What The Fed’s Interest Rate Cut Means For Climate Change

The Federal Reserve’s decision Wednesday to start cutting interest rates could bolster green energy investments, which took a hit as the U.S. central bank drastically increased the cost of borrowing money over the past two years in a scramble to tamp down post-pandemic inflation.

At its 2 p.m. meeting, the Fed slashed interest rates by 50 basis points ― one-half a percentage point ― delivering an even larger cut than the quarter of a percentage point Wall Street forecasters initially expected.

But analysts said the market needs rates to come down further to reverse the project delays and cancellations slowing the global transition away from fossil fuels, as well as warned that many emerging clean energy sectors ― from next-generation nuclear power to hydrogen fuel ― require additional support through government policy changes.

“It’s not going to do a huge amount to help the projects that have struggled with the cost of debt,” Peter Martin, the chief economist at the British-based energy consultancy Wood Mackenzie, told HuffPost. “It’s a bit of a psychological boost in terms of showing we are about to close the chapter on those really aggressive rate hikes.”

Starting in March 2022, the Fed hiked rates 11 times, beginning in increments of one-quarter of a percentage point at a time but building into the steepest climb in borrowing costs since the 1980s.

By October, the International Energy Agency warned that higher rates were spiking the cost of building all kinds of clean energy projects. Before the end of that month, the world’s largest offshore turbine developer, the Danish giant Ørsted, canceled its high-profile wind farm off the coast of New Jersey. A month later, the reactor startup NuScale abandoned its landmark project to build the United States’ first small modular atomic power units.

The cost of personal loans surged even higher than the federally set rate, reducing the number of homeowners who could afford to borrow money to pay for installing solar panels, swapping out fossil-fueled appliances for electric ones, or buying an electric car. Residential solar installations plunged 20% so far this year, while sales slowed for heat pumps and chargeable cars.

For years, investors have considered fossil fuel projects to be riskier than solar and wind, given the global push to slash sources of planet-heating emissions. As a result, oil and gas companies already paid higher interest rates compared to renewable developers, who borrowed cheaply against long-term contracts to sell green electricity.

That insulated fossil fuel projects from the interest rate rise. A 2 percentage point increase in rates spikes the cost of electricity from renewables by as much as 20%, according to an analysis Martin published in April. By contrast, the cost of a new combined-cycle gas turbine plant only grew by 11%.

Money has flowed away from higher-risk investment companies over the past two years. The venture capital industry that propelled the technology boom of the last few decades once saw 2,500 deals inked per quarter. Today, the number of contracts signed is roughly one-fifth of that peak, said Sean O’Sullivan, founder of the venture capital firm SOSV, which has a large portfolio of climate-tech and energy companies.

Many climate-tech startups managed to avoid folding over the past two years, he said, because investors warned companies that netted big funding rounds in 2022 — after the passage of the largest U.S. climate spending package in history — to conserve money for expected lean times ahead.

But O’Sullivan said the nature of the climate-tech industry is changing as the energy transition starts to take shape. Instead of looking for companies with the potential to dominate and displace entire industries as Silicon Valley giants of the past had, energy-focused VCs are getting wonky, seeing the most promise in specialized firms that can command a small but necessary link in a clean energy supply chain.

“The markets for batteries and other new energy production techniques are so huge, even just being a company with tens to hundreds of millions of dollars in revenue is now attractive, whereas everyone was thinking you had to be the next Exxon and have $10 billion in revenue,” O’Sullivan said. “Screw that.”

Still, he said, companies have delayed launching pilot projects for critical but nascent industries like sustainable aviation fuel or carbon removal technology because of higher borrowing costs.

Now that the Fed has cut rates by half a point, O’Sullivan said that “people will start loosening up a little bit.” If it had ended up cutting by just one-quarter of a point — as one member of the bank’s board of governors, Republican Michelle Bowman, advocated for in her lone dissenting opinion out of 12 on the committee — he said that we wouldn’t have seen “anything happen overnight.” He also predicted what would’ve happened if a full point had been cut, saying, “You’ll see tens of billions of dollars become more available for capital in these clean energy projects.”

“No matter what, you’ll see enthusiasm,” O’Sullivan said. “If you see a bigger cut, you’ll just see a huge sigh of relief, and people will start getting back to dusting off the business plans that were unfundable as of yesterday.”