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Economy

What the Jumbo Fed Cut Means for Renewables

Let’s run some numbers.

Jerome Powell.
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Renewable energy just became a much more enticing investment.

That’s thanks to the Federal Reserve, which announced today that it would reduce the benchmark federal funds rate by half a percentage point, from just over 5% to just below. It’s the beginning of an unwinding of years of high interest rates that have weighed on the global economy and especially renewable energy.

The Federal Reserve’s economic projections also indicated that the federal funds rate could fall another half point by the end of the year and a full point in 2025. The Federal Reserve began hiking interest rates from their near-zero levels in March 2022 in response to high inflation.

High interest rates, which drive up the cost of borrowing money, have an outsize effect on renewable energy projects. That’s because the cost of building and operating a renewable energy generator like a wind farm is highly concentrated in its construction, as opposed to operations, thanks to the fact that it doesn’t have to pay for fuel in the same way that a natural gas or coal-fired power plant does. This leaves developers highly exposed to the cost of borrowing money, which is directly tied to interest rates. “Our fuel is free, we say, but our fuel is really the cost of capital because we put so much capital out upfront,” Orsted Americas chief executive David Hardy said in June.

So what does that mean in practice? Let’s look at some numbers.

Wood Mackenzie estimates that a 2% increase in interest rates pushes up the cost of energy produced by a renewables project by around 20%, compared to just over 10% for conventional power plants.

Meanwhile the investment bank Lazard estimates that reducing the cost of capital (the combined cost of borrowing money and selling equity in a project, both of which can be affected by interest rates) from 7.7% — the bank’s rough assumption over the summer — to 5.4% would lower the levelized cost of energy for an offshore wind system from $118 to $97 — around 17% — and for a utility solar project from $76 to $54 — roughly 28%. While there's not a one-to-one relationship between interest rates and the cost of capital, they move in the same direction.

Reductions in cost of capital also make more renewables projects viable to finance. According to a model developed by the Center for Public Enterprise, a typical renewable energy project with a weighted average cost of capital of 7.75% will have a debt service coverage ratio (a project’s cash flow compared to its loan payments) of 1.16. Investors consider projects to be roughly viable at 1.25.

So at the cost of capital assumed by Lazard, many projects will not get funded because investors don't see them as viable. If the weighted average cost of capital were to fall one percentage point to 6.75%, a project’s debt service coverage ratio would rise to 1.28, just above the viability threshold. If it fell by another percentage point, the debt ratio would hit a likely compelling 1.43.

“As rates fall, projects become increasingly financially viable,” Advait Arun, senior associate of energy finance at the Center for Public Enterprise and Heatmap contributor, told me matter-of-factly.

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Politics

The Only Path to Permitting Reform Runs Through Trump

Congressional Democrats will have to trust the administration to allow renewables projects through. That may be too big an ask.

Donald Trump.
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How do you do a bipartisan permitting deal if the Republicans running the government don’t want to permit anything Democrats like?

The typical model for a run at permitting reform is that a handful of Republicans and Democrats come together and draw up a plan that would benefit renewable developers, transmission developers, and the fossil fuel industry by placing some kind of limit on the scope and extent of federally-mandated environmental reviews. Last year’s Energy Permitting Reform Act, for instance, co-sponsored by Republican John Barrasso and Independent Joe Manchin, included time limits on environmental reviews, mandatory oil and gas lease sales, siting authority for interstate transmission, and legal clarity for mining projects. That passed through the Senate Energy and Natural Resources Committee but got no further.

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And more of the week’s most important conflicts around renewable energy.

The United States.
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Q&A

Should Renewable Energy Companies Sue Trump?

They don’t have much to lose, Heiko Burow, an attorney at Baker & Mackenzie, tells me.

Heiko Burow.
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This week, since this edition of The Fight was so heavy, I tried something a little different: I interviewed one of my readers, Heiko Burow, an attorney with Baker & Mackenzie based in Dallas, Texas. Burow doesn’t work in energy specifically – he’s an intellectual property lawyer – but he’s read many of my scoops over the past few weeks about attacks on renewable energy and had legitimate criticism! Namely, as a lawyer who is passionate about the rule of law, he wanted to send a message to any developers and energy wonks reading me to use the legal system more often as a tool against attacks on their field.

The following conversation has been abridged for clarity. Let’s dive in.

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