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Economy

It’s Not Just You — High Interest Rates Are Hurting the Planet, Too

Unlike with climate change, however, there are some straightforward fixes.

A tangled wind turbine.
Heatmap Illustration/Getty Images

New clean energy projects have a lot going for them. For one, building them has gotten extremely cheap. At the same time, because the wind blowing and the sun shining are unlimited free resources, operating costs for a clean energy power plant are also pretty low. That’s the beauty of a clean energy economy — it reduces our exposure to the price swings, recessions, political instability, and surging inflation that come with fossil fuels.

The problem is that the cure for surging inflation — hiking up interest rates — is having a big, bad impact on clean energy. Elevated interest rates directly and disproportionately raise costs for clean power projects, throwing a handbrake on the clean energy transition and its deflationary impacts exactly when we need them most.

Here’s how it happens: Nearly all the costs of clean energy projects are upfront capital expenditures to cover things like building wind turbines and installing solar panels. And as anyone with a mortgage or car loan can tell you, the higher the amount you need to finance up front, the more you care about your interest rate.

By comparison, a fossil fuel power plant will pay as they go for the fuel they need to operate, meaning they have less to finance. And there’s the rub — those extra financing costs get passed on to clean energy consumers. Even if a fossil fuel power plant and a clean energy power plant have equivalent associated costs, if one has to finance more of that cost upfront at higher and higher interest rates, it’s going to be less competitive. Estimates suggest that as interest rates rise, the total cost of energy from a gas power plant might rise 8%, but for a clean energy project the same cost could rise as much as 47%.

That impact is being felt across the developed world — Bloomberg’s clean energy research division, BNEF, estimates that 60% of the cost increase for offshore wind is the direct result of rising interest rates — but the impact in the developing world is even more insidious. In emerging markets, the financing cost to deploy the exact same technology can be as much as seven times higher. That’s a big part of the reasoning behind the International Energy Agency’s estimate that we’ll have a $2 trillion clean finance gap in emerging and developing economies by 2030.

In one respect, however, we are in luck — financial regulators have a wide variety of tools they could deploy to solve this problem by creating lower, dual rates for clean energy.

One way to do that is to create dedicated central bank programs that give banks access to cheap credit if they pass it on to sectors of the economy that align with key industrial policy goals — like, say, solving climate change. If this kind of facility existed, your local bank could decide that because you put solar panels on your roof, bought an electric car, or installed a heat pump, it could offer you a mortgage at 4% instead of today’s 7% rate. Or it could finance an offshore wind developer’s first projects at below-market rates, helping to make them competitive in a challenging economic environment.

As we all know, however, creating new programs or passing new policies is hard. Instead, we might want to just make existing lending programs greener. In the EU, for example, leaders at the European Central Bank are considering using existing programs to provide banks with financing at favorable rates if they use it to support clean energy.

Meanwhile, here in the U.S., the Fed could reduce discount window interest rates and adjust collateral policies to incentivize clean energy lending — in other words, it could set the terms on which banks borrow from the Fed to support green loans and discourage dirty loans. Intervening this way would incentivize banks to lend more to clean energy at lower rates.

The Fed could also use its emergency powers to create a new program just to provide clean energy with cheaper capital because of the adverse impacts of high interest rates. It recently used these powers to create the Bank Term Funding Program explicitly to mitigate the impact of higher rates on banks; in “unusual and exigent circumstances” and with the Department of the Treasury’s approval, it could adopt a new program to provide similar direct support for clean energy. A once-in-a-civilization clean energy transition to head off a climate crisis, underwritten by historic climate legislation whose impact is now threatened by rising interest rates, would seem to qualify.

But wait, there’s more! The Fed, along with its fellow banking regulators the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, could leverage the new Community Reinvestment Act regulations to encourage certain clean energy investments, including community solar and “microgrid and battery” projects that could help smooth out power supply to public housing in extreme weather.

And of course, it’s not just central banks that can create lower dual rates for clean energy. Public finance institutions can also play an instrumental role by using their own lower cost of finance to bring down the cost of credit. For instance, the EU is providing financial support for the wind industry in the form of loan guarantees from the European Investment Bank. Loan guarantees work by putting the full credit of the government behind a particular project, thereby giving lenders more confidence they won’t lose their money, which brings down the cost of finance.

In the U.S., subsidized loans and guarantees funded by the Inflation Reduction Act and administered by the Department of Energy’s Loan Programs Office are already helping to create dual rates for offshore wind — which, thanks to new Treasury guidance, can now be extended to cover associated infrastructure like sub-sea cables. Still, that’s nowhere near what the Fed could do. Add in the new green bank capitalized with funding from the IRA that could extend low-interest loans for everything from electric vehicles to heat pumps and we’ve got a bevy of tools at our disposal.

For those wondering whether this kind of Fed policy could be co-opted to support everything from defense manufacturing to fossil fuel production, the answer is that industries always lobby for favorable policy wherever they can get them. But dual interest rates and targeted lending programs are common practice around the world, even in free market economies, with no such terrible consequences. At the end of the day, policy is just a tool, and it’s up to us to make sure it is used to achieve society's goals, not corporate profits.

Concern over the impact of rising interest rates on clean energy and the economy more broadly is hitting a crescendo, and for good reason. This week the Fed governors will meet to decide whether further rate increases are still warranted. Most Fed-watchers think this cycle of rising interest rates is finally over, but there’s no such thing as a guarantee.

More importantly, even if the Fed says “enough,” the reality is that our currently elevated rates will almost certainly take years to come down. Meanwhile, we have a rapidly vanishing window of time to reach peak emissions to stay under the Paris Agreement’s limit of 1.5 degrees Celsius of temperature rise. That means we need new targeted policy interventions that bring down the cost of finance to keep the clean energy transition humming. Unlike climate change, the impact of high interest rates on clean energy is not a force of nature. It’s one we can control.

Justin Guay

Justin Guay is the Director for Global Climate Strategy at the Sunrise Project. He has 15 years of experience in nonprofit advocacy and strategy development working for ClimateWorks Foundation, Packard Foundation, and the Sierra Club. Read More

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