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Dive Overview:
Rising interest rates are hitting renewable energy harder than fossil fuel-based energy sources, and could also affect the viability of emerging energy technologies such as low-carbon hydrogen, according to an analysis published in April by Wood Mackenzie.
According to Wood Mackenzie, a 2 percentage point increase in interest rates could raise the levelized cost of electricity from renewables by up to 20%, with large-scale solar PV being hit the hardest. In contrast, the levelized cost of electricity from combined cycle natural gas plants would rise by just 11%, in part because fossil fuel generators were already paying higher interest rates before central banks began raising interest rates.
Peter Martin, head of economics at Wood Mackenzie and lead author of the rates report, said rising rates could jeopardize the energy transition and impact the drive to expand domestic manufacturing in the U.S. It remains unclear whether the Federal Reserve will start cutting interest rates this year, which are among the highest in decades.
Dive Insights:
Over the past few years, investors have generally viewed wind and solar as less risky than traditional energy projects like oil and gas, Martin said, and rising interest rates have narrowed the gap between renewable and fossil fuel power costs, which is really hurting renewable energy developers in today's high-interest rate environment.
Martin said that even before central banks in the U.S. and around the world began raising interest rates, traditional energy projects were already paying interest rates of 5% or more to secure loans for new projects, while renewables enjoyed much lower debt costs until the recent rate hikes.
Renewables and emerging energy technologies such as low-carbon hydrogen also require more up-front capital investment before they can begin to operate and generate profits, making those sectors even more sensitive to interest rates, Martin said. Renewable energy developers are also likely to use more debt, rather than equity financing, to cover those up-front costs, Martin said.
As a result, renewables are experiencing even bigger increases in borrowing costs than comparable sectors such as oil, gas and mining, he said. Large-scale solar power is bearing the brunt of the impact, but emerging technologies such as low-carbon hydrogen and carbon capture could also take a hit. 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, higher borrowing costs would narrow profit margins and perhaps slow development, Martin said. But even with higher borrowing costs, wind and solar remain the cheapest sources of energy in many markets, according to Wood Mackenzie.
Martin said interest rates could also impact the push for domestic manufacturing expansion in the U.S. by making it more costly to build new factories in the U.S. compared to building projects in China. Regardless of when the Federal Reserve starts cutting interest rates in the U.S., Chinese manufacturers will likely enjoy much lower interest rates for the next 20 years because of China's economic slowdown, he said.