Firming revenue to drive UK battery surge in 2021

The UK is leading European deployment of battery storage assets. But leadership is a relative concept. On an absolute basis, battery volumes are still low, with just over 1GW of installed UK capacity and annual growth rates fluctuating between 100 – 400 MW since 2017.

“Before you pick up the phone to Samsung or Tesla to rush through an order, there are some important caveats to consider…”

Numbers are regularly quoted around a large UK ‘battery development pipeline’ which has grown to more than 10GW.  This pipeline reflects the fact that it is relatively easy to locate potential battery sites (which are typically small and community friendly compared to power plants). But the reality is that many of these pet development projects will never make it past an investment committee.

Convincing investors to support battery projects is challenging. Revenue stacks are complex and have significant exposure to wholesale & balancing prices. There are no CfD or feed in tariff support mechanisms and capacity payments are relatively low. The optimisation & monetisation of batteries also requires expert trading capability, either in-house or via a third party contract.

Despite all these challenges there is likely to be a surge in UK battery investment in 2021. In today’s article we look at why.

Battery investors have been cautious

As well as the broader challenges we set out above, there are three factors that have encouraged potential battery investors to hold back and wait:

1. Falling cell costs
2. Rising revenues (e.g. as intermittency increases & thermal asset close)
3. Limited revenue track record from operational batteries

Why invest today if you can get paid more to do it at lower cost and with greater certainty in 2 to 3 years time?

The answer to this question has evolved with the introduction of a new frequency response product called Dynamic Containment in Q4 2020. Near term support from frequency response revenues is underpinning confidence in UK battery revenue stacks across the early to mid 2020s. And that is set to tip the balance for many investors in 2021.

Frequency response revenues

The conditions of low demand and high renewables penetration in 2020 exposed some major flexibility issues confronting the UK power market. System frequency and inertia issues (e.g. relating to loss of the largest unit of the system) have been a particular focus.

System stability issues saw the system operator (National Grid) introduce a new Dynamic Containment (DC) frequency response product in Oct 2020, specifically targeting fast response battery flexibility. This comes in addition to the conventional FFR service which is provided by a broader range of flexible assets.

The importance of the DC service is the price signal it is sending to new battery investors. Chart 1 shows DC auctions clearing at around 17 £/MW/h since the service was introduced. This level represents what is currently an unofficial cap on what Grid is prepared to pay for the service. That is the equivalent of just under 150 £/kW/yr of revenue for a 1 hour duration battery, well in excess of the required annual return to support investment.

Importantly, from this week Grid is enabling battery operators to capture both DC and BM revenues.  Provision of DC services constrains potential value capture in the BM but does allow the ‘stacked’ capture of revenue across balancing and ancillary services.

Before you pick up the phone to Samsung or Tesla to rush through an order, there are some important caveats to consider:

• The level of Grid demand for DC (1.1-1.4GW across the remainder of 2021), exceeds the current supply of batteries able to provide the service (hence auctions clearing at the soft price cap).
• It is challenging for some batteries to qualify for DC e.g. it requires live metering of data and many older and smaller embedded batteries aren’t set up for this.
• As installed battery capacity grows quickly across 2021-22, the DC price is set to fall. It will also become more dynamic in response to system requirements and the opportunity cost of alternative sources of battery revenue.

Those caveats digested, DC is still an important additional price signal for battery investors. High DC returns also pull battery capacity away from provision of FFR services, supporting the FFR price received by batteries and other flexible assets (e.g. gas engines & pump hydro).

Bigger structural drivers supporting battery investment

Frequency response revenues are an important near term ‘bridge’ to support battery investment cases across the early to mid 2020s. But by mid-decade, the volume of installed batteries competing to provide frequency services is set to create significant downwards price pressure on DC and FFR.

This is why the structural supply and demand dynamics supporting wholesale & balancing revenue streams are so important in driving battery investment cases.

2020 saw a combination of increased renewable targets and accelerated closure of nuclear & coal assets.  Variable output generation is increasing rapidly at the same time dispatchable flexible capacity is falling. This is resulting in growing evidence of rising wholesale & balancing price volatility.

This winter there have been 4 energy market notices (previously known as NISMs) issued to signal insufficient capacity on the system. Wholesale prices have risen above 1000 £/MWh, Balancing Mechanism prices above 4000 £/MWh. Investor confidence is also being supported by a growing battery revenue track record, as the number of operational assets on the system rises.

The other important structural force supporting battery investment is appetite from renewable portfolios to invest in battery flexibility. This is partly driven by the project IRR benefits of collocating batteries with renewables, but also by the impact of batteries in diversifying renewable portfolio risks associated with price cannibalisation, balancing & wholesale price levels.

These structural drivers, in combination with the near term ancillaries revenue bridge are set to substantially accelerate battery investment in 2021.

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