Persistence in high interest rates could increase the cost of transitioning to a net zero global economy, according to analysis by Wood Mackenzie.
This is due to the higher cost of borrowing negatively affecting renewables and nascent technologies, compared with the more established oil and gas industry, as well as metals and mining sectors, which remain comparatively insulated, found the report.
The higher interest rate environment is a headwind to the energy transition globally, which is estimated to require $75tn in investment if the world is to reach net zero by 2050.
Conflicts of interest: the cost of investing in the energy transition in a high interest-rate era discovered that higher interest rates disproportionately affect renewables and nuclear power.
The high capital intensity of these types of energy projects and low returns mean future projects will be at risk, said the report.
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.
“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.
In the US, Wood Mackenzie analysis shows that a two 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 $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.
Nascent technologies, such as low-carbon hydrogen, face “remarkable levels” of capital investment and high capital intensity put these projects “under threat” amid higher interest rates, stated the report.
In the report, Wood Mackenzie identified three policy priorities for policymakers.
The first is to focus on targeted and non-discriminatory subsidies to minimise nationalistic subsidy battles that are counterproductive to global emissions targets.
The second is to bolster carbon markets, including conclusion of outstanding sections of Article 6 of the Paris Agreement, the original “rulebook” on carbon markets and non-market approaches to mitigating global emissions.
The third is to mobilise climate finance with greater use of financial mechanisms and instruments to maximise private-sector investment is needed, where central banks could offer loans to commercial banks at preferential rates, specifically to be used to finance low-carbon investments.