Why Solar Energy Stocks Soared on Thursday.

Solar energy stocks jumped double digits on Thursday after inflation data came in cooler than expected. The closely watched Consumer Price Index (CPI) fell 0.1% month over month in June after being flat in May. Prices were up just 3% over the past year.

Inflation is a key indicator investors watch to predict what the Federal Reserve is going to do with interest rates. High inflation is what led to higher interest rates over the last two years and now that inflation seems to be reversing. The Federal Reserve may reverse its interest rate policy to stimulate the economy as early as its September meeting.

Solar energy stocks, including SunPower $SunPower (SPWR.US)$ Sunrun $Sunrun (RUN.US)$ , and Sunnova $Sunnova Energy International (NOVA.US)$ , reacted positively because interest rates are a key driver of the value they generate from long-term contracts to sell electricity to customers. Shares of SunPower were up as much as 10.5% on Thursday, Sunrun rose 14.2%, and Sunnova increased 17.6%. The stocks are up 6.5% 14%, and 16.8% respectively as of 3 p.m. ET.

Solar energy, energy, and interest rates
Interest rates have always been a key driver to the solar industry because most installations are paid for upfront by installers and generate a return over 20 to 30 years. All three of these companies generate most of their sales through what's called power purchase agreements, or long-term agreements to sell electricity to customers while the installer owns the system on the customer's roof. That means the installer needs to find financing to justify the installation in the first place.

Higher interest rates over the past two years combined with policy changes in California have had a cooling effect on the solar industry and solar energy stocks have taken the brunt of that.

Outside of interest rates, the only two levers companies are able to pull to increase margins are reducing costs that reduce the upfront investment made in solar installations or raising prices for customers, which ultimately makes it less compelling to go solar in the first place. Cost reductions have been moving through the system with solar panels and inverters falling in cost over the past two years, but interest rates continue to hinder the industry's growth. This could be changing.

The caution about interest rates
According to Bloomberg, the 10-year Treasury rate fell 9 basis points today based largely on the CPI news. Rates are down 21 basis points over the past month to 4.19%.

This is a benchmark for the solar industry and the decline would be welcome for the industry, but the moves are still modest at this point and won't make companies profitable overnight.

What investors need to watch is the installation cost trend to see if costs are coming down, which would be a sustainable boost for the industry. We will learn more about progress on both the cost and price front when earnings are released about a month from now, but it appears the worst for the industry may be over. Falling rates could be the boost solar stocks need to end 2024 on the right foot.