Green Energy Is Stuck at a Financial Red Light
Rising interest rates are just one of many factors that could throw a wrench in wind and solar developers’ plans
After years of uncertainty, last year’s Inflation Reduction Act finally gave America’s renewable-energy industry a long, green signal. Now the economy is blocking the road.
The wind and solar industries have always suffered from the short-term nature of subsidies, with federal tax credits often extended in nail-biting one-year increments. Last year’s climate bill changed that, giving the industry subsidies that last at least a decade. But just as policy winds blow in their favor, two critical growth drivers—interest rates and equipment costs—are moving in the wrong direction.
Wind and solar projects are especially sensitive to rates because debt can comprise as much as 85% to 90% of capital expenditures. Renewable developers have known only low rates for most of their history. Nearly all U.S. utility-scale solar facilities and 85% of onshore wind farms were installed since 2009, during which period the target federal-funds rate was close to 0% in eight out of 13 years. Not any more: After the most recent hike, rates are the highest since 2007.
Renewable energy projects tend to be financed with floating-rate loans that rise and fall with the benchmark interest rate. Thankfully, most of those projects are well-shielded from rate risk because lenders require them to hedge at least 75% of their loans through swaps, according to Elizabeth Waters, managing director of project finance at MUFG. Most ended up hedging 90-95% to lock in low rates, she noted. But those swaps won’t help new projects. Some new solar and wind projects facing higher borrowing costs than when they were planned might not make it off the drawing board.
Borrowing isn’t the only thing that costs more. Following years of price declines thanks to technology and economies of scale, equipment is getting more expensive too. Trade policies aimed at Chinese manufacturers have caused delays and shortages for the solar industry, which relies heavily on the country for its components. German utility RWE, an active developer in the U.S., said in its annual report released last week that imports of solar modules from Asia are now subject to “stringent checks” and said it could fall behind on its expansion plans if the U.S. continues to “impede the procurement of solar panels.”
After falling to a record low in 2020, the average price of a solar photovoltaic system rose in 2021 and then again in 2022, according to data from the Solar Energy Industries Association and Wood Mackenzie. Meanwhile, the average cost to build an onshore wind farm in the U.S. rose in 2020 and 2021 before leveling off last year, according to data from BloombergNEF. Supply-chain issues and interconnection delays already started slowing the clean power industry last year: In 2022 it installed 25.1 Gigawatts of total capacity, a 16% decline from a year earlier, according to the American Clean Power Association, which tracks solar, wind and energy storage. While that’s still enough to meet roughly half of Texas’ electricity demand, it was nonetheless below expectations–though part of the drop was driven by an preplanned phase-down for tax credits commonly used by the wind industry before the Inflation Reduction Act was passed.
Ultimately, solar and wind’s ability to absorb cost and interest-rate hikes depends on how willing utilities and corporations are to pay higher prices. Many onshore wind and solar projects have been able to renegotiate pricing on their power purchase agreements because demand is robust, according to industry executives. But cracks are showing for offshore wind, which is more exposed to rising costs and rates because it takes longer to develop. BloombergNEF estimates that the weighted average cost of capital for U.S. offshore wind projects rose to 5.25% in 2022 from 4.41% in 2020.
Developer Avangrid Renewables, for example, is trying to terminate its power purchase agreement with utilities in Massachusetts for a 1.2 Gigawatt offshore wind project after an unsuccessful attempt at renegotiating its fixed-price contract. If built, Commonwealth Wind would generate enough energy to power 700,000 homes. The company cited “historic price increases for global commodities, sharp and sudden increases in interest rates, prolonged supply chain constraints, and persistent inflation” since the project secured a contract in late 2021. Avangrid plans to bid the same project into the state’s next competitive offshore wind procurement, a spokesman said over email. Danish power company Orsted said in its annual report released February that it incurred an impairment of 2.5 billion Danish kroner, the equivalent of $369 million, on its 50% interest in the Sunrise Wind project off the coast of New York, noting that the project cost has increased substantially since its bid in 2019.
As the name implies, the Inflation Reduction Act is supposed to relieve some of these cost pressures. But it won’t feel like a bonanza without clarity on how the rules apply. Expanding the eligibility of tax credits to more technologies, for example, has spread the limited pool of tax equity investors—that is, those with both the tax burden and the know-how to use renewable tax credits—more thinly across more projects. Ironically, that has shrunk the pool of tax equity available to solar and wind in the near term. The bill tries to address this by making such tax credits transferable, but industry executives said that pool of capital will remain constrained until there is more guidance.
There are two other more recent developments worth watching: One is the plummeting cost of natural gas which, if prolonged, could impact demand for solar and wind on the margins. The U.S. benchmark Henry Hub has fallen 49% year to date. Secondly, banks’ recent turmoil could shrink their ability to lend. Ted Brandt, chief executive of clean-energy focused investment bank Marathon Capital, notes that the industry has always had cheap debt, cheap equity and “massive liquidity chasing it.” How the industry will respond to expensive capital is still an open question, he said.
It isn’t enough for policy winds to blow in the right direction for a renewable energy boom–economic headwinds need to abate too.