What Powell’s Interest Rate Observations Say About Green Investing

OOn May 1, Federal Reserve Chairman Jerome Powell delivered a two-part message to anxious interest rate watchers. The Fed is unlikely to raise interest rates this year, but policymakers are also in no rush to cut them from 5.25% to 5.5%. “I don’t know how long it’s going to take,” Powell said of when the Fed might cut rates.

Interest rates shape markets, and this is especially true in the case of renewable energy. Clean energy projects typically have high upfront costs, but are cheaper to run than their fossil fuel counterparts because they do not require operators to continually purchase fuel. As a result, the price of clean energy is largely determined by the cost of debt that developers take on when they first build the project.

Energy experts sometimes refer to what they call the levelized cost of electricity, or LCOE, to compare the cost of producing electricity over the lifetime of different facilities or energy sources. This number incorporates all the different costs associated with building and operating a plant, from development to decommissioning. An April analysis from research and consultancy firm Wood Mackenzie found that a 2 percentage point interest rate increase would lead to up to a 20% increase in LCOE for renewables. Power plants running on natural gas face only an 11% increase in LCOE under the same interest rate conditions.

At the same time, major oil and gas companies have made record profits over the past few years, providing companies with large resources and leaving them less dependent on debt to finance projects.

The challenge that interest rates pose for renewable energy is not new. In fact, it’s been a key point of discussion in energy and climate circles since inflation began to rise rapidly in the wake of COVID. But what is new is the prospect of a longer period of high and sustained interest rates. Billions of dollars in renewable energy projects have been announced since the passage of the Inflation Reduction Act, but many projects still require final investment decisions. And higher interest rates risk making the math go wrong.

The interest rate environment is definitely a headwind, but there are still reasons to stay the course with renewables. Of course, the economics of wind and solar energy depend greatly on location. In many places, they remain a good bet even with higher interest rates. In some places, including Europe, governments have set decarbonization or renewable energy standards regardless of the additional costs. Finally, it is worth considering that energy markets are dynamic, a trend that is expected to continue. A rise in fossil fuel prices driven by geopolitical stability or other unexpected developments could change the math.

And then there is the climate imperative. The energy infrastructure we build today will exist for decades and will determine how far we are from meeting climate goals. If interest rates remain high, policymakers interested in addressing climate change may have to look for new ways to continue pushing the world toward cleaner energy sources, whether through the further development of carbon markets or the implementation of new mechanisms under discussion designed to reduce the cost of emissions. capital for clean energy.