No Nuclear Renaissance? Blame it on the Fed.

Leaving borrowing costs higher for longer crushes investment and thereby worsens energy inflation.

Don’t expect a lower Federal Funds rate anytime soon: That’s the subtext within pretty much every statement from central bank officials the past couple weeks.

The prevailing sentiment seems to be that by loosening policy “too quickly,” the Fed would run the risk of having inflation “stuck” way above their long-term target. And equally, it’s fair to say officials feel little sense of urgency right now regarding the economy, mainly any risk of recession from keeping rates high, given employment measures remain healthy.

Nonetheless, there are real world consequences of leaving borrowing costs higher for longer. That’s mainly a far lower level of investment in key areas of the economy, where maintaining balance between long-term supply and demand is critical to restraining inflation. And there’s no better example right now than energy.

The Fed excludes the cost of food and energy from its preferred inflation gauge. That’s under the premise that if included their price volatility would mask “real” changes in “underlying” inflation.

This is truly an easier position to take when the price of a gallon of gas or milk is not a major line item expense for you personally. But leaving aside the question of how to best measure inflation, it’s a fact that investment in energy the past several years has lagged where it’s been in previous price cycles.

That starts with the North American shale oil and gas industry. Rather than ramp up output to take advantage of spiking commodity prices in 2022, producers used their cash windfall to pay off debt and buy back stock. And while US oil output reached new highs last year, it was the result of greatly increased efficiency, as overall levels of capital spending (CAPEX) remained subdued.

We’re still a week or two out from when most oil and gas producers will announce 2023 earnings and update their CAPEX plans. But based on Q4 results and guidance from major North American midstream company Kinder Morgan Inc (NYSE: KMI) released last week, pipeline companies aren’t expecting anything more than some incremental volume increases at most—and that mainly the result of expanding assets in areas of the energy patch that are still growing such as LNG exports.

Kinder’s 2024 price projections are $72 per barrel for West Texas Intermediate Crude oil and $2.80 for Henry Hub natural gas. That basically indicates the expectation of stable prices from here, hardly a forecast to spur meaningful capital spending and production growth for oil and gas. Rather, it’s a clear incentive for companies to continue living within their means—funding all CAPEX, dividends and the lion’s share of debt refinancing with operating cash flow.

There’s also a pretty good case higher borrowing costs will induce both oil and gas producers and midstream companies to hold in more cash than usual to pay down debt and avoid higher interest expense. For example, even Enterprise Products Partners (NYSE: EPD)—with its A- rating from S&P the highest in North American midstream—paid a yield of 4.637 percent for 3-year bonds issued earlier this month.

That’s significantly above the coupon yield of just 3.9 percent for bonds it will pay off next month with the proceeds. And it means higher interest expense for Enterprise, a direct consequence of the Fed holding borrowing costs higher for longer. That’s no doubt a major reason why Enterprise cut CAPEX from $6.1 billion in 2022 to barely $4 billion last year, despite clear opportunities to expand its energy export-related infrastructure.

Reduced oil and gas spending can also be partly blamed on tightening regulation and particularly court actions that have successfully delayed numerous projects to death. The soon-to-be started up 303-mile Mountain Valley Pipeline bringing Appalachian natural gas to Virginia and eventually North Carolina is the exception that proves the rule, having literally required an act of Congress to go through.

But investment in other energy sources has also been measurably clipped by higher for longer borrowing costs. And given the Fed’s current stance of rate cuts later rather than sooner, it’s a fair bet it will continue to be in 2024, at the cost of long-term energy inflation.

Solar is the notable exception, as Bloomberg New Energy Finance forecasts this country will add 38 gigawatts of new production capacity this year. That’s thanks to a favorable combination of plunging component prices due to a massive increase in production capacity, build times for facilities of less than a year allowing costs to be largely locked in, and now a thriving market for selling tax credits developers generate.

But even the solar industry has seen numerous casualties since the Fed began jacking up rates in early 2022. Mainly, residential solar sellers have seen sales crater and margins collapse, largely because they’re no longer able to offer buyers low cost financing. Last week, industry leader SunPower (NSDQ: SPWR) commenced an emergency restructuring plan, attempting to dramatically to cut costs to win another waiver from its primary lenders.

Last week in my Substack column “Offshore Wind’s Not Dead Yet, I highlighted the crunch currently faced by developers of US offshore wind. Basically, any project unable to lock in the bulk of its costs before the Fed pushed up rates has literally gone from immensely profitable to wholly uneconomic in a matter of months.

The result has been mass cancellations of selling contracts, project suspensions and billions of dollars of writeoffs by primary developers. And at this point, it seems unlikely industry will achieve even one-third of the Biden Administration’s goal of 30 gigawatts of offshore wind by 2030. 

Nuclear faces even stronger headwinds from the same sources. In the next few weeks, Southern Company (NYSE: SO) will bring the second of two new AP1000 nuclear reactors on stream at the Vogtle site in Georgia. They’re the first new nuclear plants to come on stream in the US since the 1980s. And thanks to consistent support from state regulators, the company will earn a competitive return on its investment in the project.

The Plant Vogtle opening, development of designs for “small scale” reactors, generous financial incentives in the 2022 Inflation Reduction Act and newfound appreciation for nuclear as baseload CO2-free energy have understandably rekindled hopes for an American nuclear renaissance.

Unfortunately, the Fed’s now nearly two-year tilt at inflation windmills has all but doomed the chances of a new US nuclear boom, adding the burden of unaffordable financing to technical challenges and regulatory hurdles. Not one regulated utility has announced a new project since Vogtle crossed the finish line. And in November, once promising NuScale Power (NSDQ: SMR) was forced to cancel its first small scale nuclear project due to soaring costs, subsequently announcing a 28 percent workforce cut in a bid to survive.

Currently operating nuclear facilities are winning license extensions to keep running longer. For example, the Nuclear Regulatory Commission recently announced it’s extending the life of Dominion Energy’s (NYSE: D) North Anna reactors in Virginia by 20 years. And it will also allow extended operations for PG&E’s (NYSE: PCG) Diablo Canyon in California.

But the Fed’s decision to keep borrowing costs higher for longer this year will be a strong disincentive for any multi-year energy project. And despite growing appreciation of nuclear as a fuel source, it’s likely the last nail in the coffin for any major new project announcement—at least this year.