SolarKal Quarterly 3Q24
The Federal Reserve’s long-anticipated rate cut happened this week, signaling the Fed’s satisfaction with its fight against inflation. The larger-than-expected cut (50 basis points instead of an estimated 25) is just the start, as investors expect continued cuts through at least the end of the year. While it feels like rates have been high for eons, it’s worth noting that they were near zero as recently as March 2022 — just two and a half years ago.
Yet those two and half years have slowed the rate of capital deployment, as most investments in renewables are debt-financed and immediate-term ones. The cost of building and operating a solar system is highly concentrated in construction rather than in ongoing generation or operations. Higher rates means higher costs means higher breakevens; Wood Mackenzie noted that a 2% increase in rates equals a 20% increase in the levelized cost of energy (LCOE) for renewables (versus just 11% for a combined cycle gas plant).
In fact, nearly all U.S. utility-scale solar facilities have been installed in a period when the fed funds rate was close to 0%, as shown in this chart:
Now, with rates moving lower, the same is true in reverse. The new lower trajectory will immediately unlock a swath of projects as long as the economy remains on solid footing. Investment bank Lazard estimates that reducing rates from an average of 7.7% to 5.4% would lower the LCOE by 28%, drastically increasing the number of financeable projects.
For commercial real estate asset owners, SolarKal expects lower developer financing costs to yield higher bids on lease payments and more compelling power purchase agreements. In addition, solar asset values may rise as a system’s cash flows increase in value with lower rates, though rates will likely need to fall further for a more tangible impact.
The Inflation Reduction Act (IRA) celebrated its birthday on August 16. It’s been just two years since President Joe Biden signed the bill into law after Vice President Kamala Harris cast the tie-breaking vote in a 50-50 Senate. It has been game-changing legislation for solar, and it’s something we’ve covered extensively from the beginning. We also chimed in with a nine-month update and again as part of our Election 2024 preview because it’s always wise to keep a watchful eye on any two-year-old.
Indeed, the White House celebrated much like a proud parent might — with a fact sheet and a Harris statement touting (among other things):
House Republicans have also lined up behind the IRA, with 18 representatives submitting a letter to House Speaker Mike Johnson emphasizing that these “energy tax credits have spurred innovation, incentivized investment, and created good jobs,” which suggests real staying power regardless of the outcome of the election.
In part driven by the IRA, solar remains the incremental market share winner — solar represented a whopping 54% of new U.S. electricity generation capacity in 2023, per the U.S. Department of Energy.
Amazing achievements so far, but the report card is still incomplete. The domestic content adder wasn’t sorted out until a few months ago, which has slowed down a plethora of projects in development. Investments in U.S.-made panels have yet to translate to meaningful domestic manufacturing, though reports suggest domestic could be a player within the year.
We won’t know the final grades for years to come, but two years in, it’s clear that the overall macro environment has improved. However, with solar accounting for just 5.6% of total annual electricity generation, the industry is still in its growth phase.
Quarterly Quick Hits:
What I’m Looking Out For:
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