Clean hydrogen projects at risk due to high interest rates: WoodMac

Low-carbon hydrogen projects could be under threat due to high interest rates, according to recent analysis by research firm Wood Mackenzie.

Interest rates have risen since the so-called “zero-era” following the 2008 financial crash, with 2023 seeing “the most aggressive hiking cycle in 40 years”, WoodMac notes.

Meanwhile, structural trends that drive inflation — such as global trade reshuffling, de-globalisation and production onshoring in the name of supply chain or energy security — are only growing more intense.

“While inflation has fallen towards central banks’ targets of around 2%, rates may not come down as far or as quickly as markets anticipate,” the research firm adds.

Clean energy more broadly, including renewables and nuclear, is expected to struggle with a higher cost of borrowing, given these projects are capital-intensive and have a higher “gearing” or debt-to-equity ratio than oil & gas.

WoodMac data suggests that the power and renewables sector has seen its weighted average cost of capital rise from less than 2% to nearly 4% from 2021 to 2023.

However, WoodMac highlights that hydrogen and other nascent technologies such as carbon capture and storage will be particularly hard hit by inflation.

“With their remarkable levels of capital investment and high capital intensity, these projects are under threat amid higher interest rates,” the research firm warns.

“The capital intensity of hydrogen varies greatly by project, with capex ranging from 20% to 75% of total cost. At higher capital intensities, a 2-percentage point increase in interest rates lifts the levelised cost of hydrogen by around 10%.”

Another potential problem for hydrogen is its relative risk. WoodMac notes that clean energy can generally secure debt at a lower cost than oil & gas or metals and mining sectors, based on mechanisms to reduce price and offtake risk such as power purchase agreements or the presence of subsidies.

However, while WoodMac does not explicitly comment on hydrogen’s bankability, as a new technology it may struggle to secure the same terms as renewables and power due to its technology risk.

The research firm also warns that high interest rates could also put government subsidies at risk.

“With elevated debt and higher interest rates, governments’ debt servicing costs are increasing,” WoodMac notes. “This squeezes out other government spending and could restrict transition efforts by reducing supportive subsidies and tax incentives or cutting direct public capital investment in a low-carbon economy.”

China is raised as an example, where although the central government ended subsidies for new renewable power capacity in 2022, its legacy subsidy payments to the sector have risen from ¥40bn ($5.5bn) in 2022 to ¥100bn in 2023. “As of 2021, subsidy arrears stood at RMB400 billion, as eligible projects outstripped available funding.”

WoodMac also notes that in the US, $1 of every $7 of government spending goes towards interest payments — and the Inflation Reduction Act is already set to total $1.8trn in subsidies to the power sector alone by 2050. “Budget trade-offs are a reality,” it says.

The research firm calls on governments to ensure subsidies are efficiently allocated to where they will have the greatest impact, bolster carbon markets and mobilise climate finance, such as by allowing central banks to offer loans with preferential rates to commercial banks if the money is used for green investments.