Fed Interest Rate Cuts Ease Clean Energy Headwinds
What side of the bed did you wake up on today? The answer might shape your view of clean energy’s prospects in the United States.
If you woke up on the right side, it’s easy to be flush with optimism. This year 96% of the new power added to America’s electric grid will come from wind, solar, and storage, and almost all the projects in our development pipeline are clean energy.
The Inflation Reduction Act created unprecedented 10-year policy certainty for U.S. renewables, which spent decades living or dying with one- or two-year extensions of their primary tax credits, often arriving during the week between Christmas and New Years.
Those 11th hour verdicts made investment decisions for the following year fraught with uncertainty, and there’s nothing the business community hates more than a murky landscape.
More reasons for optimism include:
But what if you woke up on the wrong side of the bed?
On those days, it’s easy to feel dour about the clean energy transition because we’re still not moving fast enough to hit our climate targets. Renewables face strong headwinds from multiple fronts such as high interest rates, glacial progress connecting projects to the grid, supply chain constraints, and siting challenges.
Fortunately, the Fed just nudged us closer to the right side of the bed—its recent rate cut will improve clean energy economics.
Renewables And High Interest Rates: As Unappetizing As Peanut Butter And Mustard Sandwiches
High interest rates and renewables don’t pair well. The elevated rates of the past several years have artificially driven up the cost of wind and solar while shrinking the pool of available financing. As a result, developers have delayed or canceled potential projects, slowing new clean additions to the grid at a time when we need new power due to growing electricity demand, among other reasons.
Why do high rates have such an outsized impact? Because renewables run on free fuel from the wind and sun, most of their capital costs are upfront. However, high interest rates make this upfront capital more expensive to access, thus making projects cost more or even become financially unviable.
For example, an offshore wind project derives 70% of its expenditures from the cost of capital, compared to just 20% for a gas plant, according to Wood MacKenzie.
“Renewable energy in general is very, very susceptible to rising interest rates and offshore wind, even the most of all of the renewable energy sectors because it’s so capital intensive,” said Orsted Americas chief executive officer David Hardy. “Our fuel is free, we say, but our fuel is really the cost of capital because we put so much capital out upfront.”
Additional analysis from Wood Mackenzie “shows that a 2% increase in the risk-free interest rate pushes up the levelized cost of electricity for a renewables project by 20% compared with only 11% for a combined cycle gas plant.”
The Fed brings relief
The Fed’s recent half point rate cut finally takes a step in the right direction for renewables, which had been languishing under the high rates designed to cut inflation.
“As interest rates rose 300 bps, it just fundamentally changed the economics of the projects, said Orsted CEO Hardy.
This month’s rate cut will make it cheaper to access the upfront capital needed to build renewable energy projects. Although rate cuts and the cost of capital don’t exactly mirror each other, they follow the same trendline. For example, the investment firm Lazard finds cutting the cost of capital from 7.7% to 5.4% lowers the cost of an offshore wind project by about 17%.
“As rates fall, projects become increasingly financially viable,” Advait Arun, senior associate of energy finance at the Center for Public Enterprise and Heatmap contributor, told Heatmap News.
More Relief On The Way (Hopefully)
The Fed’s half point cut is a positive omen that should boost investor confidence. The real jolt could be on the way, however, as forecasters predict the Fed could cut rates another half point before the end of the year and another full point in 2025. That could result in tens of billions of dollars in new investment and a big shot of adrenaline for the clean energy industry.
“We can go quicker if that is appropriate. We can go slower if that’s appropriate. We can pause if that’s appropriate,” Fed Chair Jerome Powell said. “This process evolves over time.”
Those cuts should help unclog America’s clean energy development pipeline.
“If you see a bigger cut, you’ll just see a huge sigh of relief, and people will start getting back to dusting off the business plans that were un-fundable as of yesterday,” said Sean O’Sullivan, founder of the venture capital firm SOSV.
Not Just Utility-Scale: Help For Homeowners Too
The past half decade’s high interest rates also impacted consumer choices, making mortgages and car loans more expensive. Rooftop solar was no exception—high rates made rooftop solar loans more costly, slowing the development of another clean technology.
“The residential solar market has really been battered lately, and I do think [the cuts are] going to help tremendously,” said Mona Dajani, partner and global co-chair of energy, infrastructure and hydrogen at law firm Baker Botts.
This cut means a $30,000 residential solar system could now be $3,000 cheaper.
“It may not sound like much, but this rate cut will save solar shoppers thousands of dollars in interest over the lifetime of their solar panels,” said Spencer Fields, director of insights at EnergySage. “Most solar adopters finance their system with a loan, so dropping interest rates will help make solar more affordable and likely drive-up demand for new commercial and residential solar installations.”
Let’s Brighten Our Outlook
We all know what to do for a better shot at waking up on the right side of the bed—limit screen time before going to sleep, get to bed at a reasonable hour, avoid a late day cup of coffee.
We also know what to do to feel more optimistic about the clean energy transition: Update and expand our electric grid, reform the interconnection process, improve transmission planning, and set state and national clean energy standards.
The high-interest rate headwinds are easing—let’s get to work on the other factors that might make us feel less pessimistic about the clean energy transition.