European battery investment wave

European power markets have a flexibility problem. And batteries are currently the only scalable low carbon flexibility solution. But a system requirement for flexibility is not on its own enough to underpin a battery investment case.

“There is an inherent minimum level of price volatility that supports battery returns.”

There is currently a disconnect between the investability of batteries and the scale and pace of new flexibility required.  But that may not be the case for much longer.

Policy maker awareness of a looming flexibility problem is gradually increasing.  As renewable targets are ramped up to facilitate 2050 net zero emissions goals, flexibility has become a core policy and industry focus.

In today’s article we look at the battery investment landscape across key European markets. We consider how the battery revenue stack varies across markets, how policy tailwinds are swinging behind battery investment and how renewable portfolios are driving momentum.

We also introduce our Q4 2020 briefing pack on European battery investment which can be downloaded via a link at the end of the article.

Looming capacity deficit

European power markets have had a surplus of generation capacity since the sharp decline in demand following the 2008-09 financial crisis. But that surplus is set to disappear and transition to a capacity deficit over the next 3 years.

There is a simple driver of this emerging capacity deficit. The closure of coal and nuclear plants is significantly outpacing the development of renewables on a derated capacity basis.

Across Europe, there is set to be more than 30 GW of net derated capacity reduction between 2020 – 23, more than 60GW by 2030. And those numbers only include regulatory scheduled coal & nuclear plant closures. There may be an additional 20-30GW of older gas plant closures by 2030.

The most immediate challenge European power markets face is ensuring enough flexible capacity to:

1. Balance large & rapid swings in intermittency e.g. 100GW+ average intraday swings in solar output by 2030 (this includes providing ancillary services such as frequency response).
2. Provide energy in periods of low wind & solar output, as nuclear, coal & gas plants are decommissioned.

Gas-fired capacity will step in to dominate provision of this flexibility as coal and nuclear plants close. But there are not enough gas plants to plug the growing flexibility deficit as the 2020s unfold. And a new wave of gas plant investment is not consistent with net zero 2050 targets.

This is where batteries come in.

European battery investment landscape

Battery investment has moved well beyond the experimental phase. The UK is the most mature market, with over 1GW of installed capacity and a pipeline of several GW behind. Most of Europe’s other major power markets have installed battery capacity in the low hundreds of MWs, but with growing investment pipelines.

In Diagram 1 we show the key markets that are likely to drive battery investment across the next decade.

The common theme across these green shaded markets is (i) closure of existing thermal capacity (e.g. coal, nuclear & gas) and (ii) a rapid increase in penetration of variable output wind & solar capacity.  These markets include UK, Ireland, Germany, France, Belgium, Netherlands, Italy, Spain & Portugal.

In Table 1 we summarise the battery investment landscape across these markets.

In summary, battery investors are finding specific projects that work.  Rapidly declining cell costs and growing policy tailwinds are helping. But battery investment is not even close to scalable at the pace and volume required to address the looming flex deficit.

That could change over the next 2 to 3 years.

Battery investment challenges

One of the big challenges battery investors face is getting comfortable with a merchant business model.  The battery revenue stack is typically supported by a base tranche of ancillary & capacity returns. But battery investment cases also rely on a significant exposure to wholesale & balancing revenues.

Renewable investors are currently dominating deployment of batteries.  Infrastructure investors have historically been cautious taking on merchant risk, given downside exposure from adverse market outcomes. But rising merchant risk is a reality confronting many renewable portfolios, due to a combination of:

• Existing policy support mechanisms rolling off (e.g. feed in tariffs & renewable obligations)
• Policy makers gradually transferring wholesale & balancing risk onto investors as costs fall
• Falling yields pushing investors out on the risk curve.

Against this backdrop, renewable investors are realising that merchant risk on batteries is no worse than merchant risk on wind & solar assets, and is in some cases more attractive.

Renewable assets are primarily exposed to wholesale power prices, batteries to price volatility. While wholesale power prices can fall to zero (& below), there is an inherent minimum level of price volatility that supports battery returns.

There are two other benefits of adding batteries to renewable portfolios:

1. Co-location of batteries with the right PV asset can create genuine value uplift (e.g. 1.5 – 2.0% IRR).
2. Batteries can diversify wind & solar asset risk and improve renewable portfolio risk/return profiles.

The other major hurdle for battery deployment is developing a robust investment case. We explore this challenge in more detail in our briefing pack that you can download free of charge via the link below.