Fed rate cuts ease clean energy headwinds

Which side of the bed did you wake up on today? The answer could shape your view of the prospects for clean energy in the United States.

If you woke up on the right side, it’s easy to be optimistic. This year, 96% of new capacity added to the U.S. electric grid will come from wind, solar, and storage, and nearly all of the projects in our pipeline are clean energy.

The Inflation Control Act created an unprecedented 10 years of policy certainty for U.S. renewable energy sources, which for decades lived or died on one- or two-year extensions of their basic tax credits, often coming during the week between Christmas and New Year’s.

These 11^t The hourly verdicts left investment decisions for the next year fraught with uncertainty, and there’s nothing the business community hates more than an unclear landscape.

Other reasons for optimism include:

What if you wake up on your left foot?

On days like these, it’s easy to feel gloomy about the clean energy transition, because we’re still not moving fast enough to meet our climate goals. Renewables face strong headwinds from multiple fronts, including high interest rates, glacial advances connecting projects to the grid, supply chain constraints and location challenges.

Fortunately, the Federal Reserve just got us closer to the right side of the market — its recent interest rate cut will improve the economics of clean energy.

Renewables and High Interest Rates: As Unappetizing as Peanut Butter and Mustard Sandwiches

High interest rates and renewables don’t mix. The high interest rates of the past few years have artificially raised the costs of wind and solar power 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 capacity because of growing electricity demand, among other things.

Why do high interest rates have such a huge impact? Because renewables run on free fuel from wind and sun, most of their capital costs are up front. But high interest rates make that upfront capital more expensive to access, making projects more expensive or even financially unviable.

For example, according to Wood MacKenzie, an offshore wind project generates 70% of its capital cost expenditure, compared with just 20% for a gas-fired power station.

“Renewable energy in general is very, very vulnerable to rising interest rates and offshore wind, even more so than any other renewable energy sector, because it’s so capital intensive,” said David Hardy, CEO of Orsted Americas. “We say our fuel is free, but our fuel is actually a cost of capital because we’re investing so much capital up front.”

Additional analysis from Wood Mackenzie “shows that a 2 percent increase in the risk-free interest rate increases the average cost of electricity for a renewable project by 20 percent, compared with just 11 percent for a gas-fired combined-cycle plant.”

Fed brings relief

The Fed’s recent half-percentage-point rate cut finally represents a step in the right direction for renewable energy sources, which have struggled with high rates aimed at reducing inflation.

“The 300 basis point increase in interest rates has fundamentally changed the economics of projects,” said Hardy, Orsted’s chief executive.

This year’s cut in interest rates will make it cheaper to get the upfront capital needed to build renewable energy projects. While interest rate cuts and the cost of capital are not exact mirrors of each other, they do follow the same trend line. For example, investment firm Lazard found that cutting the cost of capital from 7.7% to 5.4% reduces the cost of an offshore wind project by about 17%.

“As interest rates come down, projects are becoming more and more viable,” Advait Arun, senior fellow for energy finance at the Center for Public Enterprise and a Heatmap contributor, told Heatmap News.

More relief on the way (I hope)

The Fed’s half-point rate cut is a positive sign that should boost investor confidence. But the real shock may come as forecasters predict the Fed could cut rates by another half-point before the end of the year and another point in 2025. That could result in tens of billions of dollars in new investment and a big dose of adrenaline for the clean energy industry.

“We can go faster if that’s appropriate. We can go slower if that’s appropriate. We can take a break if that’s appropriate,” Fed Chairman Jerome Powell said. “This is an evolving process over time.”

These cuts should help smooth the path for America’s clean energy development process.

“If we see bigger cuts, we’ll see a huge amount of relief and people will start dusting off business plans that couldn’t be funded yesterday,” said Sean O’Sullivan, founder of venture capital firm SOSV.

Not just on a public utility scale: help for homeowners too

High interest rates in the last half-decade have also affected consumer choices, making mortgages and auto loans more expensive. Rooftop solar panels were no exception—high interest rates have made loans for rooftop solar panels more expensive, slowing the development of another clean technology.

“The residential solar market has been hit hard recently and I think (the cuts) will help the market a lot,” said Mona Dajani, partner and global co-chair of energy, infrastructure and hydrogen at law firm Baker Botts.

This cut means a $30,000 home solar system can now be $3,000 cheaper.

“It may not sound like much, but this reduction in interest rates will save customers who purchase solar panels thousands of dollars in interest over the life of the system,” said Spencer Fields, director of analytics at EnergySage. “Most solar panel users finance their systems with a loan, so the reduction in interest rates will make solar panels more affordable and likely increase demand for new commercial and residential solar installations.”

Let’s brighten our perspectives

We all know what to do to have a better chance of getting out of bed on the right foot — limit screen time before bed, go to bed at a reasonable hour, avoid drinking coffee in the late afternoon.

We also know what we need to do to be more optimistic about the clean energy transition: modernize and expand our power grid, reform the grid connection process, improve transmission planning, and set clean energy standards at the state and national levels.

As the headwinds from high interest rates fade, let’s look at other factors that might make us less pessimistic about the clean energy transition.