NEWS
RELEASE
Renewables and nascent low-carbon
technologies most exposed to high interest
rates
Policymakers should focus on bolstering
carbon markets, maximising subsidy efficiency and mobilising green
finance
LONDON, 18 April 2024 – If high
interest rates persist, transitioning to a net zero global economy
will be even harder and more costly. 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.”
In the report, Wood Mackenzie identified three
policy priorities for policymakers:
- Focus on subsidy
efficiency. With government finances under pressure,
subsidies need to have the maximum impact on decarbonising the
global economy. Targeted and non-discriminatory subsidies are most
efficient, minimising nationalistic subsidy battles that are
counterproductive to global emissions targets.
- Bolster carbon
markets. First and foremost, conclude outstanding sections
of Article 6 of the Paris Agreement, the original ‘rulebook’ on
carbon markets and non-market approaches to mitigating global
emissions.
- Mobilise climate
finance. Greater use of financial mechanisms and
instruments to maximise private-sector investment is needed.
Central banks could offer loans to commercial banks at preferential
rates, specifically to be used to finance low-carbon
investments.
ENDS
Editor’s Notes:
About the report: ‘Conflicts of
interest: the cost of investing in the energy transition in a high
interest-rate era’
The ‘zero era’ for interest rates has come to an
end. The higher cost of borrowing affects energy and natural
resources sectors unevenly. Highly capital intensive and often
reliant on subsidies, low-carbon energy and nascent green
technologies are most exposed. In contrast, the oil and gas
industry, and large metals and mining companies, are relatively
well positioned. In a higher-interest-rate scenario, achieving net
zero will be even harder and costlier. This report is essential
reading for investors, companies and policymakers looking to offset
the interest-rate headwinds. Read more.
For further information please
contact:Vivien Lebbon, T: +44 330 174 7486, E:
Vivien.lebbon@woodmac.com
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