Higher interest rates pose a challenge to financing renewables

For developers of clean energy projects – which require borrowing significant up-front capital – higher interest rates are a cause for concern.

The era of low interest rates

The years after the 2008 financial crisis were marked by historically low interest rates as governments made efforts to encourage investment across industries. Along with targeted policy support and falling costs of installation, this drove increasing investment in clean energy technologies throughout the 2010s. Annual spending on solar PV and wind projects has grown by more than $300bn in the past five years alone .

This trend is at risk of being reversed by high global interest rates, according to analysts .

Higher interest rates vs. renewables installation

Renewable energy projects are vulnerable to interest rate hikes because developers must borrow large amounts of capital to cover the high upfront costs associated with building solar and wind farms. Typically, these high upfront costs are offset over time by much lower operating expenses.

As borrowing becomes more expensive, developers are put under greater financial pressure, with profits squeezed and the most leveraged companies at risk of default. This is a particularly stark problem for developers in emerging and developing economies, where the cost of borrowing is already up to three times higher than in developed economies – an IEA survey published in November 2023 found that nine out of ten respondents anticipate increases in the cost of capital in emerging and developing economies.

At the same time, the cost of renewables installation has been pushed up by commodity price volatility and supply chain disruption, although there are signs these pressures are easing .

Central banks are also starting to plan interest rates cuts , which could also be welcome news for renewables investment.

What's the cost?

A 2020 analysis by the IEA estimated that a five per cent rise in interest rates would push up the levelized cost of electricity from gas only marginally, but from wind and solar by a third. Now, we are seeing the real effects, with the levelized cost of wind and solar rising for the first time after decades of declining costs. According to a Lazard report, the average levelised cost of electricity generated by solar PV was $38/MWh in 2021, but $60/MWh in 2023 .

Experts are warning that this trend could discourage efforts to transition away from fossil fuel-fired plants, which have low upfront costs in comparison.

There has been a tangible slowdown in the renewables project pipeline, with offshore wind hit hardest by higher interest rates. In 2023, developers cancelled or postponed 15GW of offshore wind projects in the US and UK as higher financing and materials costs have made these projects difficult or even impossible to deliver at the prices planned. Auctions have been left undersubscribed , with one offshore wind auction in the UK notably attracting no bids at all .

Meanwhile, the solar PV industry has been exposed to a distinct set of pressures. In addition to cost and financing pressures, the industry is faced with a large excess in manufacturing capacity (amid a rapid scale-up and concentration of manufacturing capacity in China ) which is limiting profitability throughout the entire solar PV supply chains. Prices for solar PV modules are now falling to record lows despite rising demand.

The road to net-zero

To keep the Paris Agreement target of limiting global warming to 1.5°C in sight, installed renewables capacity must keep growing – and quickly. At COP28, leaders agreed to triple capacity by 2030 .

Ensuring continued investment also calls for policy interventions to address the challenges facing wind and solar developers.

These could include designing auctions with changeable economic conditions in mind; incentivizing security, sustainability, and resilience in renewables supply chains; strengthening confidence in renewables demand, such as by addressing inconsistent auction volumes; and taking steps to reduce the cost of capital in emerging and developing economies.

Central banks are now responding to lower inflation by planning interest rates cuts , which could be welcome news for renewables investment.

The industry already faces an uphill climb to meet ambitious renewables targets – action to ease the pressures of higher interest rates will remove some of the obstacles in its path.

Article originally published on the IEF website - https://www.ief.org/news/higher-interest-rates-pose-a-challenge-to-financing-renewables