Clean energy projects are getting some relief from one of the biggest challenges they’ve faced over the last four years — rising interest rates.
The United States Federal Reserve lowered interest rates by half a percentage point last week after years of pushing them higher to combat inflation. The action followed similar moves by the European Central Bank, which has lowered its rates twice this year.
Interest rates, which have jumped five-fold since 2020, are effectively the price to borrow money. That higher funding cost has caused some renewables projects to struggle and become less affordable, especially compared to projects that rely on coal, oil and natural gas, according to economists. While not a cure-all, lower rates are a needed boost.
Indeed, the easing of interest rates is likely boosting the mood at the countless events going on throughout New York City this week connected to Climate Week.
“The cost of clean energy has gone up significantly in the past few years,” said Rich Powell, chief executive of the Clean Energy Buyers Association, a group of large companies with aggressive clean energy targets. The turnaround on interest rates is a “welcome relief,” he said.
But the events of the last few years have changed the math for clean energy projects, and the industry’s challenges are far from over.
One-two punch
Wind, solar, geothermal, nuclear and other kinds of clean energy projects require large investments upfront to build and connect to electricity networks, making these projects vulnerable to both inflation and the higher interest rates used to combat it.
“Everyone’s facing higher interest rates, but there’s some energy solutions out there which are more sensitive to that than others,” said Peter Martin, an economist at energy consultancy Wood Mackenzie. “They’ve got really high share of capital intensity, so they need large amounts of upfront capital.”
Inflation is reflected in the rising prices of everything that goes into a project, from shipping fees to construction worker salaries.
The outsized impact of interest rates on a renewables development is striking: a two-percentage point swing in interest rates can mean a 20% change in the total cost of the electricity from a renewable-energy venture over its lifetime, according to economists at Wood Mackenzie. In highly capital-intensive hydrogen projects, where construction and capital costs can comprise three-quarters of the total, that two-percentage point increase could lift the final price by 10% over the life of the facility, Wood Mackenzie said.
“In contrast, the oil and gas industry, while also highly capital intensive, has far less exposure to the cost of debt, so is less affected by higher rates,” the consultancy wrote.
While some fossil fuel projects are not immune, they are generally far less affected by interest rate swings. For a natural gas power plant project, the change in the cost of electricity for a two-percentage point interest rate swing is 11%, Wood Mackenzie figured.
Paradigm shift
Historically low borrowing costs from 2012 to 2020 helped fuel a historic boom in renewable energy development by pushing upfront costs down. In May 2020, ten-year benchmark interest rates were 0.6%, the lowest in more than 50 years.
As the global economy lurched back into gear when the Covid-19 pandemic started to ease, shipping expenses rose and convoluted supply chains made it harder to get renewable energy components. Then Russia’s invasion of Ukraine sent energy prices soaring, further pushing up transportation and construction costs.
Those factors helped push the price of goods across the economy upward. To tamp down this inflation, central banks began ramping up short-term interest rates, which in turn pushed longer term rates up as well. The U.S. 10-year benchmark interest rate reached 4.9% in April, the highest since 2007.
Many wind projects, which require extensive borrowing to get underway, were either cancelled or had to be renegotiated, causing delays. Nuclear projects and battery factories have suffered cost overruns or been abandoned, in some cases leaving behind government subsidies intended to incentivize clean technology.
Renewable energy start-ups with business plans that depended on borrowing money at low cost to build factories, or even pay employees, have also struggled.
“When interest rates went up, smaller companies that were just starting up now find themselves in debt, so you’re seeing a lot of them getting washed out, going into bankruptcy and so on,” said Gautam Jain, an economist with the Center on Global Energy Policy at Columbia University.
Few expect borrowing costs to return to the historically low levels again, but the shifting tide is still welcome.
“It’s a big boost,” said Bob Randolph, vice president of operations at Quality Solar, which builds rooftop solar for homes and small businesses in central Michigan.
The new normal
Long-term interest rates, which matter most for renewables projects because most of their costs are financed upfront, have been falling for weeks in anticipation of cuts by central banks. Borrowing costs will continue to decline going forward, as well, if rates keep drifting lower this year and next, as financial markets are expecting.
Steady or even slightly falling rates should help stabilize the renewable energy industry and bring more predictable and even rising returns.
Nonetheless, clean energy developers could still have a tougher time competing against fossil fuels without government support, predicts Wood Mackenzie. Given the historically higher-interest rate environment that is likely for the foreseeable future, clean energy projects may need subsidies at least equal to those for coal, gas and oil in most countries to stay competitive.
“If you do nothing different, this will actually be incentivizing traditional hydrocarbon fuels over the low-carbon technologies,” said Martin of Wood Mackenzie.
Source: This story was originally published by ciphernews, Bill Spindle
Photo by Tom Fisk: https://www.pexels.com/photo/solar-farm-at-sunny-day-9893729/
