Central banks are emerging as a bigger threat to the green-energy revolution than Donald Trump.
While the U.S. president is tinkering with rules to give coal a leg up over wind and solar, it’s higher interest rates that threaten to scale back the flow of cheap financing that helped funnel $2.9 trillion into renewables in the past decade.
The U.S. Federal Reserve, European Central Bank and Bank of England all are shifting towards tighter monetary policies, and investors in renewables are starting to think about how higher borrowing rates will hurt the economics of their projects. Most vulnerable are developers that rely on non-recourse bank loans for most of their project costs, including some U.S. rooftop-solar installers.
“Renewables have benefited greatly from quantitative easing and low cost of capital,” said Anthony Gordon, managing member of Gordon Energy Partners and the former managing director of energy and infrastructure at Och-Ziff Capital Management Group LLC. “The flood of cheap money has helped get enough projects built that the technology has matured. But this very success may have us on the cusp of a correction.”
Higher rates would be a significant headwind for policymakers attempting to make good on commitments made more than two years ago in the Paris Agreement on climate change. Investment flowing into clean energy may need to triple by 2030 to $900 billion a year in order to meet the treaty’s goals.
For more on where rates are expected to rise first, click here
Tighter monetary conditions will reshape how renewables get funding. Here’s what’s happening:
1. Bank debt is about to become more costly
Financing costs for renewables are near record lows. For wind farms in Europe, debt costs have fallen 43 percent since 2013, according to Bloomberg New Energy Finance. Rock-bottom interest rates combined with years of quantitative easing have fanned competition among banks to put their cash to work, slashing the price of loans and loosening borrowing conditions, or covenants.
As central banks ratchet back stimulus programs and interest rates rise, banks may find themselves locked in loans for decades at unprofitable rates, according to Alejandro Ciruelos, managing director for energy and infrastructure at Banco Santander SA.
“What is dangerous from a bank perspective is that your cost of funds today reflects market conditions today,” Ciruelos said. “But in project finance, you lend for fairly long tenors. So you could be locking in a spread now where if market conditions change dramatically, it could be lower than your cost of funds.”
As that unfolds, fewer green projects are apt to get new loans, said Angus McCrone, senior analyst at Bloomberg New Energy Finance.
“Banks could start to regret the low margins they charged on project loans in recent years,” McCrone said. “Some developers would find that some of their projects were no longer economic to build.”
2. The cost of clean power may have fallen too much
Revenue from wind and solar projects may not be sufficient to cover the debt on all projects once capital costs increase because sponsors have narrowed their margins so much there’s no cushion left for harder times, said John Pires, head of M&A and project finance at Northland Power Inc., a Toronto-based developer.
“A lot of the auctions now are being dominated by large utilities with very aggressive pricing assumptions,” Pires said. “They may start having higher interest rates if they didn’t lock in long-term corporate or project-level debt.”
Costs have fallen so much that the projects built will lose money, said Ignacio Galan, chief executive officer of Iberdrola SA, Spain’s largest utility.and one of the all-time biggest investors in renewables. “The bubble exists,” Galan said in an interview. “People are putting crazy prices in certain auctions. I think it’s not sustainable.”
Some projects that haven’t yet reached a final investment decision might not get built, said Mark McComiskey, senior managing director at AECOM Capital, an infrastructure investment firm based in Los Angeles. “When a project was bid to a 6 percent equity return to start, a 1 percentage point increase in debt costs on something that’s 80 or 85 percent levered means you are done — that’s the trouble.”
Others could become insolvent, said Trevor D’Olier-Lees, a senior director focusing on infrastructure at S&P Global Inc. “When people have aggressively financed, whether it be through weak covenant protection or aggressive assumptions, it can lead to an increase in defaults,” he said.
Utilities such as Enel SpA, Iberdrola SA in Europe and Duke Energy Corp. in the U.S. have the biggest balance sheets and are best placed to weather higher rates.
“Renewables before were an easy game,” said Antonio Cammisecra, head of Enel Green Power, the utility’s renewable energy arm. “Today you have to find the best project, to finance in the best way, to pay as low a cost as possible.”
3. Renewables are becoming more risky
Once safe as the subsidized rates they were paid for power, renewables increasingly are having to compete against lower-cost natural gas and coal as governments scale back support.
Last year, Germany and the Netherlands lured bids to build offshore wind farms without any subsidy. A number of solar projects were also being built aid-free in Portugal, Spain and even the U.K. Those leave the developer dependent on market power prices.
Banks and institutional investors are likely to find renewables less appealing as an asset class, given the risks they’re taking on.
“A considerable portion of the institutional capital available to the renewables sector is not ready to support fully merchant projects yet,” Ciruelos said. “This also applies to commercial banks and multilateral institutions.”
Some developers are seeking to sign long-term supply contracts with companies, fixing a price through a different avenue. Big technology companies in particular such as Amazon.com Inc., Facebook Inc. and Apple Inc. are buying renewable electricity to run energy-intensive data centers.
“In some instances, they’re riskier than traditional feed-in tariffs because at the end of the day, a company is typically going to have more credit risk than a government,” said Juan Pablo Cerda, managing director of Almach Energy Ltd., a company that advises on corporate power purchase agreements. “But this is emerging as a key way to stabilize revenue streams.”