Why Renewable Energy Stocks Could Have a Great Year

Like it or not, renewable energy stocks' performance today is tied to what the Federal Reserve does with interest rates in any given month. The value of renewable power plants rises and falls with the market's interest rates, and the impact of their movement trickles down to influence demand for everything from solar panels to inverters and wind turbines.

So far in 2019, interest rates on U.S. Treasury bills have dropped to lows last seen in 2017, and that's a welcome development for renewable energy investors.

Why interest rates matter

A solar project is valued based on the present value of all its future cash flows. The large upfront investment in its construction is repaid via cash flows that will extend for decades. If the interest rate that investors use to value such projects goes down, the project's value goes up.

For example, if a wind or solar project is expected to generate $1 million of cash flow each year for the next 30 years, and the rate investors used to discount future cash flows is 6%, its value would be $13.8 million. If the rate investors use dropped to 5%, the project's value would rise to $15.4 million.

Thus, lower interest rates make it easier to justify the upfront cost of building a renewable energy project, and that's good up and down the value chain.

Where demand is going to show up

The first place we see demand rise is for basic components in solar and wind. In solar energy, Canadian Solar (NASDAQ: CSIQ), First Solar (NASDAQ: FSLR), and SunPower (NASDAQ: SPWR) are some of the biggest manufacturers, and they'll see both higher volume as well as higher sale prices and margins if demand increases.

General Electric (NYSE: GE) and Vestas Wind Systems (NASDAQOTH: VWSYF) are two of the biggest manufacturers of turbines and wind-related products. Wind power projects have a longer lead time than solar, so there will be a lag, but low interest rates are definitely a tailwind for them.

Developers will also benefit from lower interest rates. Sunrun (NASDAQ: RUN) and Vivint Solar (NYSE: VSLR) are two of the biggest residential solar developers in the U.S., and they sell cash flows from their projects to investors. Lower interest rates mean they get greater returns on those projects.

Yieldcos may also make a comeback if interest rates stay low for long enough. NextEra Energy Partners (NYSE: NEP), TerraForm Power (NASDAQ: TERP), and Brookfield Renewable Partners (NYSE: BEP) are three of the biggest that remain, and they'll likely see their values rise if interest rates fall. Not only will they be able to finance projects with less expensive debt, higher stock prices could make their equity cost of capital low enough to offset higher project prices, making acquisitions more palatable.

Renewable energy needs low interest rates in 2019

Renewable energy equipment manufacturers and project developers need interest rates to stay low in 2019 to make money. If they rise, solar and wind will lose some of their price advantage over fossil fuels, and the industry could slow down dramatically. For now, it looks like the Federal Reserve is planning to keep interest rates low, which should provide a tailwind for renewable energy stocks for the foreseeable future.

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Travis Hoium owns shares of First Solar, General Electric, NextEra Energy Partners, and SunPower. The Motley Fool recommends First Solar. The Motley Fool has a disclosure policy.