Renewables and Nascent Low-Carbon Technologies Most Exposed to High Interest Rates

The higher cost of borrowing negatively affects renewables and nascent technologies, compared to more established oil and gas, and metals and mining sectors, which remain somewhat insulated, according to latest report: ‘Conflicts of interest: the cost of investing in the energy transition in a high interest-rate era’ by Wood Mackenzie.

“Interest rates, which have risen sharply in the past two years, may not come down as far or as quickly as markets anticipate. This increased cost of capital has profound implications for the energy and natural resource industries, particularly the cost and pace of the transition to low-carbon technologies,” said Peter Martin, Wood Mackenzie’s Head of Economics and lead author of the report.

Higher interest rates disproportionately affect renewables and nuclear power. Their high capital intensity and low returns mean future projects will be at risk. In comparison, due to low gearing, many companies in the metals and mining and oil and gas sectors will be relatively unaffected by higher interest rates, stated the report.

In the US, Wood Mackenzie analysis shows that a 2-percentage point increase in the risk-free interest rate pushes up the levelised cost of electricity (LCOE) by as much as 20% for renewables. The comparative increase in LCOE for a combined-cycle gas turbine plant is only 11%.

Higher interest rates also affect the competitiveness of renewables, stated the report. In many markets, onshore wind and solar have an economic advantage over hydrocarbon generation sources, even without subsidies in some cases. In the US, onshore wind can generate electricity at an LCOE of US$40/MWh, 50% of the cost of gas-fired generation. However, higher interest rates are eroding that advantage.

“While power and renewables companies have higher gearing, they do compare favourably with other peer groups on a cost-of-debt basis. But this is precisely what makes them more sensitive to interest rates. Mechanisms to reduce price and offtake risk enable power and renewables companies to obtain debt more cheaply than the relatively risky oil and gas and metals and mining sectors. The recent rise in interest rates, therefore, has a larger proportional impact on their cost of debt,” Martin said.

Green Tech Under Pressure

Nascent technologies, such as low-carbon hydrogen, carbon capture, utilisation, and storage (CCUS) and direct air capture (DAC), will play an important role in the energy transition. However, remarkable levels of capital investment and high capital intensity put these projects under threat amid higher interest rates, stated the report.

“The lack of economic incentives to capture carbon and the lack of a market for hydrogen are the most significant obstacles to investment in these sectors, but for projects that do progress, higher interest rates hurt the economics. This affects both smaller development companies that struggle to access debt and larger, credit-worthy emitters that rely on low-interest leverage to render projects attractive for shareholders,” Martin stated.

How Can Policymakers Offset Interest-Rate Headwinds?

The higher interest rate environment is a headwind to the energy transition globally, which is currently estimated to require US$75 trillion in investment if the world is to reach net zero by 2050.

“The good news is that there are actions policymakers can take now to help offset or at least mitigate the burden of higher interest rates. Policymakers need to remove obstacles such as slow permitting and project approval as well as offering clear, consistent, and sustained incentives, to support the uptake of low-carbon energy and nascent green technologies.”