Abstract
We examine the impact of the interest rate and its characteristics, such as long run mean and instantaneous variance risk (VR), on renewable energy investments in the power sector. The model has stochastic electricity price, stochastic interest rate, and variance regime switches. We show that an increase in the interest rate, while generally increasing the value of a power project, can have a non-monotone effect if the subsidy is sufficiently large. VR increases (reduces) the project value in the high variance regime, if the subsidy is sufficiently large (low). Under a fixed price contract, value declines and it is optimal to delay investment following an increase in the interest rate. The model helps to explain the US offshore industry experience in 2023.
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