The renewable energy sector, which has been growing rapidly in recent years, is facing a major challenge from the central banks’ monetary policy tightening. As interest rates rise, the value and profitability of renewable projects decline, while the traditional fossil fuel industry benefits from the higher discount rates and lower competition.
Central Banks and Climate Change
Central banks have been increasingly vocal about the need to address climate change and its impact on the financial system. A 2021 survey revealed that 63% of central bankers believe climate change fits within their purview. Members of the European Central Bank even declared the battle against climate change a “core duty.”
With this promising stance, environmentalists eagerly anticipated a wave of support from these institutions. However, fast forward a few years, and things have taken a turn. Central banks have rapidly hiked interest rates, and it’s the renewable sector that is the most impacted.
The Impact of Interest Rates on Renewable Energy
One of the main advantages of renewable energy is its low operating cost and long lifespan. However, these features also make it more sensitive to changes in interest rates, which affect the present value of future cash flows. As interest rates rise, the value of renewable assets diminishes, reducing their attractiveness for investors and developers.
In contrast, fossil fuel assets, especially shale wells that realize over half their value in the initial year, are less affected by discounting. The quick returns these traditional energy sources provide are more shielded from the repercussions of rising discount rates.
Not only are shorter-duration oil and gas assets worth more but the high rates are keeping out new competing energy supplies. Renewable projects often face lengthy and costly permitting processes, which were manageable when the cost of capital was minimal. However, with rising interest rates, prolonged evaluation periods have emerged as deadly to the financial viability of these projects.1
The Evidence of Renewable Sector Struggle
The impact of interest rate hikes on the renewable sector is evident in the stock market performance of various companies. Multiple renewable companies, including Brookfield Renewable Corp, Algonquin Power, and NextEra Energy NEE 0.0%, are witnessing their stocks hit 52-week lows in the last few weeks.
Some renewable projects have also been shelved or canceled due to escalating costs. For example, Vattenfall AB recently shelved a wind farm project off Britain’s coast, and EDF Renewables called off a solar venture in Ohio.
The renewable sector is also facing headwinds from other factors, such as supply chain disruptions, labor shortages, regulatory uncertainty, and environmental opposition. These challenges are compounded by the central banks’ hawkish stance, which makes it harder for renewable energy to compete with fossil fuels.
The Need for a Holistic Approach to Energy Transition
The central banks’ interest rate hikes are not necessarily motivated by hostility towards renewable energy. Rather, they are responding to the inflationary pressures and economic recovery that have emerged after the pandemic. However, their actions have unintended consequences for the energy transition, which is crucial for mitigating climate change and ensuring energy security.
Therefore, there is a need for a more holistic approach to energy policy that takes into account both the macroeconomic and environmental objectives. Instead of treating central bankers as powerful, benevolent, technocratic guardians of price and macro stability, it is time to downgrade their role to that of servants of fiscal and industrial policies. These need to be geared toward promoting rapid decarbonization and the renewable energy transition.
