Interest rates significantly influence the trajectory of renewable energy project development. Because these projects require substantial capital, rate fluctuations can profoundly affect project feasibility and profitability. This article offers insights into the current financial landscape surrounding renewable energy lending, illuminating the impact of interest rate increases and the challenges that developers face when securing financing.
Interest Rates and Renewables
Over the last decade, technological innovation reduced project costs, while low interest rates made renewable investments more attractive than fossil fuels. Starting in 2022, rising inflation led to massive interest rate hikes, straining project budgets, slowing timelines, and squelching investors’ interest in renewable energy equity.
For example, the levelized cost of energy (LCOE) for utility-scale solar spiked from $38/MWh in 2021 to $60 per megawatt hour (MWh) in 2023. Heightened project expenses, coupled with other challenges like supply chain constraints, brought delays in 2022, resulting in a 16 percent decrease in renewable energy deployment compared to the previous year. Project sales and offtake agreements have subsequently slowed as investors confront uncertainty and tighter returns.
Financing Project Development With Rate Increases
Among all of the factors which impact project development, high interest rates have one of the most dampening effects. On July 26th, the Federal Reserve increased interest rates another quarter of a point (from 5.25 - 5.5 percent), making the benchmark lending interest rate its highest level since 2001.
Project developers confront a host of obstacles in a high interest rate environment. First, project sales slow when power purchase agreement (PPA) prices fall. During the second quarter of this year, average solar PPA prices across North America fell 1 percent to $49.09/MWh, despite three years of steep price increases. While 1 percent does not seem like a substantial decline, it is offset by a 14 percent price increase in ERCOT. So outside of the state of Texas, without an attractive offtake agreement, project developers may be in a liquidity squeeze. Developers may hold onto projects if they aren’t getting good financial returns, but they still need capital for their business to grow.
Private equity investment tends to slow when interest rates rise, which means that developers who look to equity investment may see that option dry up. Statistics bear that out. Even with the Inflation Reduction Act, private equity investment in clean energy, including battery energy storage, has had the slowest quarter since 2020.
Development debt, which Leyline provides, may be the best solution for project developers because they can still move forward on a project in the midst of a liquidity squeeze. In other words, it provides another funding source to develop projects when equity investment has slowed and offtake agreements are less attractive.
A Promising Future
Despite recent struggles, the renewable energy industry broadly has demonstrated overall financial resilience. According to the April 2023 Lazard Levelized Cost of Energy (LCOE) report, new utility-scale solar, paired solar/storage, utility-scale onshore wind, and paired wind/storage offer the lowest LCOEs among all utility-scale energy generation options. Inflation Reduction Act subsidies are expected to further reduce renewable energy costs, potentially driving them close to zero. In contrast, natural gas LCOEs remain generally non-competitive—even without renewable energy subsidies—and are unattractive due to price volatility and geopolitical instability.
Overall, clean energy investments are demonstrating greater affordability and security compared to their fossil-fuel counterparts. The International Energy Agency predicts that this year’s global solar investments will outpace oil for the first time, with overall clean technology investment expected to exceed $1.7 trillion USD.
In this era, uncertainty is the most certain thing. Moving forward, the best investment may not always be the project with the lowest LCOE. Changes in supply chains, interest rates, and inflation are hard to predict, and the specifics of the IRA are still in flux. From the start of construction to the beginning of service, the legal and financial considerations of a renewable energy project could undergo dramatic changes. Companies must learn to adapt to the nuances of this dynamic market and the implications from each shift.
Robust financial analysis and scenario planning are essential from the outset to account for potential interest rate changes, improve risk assessment, and bolster decision making throughout a project’s lifecycle. Project developers should also develop strategic relationships with government entities, renewable energy organizations, and financial partners such as ours to leverage the innovative value of collective expertise.