demand as tariffs fall will weigh particularly heavily on the European solar panel manufacturing sector in the short term," it added.
While incentives would fall across the renewable-energy sector, Fitch said that cuts would likely be steepest for photovoltaic solar projects as many countries focus on projects with higher potential energy generation, such as offshore wind farms.
The agency said the situation was likely to start to improve in 2013.
"We believe the third phase of Europe's emissions trading programme, which begins in 2013, will be a key development for solar power to become cost-effective," the rating agency said.
At that time utilities and other high carbon-emitters will have to start buying permits for their emissions, rather than being given them for free, and Fitch said this would reduce the cost difference between solar and fossil-fuel power sources.
"Over the next three or four years, we believe technology advances in the sector will also help increase efficiency and reduce the price premium compared to other energy sources," Fitch said. It added that "the difference could be further eroded if a strengthening global economy led to sustained high oil and gas prices, which would feed through to higher electricity prices."
