Surveying the European battery investment landscape

The current energy crisis in Europe is highlighting an acute shortage of flexible power capacity. The policy roadmap to address the crisis is focused on ‘doubling down’ on wind & solar, which is set to further increase the need for flex investment.

Acceleration of renewable deployment is now being driven both by a necessity to achieve energy independence as well as decarbonisation targets.

Against this backdrop batteries are currently the only economic and scalable form of low carbon balancing flexibility. The UK has led deployment of battery storage (BESS) in Europe so far. But market & policy responses to the current crisis are setting up a rapid acceleration in BESS investment across other European markets.

In today’s article we look at BESS market price signals and policy hurdles, as well as ranking battery investment opportunities across key European power markets.

BESS revenue drivers

In order to understand why BESS investment momentum is growing so rapidly, it is useful to recap 4 key categories of revenues that drive BESS returns, summarised in Table 1.

Table 1: BESS revenue categories

These revenue sources combine to drive the BESS ‘revenue stack’. However revenue categories are not simply additive, they are strongly interdependent. For example a BESS owner’s ability to capture energy arbitrage revenues is directly constrained by its ancillary & network services strategy. BESS monetisation strategies typically change dynamically from day to day (even hour to hour), driven by market conditions.

The good news for BESS investors across 2021-22 is that market events are supporting substantial uplift across all four of these revenue categories.  As a result, battery returns across many Western European power markets are rising to very attractive levels.

Growing BESS investment tailwinds

The ancillary & network revenue categories have been important in underpinning front year revenues for batteries coming online. The creation of an integrated market across Western Europe for secondary reserve (aFRR) is an important step that is helping to underpin a viable BESS revenue stack across the next 5 years.

However the system demand for ancillary and network services is small relative to the scale of BESS investment required to balance renewable output swings by the 2030s.

Over an investment horizon (30 years +), it is energy arbitrage revenue that is the key category underpinning investment case viability for most battery projects. There are two key market price signals that drive arbitrage returns:

• Price shape: the shape of intraday prices that can e.g. be hedged in day-ahead power auctions to lock in cycling value.
• Price volatility: the fluctuations in day-ahead, within-day & balancing prices from which batteries can harvest revenue via optimising & re-optimising cycling decisions.

We summarise the evolution of these two price signals across 6 key European power markets in Chart 1.

Chart 1: Intrinsic day-ahead BESS price spreads & price volatility evolution

The left hand panel of the chart shows the intrinsic value that a 1 hour battery could have hedged in day-ahead power auctions from a single cycle. Value harvested from intrinsic price shape is a key driver underpinning battery returns.

Returns from this intrinsic shape benchmark were not very exciting until 2021, with batteries relying mostly on ancillary services & intraday price volatility for revenue. However since the start of last year, this intrinsic benchmark has broadly tripled. This represents a substantial injection of hedgeable value into the BESS revenue stack.

The right hand panel of the chart shows 30 day rolling historical day-ahead price volatility across the same 6 power markets. This is a simple benchmark for what is a more complex set of volatility drivers for BESS. But it illustrates how volatility has also surged across 2021-22 as power markets have tightened. Note the 2022 numbers are year to date and therefore do not include what will likely be the impact of very high volatility in Q4 2022.

This volatility benchmark however does not do justice to the scale of increase in BESS returns from increasing price fluctuations. While the absolute percentage volatility levels have increased in the chart, the underlying price levels on which these percentages act have also surged (in the order of 8-10 times). This is driving a huge increase in BESS value capture from volatility harvesting.

The case for viable BESS returns no longer depends on theoretical modelling of markets in the 2030s. Revenues across many European markets are currently well above required long run returns on capital. That is spurring investor momentum across Europe.

What about the challenges?

Before getting too excited about the prospects of BESS investment it is also important to consider some significant challenges. In Table 2 we group these together in 5 categories to consider across all markets, although there are many nuances in individual markets which we don’t cover in this article.

Table 2: Five challenges facing BESS investors

The other major challenge facing battery investors is supply chain constraints. It is currently very difficult to source cells & certain system components (e.g. transformers) and costs are rising as a result. This may be a temporary issue but it is having a very real impact on project timelines.

For all these challenges, the current energy crisis represents a huge incentive for policy makers to better integrate BESS flexibility into power systems.  Succeeding with this is a key pre-condition for achieving the aggressive increases in renewable targets announced across the last year. In other words it is reasonable to expect strong policy tailwinds for BESS going forward.

Surveying the BESS investment landscape

At Timera we have seen a strong increase in engagement from our clients to analyse BESS investment cases across Western European markets (e.g. IT, ES, DE, FR, Benelux).  The viability of BESS projects and business models varies significantly by market & project, but below we aim to summarise some key takeaways on opportunities by market.

In Table 3 we set out a concise summary of the BESS investment opportunity landscape, with a colour code ranking of 3 factors across 6 key markets.

The 3 factors we use to rank are:

1. Growth potential: how much investment in BESS is required (as an indication of investment scalability in the market)
2. Price signals: how strong are current price signals in supporting BESS returns across the revenue stack (note this may change significantly as markets & capacity mixes evolve)
3. Policy hurdles: an assessment across the 4 categories of BESS challenges we list above.

 Table 3: BESS investment opportunities & challenges

What is driving BESS capital flows?

Western Europe is likely to require 50-70 GW of BESS investment by 2030 alone. This requirement is set to grow in line with wind & solar build beyond.

Batteries are rapidly emerging as a low carbon new asset class, underpinned by a structural demand for balancing flex to support higher renewable penetration.

Investors still face a number of practical challenges from both policy issues & supply chain constraints. However BESS investment momentum has gained pace across Europe in 2022 as the current crisis drives up returns and emphasises the requirement for new flexible capacity.

This is spurring a land grab, given not all battery projects are created equal. Good sites are driven by a combination of factors such as revenue stream access, network charging burden and colocation with renewable & EV infrastructure.

The challenge is not just about looking for a viable projects to invest in today. The smart money in the battery space is focused on acquiring site, project & partnership options that will unlock value as BESS scales.

We provide information on BESS investment cases and market opportunities only at a summary level in this article. If you are interested in more information on our analysis and how we support battery investors feel free to contact steven.coppack@timera-energy.com our Power Director or david.stokes@timera-energy.com – Managing Director.