Interest rates and the green economy: The carbon cost of higher for longer

High interest rates have created strong headwinds for the global energy transition, according to a new report by Wood Mackenzie. 

The report said renewable energy and low-carbon technologies are among the areas “most exposed” to high interest rates. 

The high capital intensity and low returns on green projects make them particularly vulnerable to high rates. 

“Interest rates… 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.

The global goal of net zero by 2040 is currently estimated to require £60tn in investment, making access to debt crucial. 

However, the report also noted that more established sectors, like oil and gas and metals and mining, remain somewhat insulated due to low debt levels. 

In the US, Wood Mackenzie’s analysis showed that a two per cent rise in the interest rates pushed up electricity costs by as much as 20 per cent for renewables. The comparative increase for a gas plant was only 11 per cent. 

“[Higher rates] affect 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 said.

Higher interest rates also erode renewables’ competitive advantage, Wood Mackenzie said. Onshore wind and solar power often have an economic advantage over hydrocarbons—in the US, onshore wind can harness electricity at half the cost of gas-powered generation. However, a higher cost of borrowing puts this advantage at risk. 

“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,” Martin said. 

Companies in the UK have already warned that the UK is not going “fast enough” with regards to the energy transition.