Feds Pledge Higher for Longer Interest Rate
Far from a Seth Rogen Pineapple Express dream, we’re talking interest rates. The US Federal Reserve recently changed its tune, hinting it may keep higher interest rates around for a while. And that means big things for energy.
Background: Following what may in hindsight have been some over-zealous COVID stimulus, costs for everything went up. This prompted the US government to hike interest rates at their fastest pace ever to try and tame inflation.
While rates affect everything from mortgage payments to the strategy of venture capital firms, the jury was out on what the Federal Reserve would decide. Now, it seems, we’re stuck in a higher interest rate environment.
Particularly for energy transition investments, this doesn’t help
To start, renewables are about as tied to interest rates as the internet is to cat memes.
In a 2020 analysis, the International Energy Agency found that a 5 percent increase in borrowing rates would increase the cost of electricity from wind and solar by a third, while impacting natural gas plants only marginally.
- Renewables in particularly are heavily financed with debt, so are particularly sensitive to even slight changes in interest rates.
And VCs: Venture capitalists are just like us: they also brag over brunch about their latest high-interest savings account.
In times when investors can earn 5 percent risk free, there is little incentive to invest in something much riskier that might just return just a little bit more.
- Venture capital is key for early-stage investments into clean tech companies. Without it, many energy innovations get left unfunded.
As the US increased interest rates, investments by venture capital have declined. Global venture capital investments in Q1 of this year were down nearly 70 percent from the 2021 highs.
Global venture capital spending by quarter, 2019-2023
And then there’s government spending. The US government has been cutting cheques like it’s Mike Tyson, but its high debt levels may start to put green subsidies at risk.
The US just passed a major milestone: In 2022, interest payments on government debt surpassed military spending. And that’s about to get even more expensive, as the US must refinance $6.7 trillion dollars worth of debt by the end of the year, which will further increase those payments.
- According to the CATO Institute, its interest payments look set not only to eclipse defense spending, but also Medicaid and Social Security.
But Medicaid and Social Security are sacred cows. Congress would earlier see the subsidies put forward in the Inflation Reduction Act (IRA) as discretionary spending before cutting either program. So as government interest payments rise, there are increased risks that IRA spending gets shut down or cut back.
Oil may also be affected
While oil is not as directly affected by higher interest rates, the end buyers of oil products certainly are. US household credit card debt just hit its highest level ever this month, passing $1 trillion.
- As those payments increase, putting homes under even more financial pressure, families may elect to skip travelling to Disneyland this year and just pay up for Disney+.
Less discretionary travel means less oil consumption.
Zoom out: With most of us having lived in a zero-interest rate environment for more than a decade, it can be tough to accept that reality has changed. But for the foreseeable future, the age of cheap, easy money is over, and the time of belt tightening and and slower growth is upon us.