Private investors that extend financial capital to a company or project expect to receive a return on their investments. Typically, private investment involves two types of parties: investors providing equity who bear more risk but expect higher returns, and lenders providing debt who bear lower risk but expect lower returns. The combination of the two determines the cost of capital for that company or project.
As financial institutions become more comfortable with low-carbon technologies, the cost of capital for related companies and projects declines. This makes it a crucial finance indicator to track how clean energy and other technologies in the low-carbon economy are attracting capital and scale.
Cost of capital is especially important for low-carbon technologies with high upfront costs, like renewable energy. Some factors can increase the cost of capital for all investments and hit these technologies harder. Economic cycles may cause the cost of capital to increase over certain periods of time, and today’s high interest rates create headwinds for renewable energy projects. Developing markets have additional real and perceived risks that raise their cost of capital.
According to IRENA, the cost of capital for renewable energy projects (which here specifically refers to solar and onshore and offshore wind) has nearly halved in the last decade, falling from an average of about 7.6% in 2010 to 3.9% in 2022. The cost of capital varied between 1.1% to 12%, with the lowest rates observed in countries like China and Germany, which have favorable policies for deployment and access to low-cost capital. Goldman Sachs analysis showed cost of capital declining by a third during the same period, with an uptick in 2022 to 4.8% likely due to rising interest rates. The corporate cost of capital for clean fuels and renewable energy equipment and services has remained around 12% through this period.
The low-carbon transition will accelerate in each market with access to cheap capital as the cost of financing low-carbon technologies declines relative to high-carbon ones and low-cost capital becomes accessible to a broader range of technologies and project types. This indicator will expand to track the cost of capital of other low-carbon technologies by regions as data becomes available.