Dive Brief:
Rising interest rates have hit renewable energy harder than fossil-fuel based sources of energy, and could also impact the viability of nascent energy technologies like low-carbon hydrogen, according to an analysis published in April by Wood Mackenzie.
A two percentage point increase in interest rates hikes the levelized cost of electricity from renewables by as much as 20%, with utility-scale solar experiencing some of the greatest impacts, according to Wood Mackenzie. The LCOE for a combined-cycle natural gas plant, by contrast, increases just 11%, in part because fossil fuel generators already paid higher rates before central banks began to hike interest.
Higher interest rates could jeopardize the energy transition and impact the U.S. push for more domestic manufacturing, said Peter Martin, Wood Mackenzie’s head of economics and the lead author on the interest rates report. It remains uncertain whether the U.S. Federal Reserve will begin to cut decades-high interest rates this year.
Dive Insight:
For the past several years, financiers have generally considered wind and solar to be less risky than conventional energy projects like oil and gas, Martin said. And that’s actually hurting renewable energy developers in today’s higher-interest environment as increased interest rates close the gap between the cost of electricity from renewable energy and fossil fuels.
Conventional energy projects were already paying 5% interest or more to secure loans for new projects before central banks in the U.S. and around the world began increasing interest rates, Martin said. Renewable energy, on the other hand, enjoyed a much lower cost of debt up until the recent rate hikes.
Renewable energy and some emerging energy technologies such as low-carbon hydrogen also require more up-front capital investment before they become operational and start generating returns, which further opens these sectors to impacts from interest rates, Martin said. And renewable energy developers may use more debt — rather than equity financing — to cover these up front costs, Martin said.
As a result, he said, renewable energy has experienced even greater increases in borrowing costs than comparable sectors, such as oil, gas and mining. Utility-scale solar has borne the brunt of the impact, but nascent technologies including low-carbon hydrogen and carbon capture could take a hit as well. Wood Mackenzie estimates that a two percentage point increase in interest rates could raise the levelized cost of hydrogen by about 10%.
For more established technologies, like wind and solar, increased borrowing costs will narrow profit margins and perhaps reduce the pace of development, Martin said. But even with increased borrowing costs, wind and solar remain the cheapest source of energy in many markets, according to Wood Mackenzie.
Interest rates could also impact the push for more domestic manufacturing in the U.S. by increasing the cost of building new factories in the U.S. compared to constructing projects in China, Martin said. Regardless of when the Federal Reserve begins to cut interest rates in the U.S., the economic slow-down in China means manufacturer’s there will likely enjoy much lower interest rates for the next 20 years, he said.
