Tariffs are the hottest topic in renewable energy right now, whether it's the solar tariffs announced earlier this year or the steel and aluminum tariffs announced last week. Tariffs are a direct cost increase for the industry, and an avoidable one at that, so it's natural that the media and companies themselves have strong opinions on them.

But a bigger threat to renewable energy companies and investors is what's happening at the Federal Reserve. Interest rates are on the rise, which will raise the cost of energy for every solar project across the U.S., making it harder for the industry to compete against fossil fuels. If the solar industry has a bad 2018, it may not be tariffs that are to blame. 

Solar farm with mountains in the background.

Image source: Getty Images.

Tariffs are no match for interest rates

The table below shows the potential impact of solar tariffs on solar projects of different sizes. I've assumed that tariffs will increase the cost of solar panels by 10 cents using a 30% tariff on a conservative $0.35 per watt market price of a commodity panel. Given higher costs in the U.S. and the fact that there's not enough capacity to exploit the 2.5 GW of cell imports excluded from the tariff, it's likely most panels installed will be imported (in excess of 70% based on existing capacity) and pay the tariff for the foreseeable future and all panels will be priced as such. 

Size of Solar Project Cost per Watt Pre-Tariffs Cost per Watt Post-Tariffs Implied Impact of Tariffs
Utility $1.00 $1.10 10%
Commercial $2.00 $2.10 5%
Residential $3.00 $3.10 3.3%

Data source: Based on industry pricing. 

You can see that the biggest impact is on large solar systems, where a small increase in costs can drive overall costs up 10%. But smaller rooftop systems would experience only a small impact from tariffs. 

Translating rising financing costs into rising energy costs

Installation costs are an important piece of the solar puzzle, but the cost of electricity a utility or other customer will pay depends on discounting long-term energy production to generate the cost per kWh we all pay for electricity. If financing costs are flat, the cost impact for electricity sales from projects above would be directly in line with the increases you see above. Think of it like a mortgage -- a 10% increase in the purchase price of a home means a 10% rise in monthly mortgage payments if everything else is equal. 

Ultimately, it's this price of electricity that matters for solar projects long term, and solar developers will bid based on their cost of construction and the rate at which they have to discount cash flow to get an implied price of electricity. The higher the interest rate they're discounting, the higher price at which electricity has to be sold on a per-kWh basis for projects to make money. If we use the mortgage example again, a home with a 4% interest rate mortgage will be much cheaper per month than the same price home with a 5% interest rate. But how much do rates impact the cost of electricity? 

In the table below, I've built some examples to show how interest rates impact the price of electricity from solar projects. I've assumed that all projects will generate consistent cash flow for 30 years and have a $0 value at the end of that period. Cost of construction is the same as the pre-tariff figures I used above, and to make numbers simple I've eliminated operating expenses from the calculation. I've also assumed that each watt installed will generate 2,000 watt-hours of electricity per year. 

Type of Solar Project Cost per kWh at 6% Discount Rate Cost per kWh at 8% Discount Rate Implied Impact of 2% Increase in Interest Rates
Utility 3.63 cents 4.44 cents 22%
Commercial 7.26 cents 8.89 cents 22%
Residential 10.9 cents 13.3 cents 22%

Calculations by the author. 

A 200-basis-point increase in interest rates would have a far bigger impact on all solar projects than the tariffs put on solar cell and panel imports by the Trump administration. What's scary for investors is that a rate increase isn't hypothetical at all. 

Rates are already rising

You can see in the chart below that interest rates are already pushing higher. The 10-year Treasury yield is up about 150 basis points since summer 2016 and could push higher if the Federal Reserve continues raising rates. 

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts.

Any increase in rates is going to hit the entire solar value chain, and it's not going to have a positive effect.

Solar companies don't like tariffs, but they hate rising rates

SunPower (NASDAQ:SPWR) has been most vocal against solar tariffs because it'll pay the highest tariffs for its high-end imported solar panels. But higher interest rates could hurt the financing of solar projects more than tariffs themselves. 

First Solar (NASDAQ:FSLR) and Canadian Solar (NASDAQ:CSIQ) are the two other manufacturers who have large solar project development businesses that will be impacted by higher rates. First Solar, in particular, could be hurt because it was seen as the one winner from Trump's solar tariffs. But with a 1 GW annual solar development pipeline, it has a lot riding on developing and selling solar projects profitably, which depends on rates staying low. 

The two other companies who won't like to see rising rates are Sunrun (NASDAQ:RUN) and Vivint Solar (NYSE:VSLR), who finance their residential solar power systems by selling long-term cash flow for upfront cash. Sunrun is particularly dependent on financing, and if investors aren't willing to pay the same as they once did for cash flow, the company could end up upside down on projects or be forced to raise prices on consumers. 

No matter how you look at it, rising interest rates are bad for solar companies -- and they're potentially a much bigger deal than solar tariffs will ever be. 

Travis Hoium owns shares of First Solar and SunPower. The Motley Fool recommends First Solar. The Motley Fool has a disclosure policy.