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Green Energy Is Stuck at a Financial Red
Light - WSJ
Rising interest rates are just one of many
factors that could throw a wrench in wind and solar developers’ plans
By Jinjoo
Lee
March 31, 2023
Wind turbines near
Whitewater, Calif., last month. MARIO
TAMA/GETTY IMAGES
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 subsidiesthat 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.
A solar site in Lumpkin, Ga.Photo: Audra Melton for The
Wall Street Journal
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.
Green Play Ammonia™, Yielder® NFuel Energy.
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