Investing in solar power companies can be profitable for investors who know all the risks.

The reason why people invest in solar power companies is obvious—a pure source of clean, endlessly renewable energy that can replace fossil fuels like oil, coal and natural gas sounds like a great investment. However, like many alternative energy sources, solar power has vast potential, but also risk to match.

Solar-power companies face three main risks:

1. Reliance on government subsidies
2. Competition from alternative power sources
3. Rapidly changing technology

When you invest in solar companies you’re counting on government subsidies

Even though sunlight is free, solar power costs considerably more to generate than power from traditional fossil fuels. The main reason is the high cost of building solar plants. This includes the cost of solar panels, mirrors, transmission lines and generators, as well as the cost to buy or lease the land to put them on.

What’s more, unless solar plants are built near conventional fossil fuel power plants, citizens may protest the installation of transmission lines on or near their property, or across natural habitats. The need to overcome those protests and get regulatory approval for new transmission lines can add to the cost of a new solar-power project.

Because of that price disparity, solar power relies heavily on government subsidies and political support. That support is based on environmental “clean” energy concerns and perceptions of climate-change urgency, as well as a push toward energy independence.

Right now, Germany and Spain are the two biggest subsidizing countries. However, President Obama’s administration strongly supports alternative energy, and has set aside $80 billion of stimulus grants for this purpose. This will add to subsidies that U.S. producers already get for their solar power. These include big U.S. government tax credits for solar energy that let individuals or businesses recover around 30% of their costs when they install solar-power equipment. (Although, in 2017, that credit is scheduled to be cut from 30% to 10% for commercial projects.)

The U.S. government also provides low-interest loan guarantees. And it may eventually add solar-power quotas for utilities. Or, it may let utilities add surcharges to utility bills to support solar power.

Globally, China’s massive stimulus plan, set in motion in 2009, includes a $454-billion environmental-subsidy program, as well as high prices paid for solar power.

When you invest in solar companies you encounter competition from alternative power sources

Short of radical advances in solar-power technology, the long-term prospect for “grid parity”—the price at which it will be equally cheap to produce a kilowatt-hour of electricity from solar as from fossil fuels—relies in large part on the prospect of higher oil and gas prices pushing up the cost of electricity generated from those sources.

When oil and natural gas prices fall, consumers are less likely to invest in solar power companies. Solar power also faces competition from nuclear power. Right now, nuclear is largely out of favour in the U.S., but China and India are steadily moving ahead with their plans to build a large number of nuclear power plants.

When you invest in solar companies you face rapidly changing technology

Solar power has attracted a lot of investment in recent years. That has quickly moved the technology forward. For example, advances in manufacturing techniques continue to steadily push down the prices of solar cells and solar panels.

At the same time, alternatives to costly silicon, which is currently used in most solar cells, are emerging. These include copper-indium-gallium-selenium solar cells.

Technological advances add considerably to the risk of solar-power companies that are solely focused on developing or making a single technology. That’s because they constantly risk being overtaken by competitors with a superior product. As well, customers may hold off purchasing their solar equipment if they believe a new technology is about to emerge. For these reasons, we think you would be far better off investing in companies with the research budgets to keep ahead of the competition and move quickly to embrace new technological developments.

Have you decided to invest in solar power companies? Share your experience in the comments.