Could Rising Interest Rates Pop the Renewable Energy Bubble?

Could rising interest rates pop the renewable energy bubble?

As the Federal Reserve and other central banks try to turn off the easy money spigot, we will likely see a growing number of corporate bankruptcies in the coming years. The renewable energy sector is particularly vulnerable and exemplifies broader problems in the global economy.

Last year, we saw a number of high-profile corporate bankruptcies, particularly in the retail sector. Toys R Us was probably the most high profile. It ranks as the second-largest US retail bankruptcy ever, according to S&P Global Market Intelligence. The story behind the Toys R Us bankruptcy gives us a glimpse at a fundamental problem eroding the strength of the economy – easy money created by Federal Reserve monetary policy. The ability to borrow a lot of money at low interest rates fueled borrowing and speculation. Malinvestment has distorted the economy and inflated bubbles that will eventually pop. This is exactly what happened at Toys R Us.

The rate of bankruptcies will likely accelerate over the next several years and spread into other sectors if the Fed follows through on its monetary tightening policies. The ugly truth is that these overleveraged companies simply can’t survive in anything remotely resembling a normal interest rate environment.

As economist Daniel Lacalle noted in an article on the Mises Wire, the past eight years of easy money and massive liquidity enabled companies to increase imbalances and create complex debt structures. Two facts bear this out.

• Corporate net debt to EBITDA levels is at record highs. About 20% of US corporates face default if rates rise, according to the IMF.
• The number of zombie companies has risen above pre-crisis levels according to the Bank of International Settlements (BIS).

The incredible transformation of the renewable energy sector over the last decade was built on easy money and government subsidies. Lacalle said understanding that disruptive technologies cannot be more leveraged than traditional technologies is key to understanding what’s going on in the renewable energy sector.

When technology reduces costs and disrupts inflationary models, basing the business on ever-increasing subsidies and higher prices and financing it with massive debt is suicidal. In the era of cheap money and extreme liquidity, many companies used the ‘green’ subterfuge to implement an extremely leveraged builder-developer model, ignoring demand, costs, and competition. A model whose sole objective was to install for the sake of installing capacity, whether there was a demand or not, and that pursued subsidies while stating that it is very competitive.”

Even in a period of low interest rates and ample liquidity, we’ve seen a number of spectacular bankruptcies in the renewable energy sector. In fact, solar company bankruptcies have exceeded those of coal and fracking companies combined. As Lacalle says, if the renewable sector is already struggling, imagine what will happen as interest rates rise.

Bankruptcies such as SolarWorld, ET Solar, American Solar, SunEdison, Sungevity, Suniva, Beamreach, Verengo Solar and others did not happen due to lack of support or technology, but due to a bubble-type business model. Increase debt to pay debt, death from excess capacity and working capital amidst unbridled imperialistic growth aspirations. While many companies filled Powerpoint slides with the competitive advantages of lower costs, their business sank due to the impossibility of generating returns above the cost of capital and the evidence of death by building working capital.”

According to Lacalle, global renewable energy sector faces refinancing needs over the next seven to eight years that exceed its entire market capitalization (134 billion euros, based on information from Renixx Index).

Lacalle says this isn’t just an issue in the renewable energy sector. The problems facing solar and wind energy companies exemplifies an economy-wide problem.

It is not a problem of technology, it is the addiction to cheap debt and growth for growth sake. And it’s not just a problem in the renewable sector. The combination of lower revenues and increased debt costs is a danger. Cost of debt rises, and cost of equity soars due to higher perceived risk, which in turn can dry up the market for capital increases and refinancing. It is not just renewables, but it is worth highlighting that energy is -again- the most vulnerable sector due to the cyclical nature of its revenues and the perpetuation of overcapacity of the past eight years. In 2018, for all sectors, refinancing needs exceed one trillion euros in Europe, Africa, and the Middle East. This figure is doubled if we include China and other markets. At the same time, the number of zombie companies has skyrocketed in the era of cheap money. What is a zombie company? Those that are not able to pay interest expenses with operating profits.”

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