Wood Mackenzie’s latest report, Conflicts of interest: the cost of investing in the energy transition in a high-interest rate era, highlights the challenges posed by high-interest rates to transitioning to a net-zero global economy.
The report suggests that if high-interest rates persist, the transition will become harder and more costly.
According to the report, the higher cost of borrowing negatively affects renewables and nascent technologies compared to more established sectors like oil and gas, and metals and mining, which remain somewhat insulated.
Peter Martin, Wood Mackenzie’s Head of Economics and lead author of the report, stated: “Interest rates, which have risen sharply in the past two years, 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.”
The report highlights that higher interest rates disproportionately affect renewables and nuclear power due to their high capital intensity and low returns.
Future projects in these sectors will be at risk, while companies in the metals and mining and oil and gas sectors, with low gearing, will be relatively unaffected.
In the US, a 2-percentage point increase in the risk-free interest rate could increase the levelised cost of electricity (LCOE) for renewables by as much as 20 per cent, compared to an 11 per cent increase for a gas-fired generation plant.
The report also emphasises the impact on nascent technologies like low-carbon hydrogen, carbon capture, utilisation, and storage (CCUS), and direct air capture (DAC), which require significant capital investment and are highly capital intensive.
Higher interest rates put these projects under threat.
To offset the challenges posed by high-interest rates, Wood Mackenzie suggests three policy priorities for policymakers:
- Focus on subsidy efficiency to maximise the impact of subsidies on decarbonisation.
- Bolster carbon markets by concluding outstanding sections of Article 6 of the Paris Agreement.
- Mobilise climate finance by using financial mechanisms and instruments to maximise private-sector investment in low-carbon investments.
The report concludes that policymakers need to remove obstacles such as slow permitting and project approval and offer clear, consistent, and sustained incentives to support the uptake of low-carbon energy and nascent green technologies.
