UK battery vs pump storage margins

Battery investment momentum is surging in 2020. This is not the result of any specific market or policy related boost for storage economics. It appears to be a more organic ‘tipping point’, where investors are recognising the scale of the role storage will need to play to support decarbonisation.

“Battery returns, driven by price volatility, have stood up relatively well across the Covid-19 period.”

The UK is currently leading the push for storage deployment in Europe. This is the result of improving policy clarity and a relative maturity of the revenue streams that drive the battery margin stack (wholesale, balancing, ancillaries, capacity & network related).

Momentum is now also building behind battery investment in NW Europe (e.g. Germany, Benelux & France) and Southern Europe (particularly batteries co-located with solar in Spain & Italy).

While there is a broad range of battery investment cases, most are underpinned by wholesale & balancing market revenue streams. And a key challenge investors are facing is the absence of a clear performance track record in these markets, given battery deployment is relatively new.

In today’s article we look at some empirical evidence on storage value capture. Our analysis shows a UK market case study comparing wholesale & balancing revenue capture of shorter duration batteries compared to longer duration pump storage.

But first we start with a bit of background on the practicalities of battery monetisation in the UK.

To BM or not to BM

UK battery operators currently face an important choice as to how they monetise their asset. The dominant monetisation strategy currently, is focused on optimisation of batteries across wholesale market and NIV (Net Imbalance Volume) chasing (trying to forecast system imbalance in order to generate positive cashout revenues).  This income is supplemented by FFR revenues (from the main frequency response market), other ancillaries and network related benefits.

NIV chasing has been an attractive strategy given revenue is supported by volatility of ‘sharp’ cashout price signals. However UK battery monetisation strategy is set to change. Increasing volumes of batteries and engines are chasing relatively small net imbalance volumes. This increases cashout price forecast error and reduces expected returns from NIV chasing.

As a result, battery operators are shifting their focus to the Balancing Mechanism (BM).  Policy changes (e.g. Project TERRE and the introduction of Virtual Lead Parties) are making the BM more accessible to a range of flexible asset owners.  And it is likely that within two or three years, the majority of UK batteries will transition away from NIV chasing to participate directly in the BM.

The BM is a ‘paid as bid’ market. In other words, assets submit bid prices (at which they are prepared to reduce output) and offer prices (at which they are prepared to increase output).  So price risk from a NIV chasing strategy is replaced by volume risk in the BM, given an operator does not know in advance whether bids and offers will be accepted.  The challenges around Gate Closure management for shorter duration batteries mean that some operators may choose not to remain focused on NIV chasing.

Projecting storage revenues in the BM requires complex analysis.  This means that benchmarks for achieved historical revenues are even more important.

A case study on wholesale & BM storage margins

Chart 1 shows an analysis of achieved storage margins and cycling performance for 3 assets across Winter 2020:

1. Arenko’s 41MW Bloxwich battery
2. First Hydro’s Dinorwig pump storage asset in Wales (wholesale & BM focused units only)
3. Drax’s Cruachan pump storage asset in Scotland

The left hand panel shows annualised average energy margin (wholesale + BM) in £/kW for the three assets.  The Bloxwich battery and Dinorwig pump storage assets have very different configurations. But they earned similar energy margins across last winter ~40 £/kW. However the shorter duration of  batteries mean that margins are significantly more weighted to BM returns than wholesale. Note – these numbers do not include other revenue streams such as capacity, ancillaries and network related revenues.

The much higher returns for the Cruachan Scottish pump storage asset reflect significant BM constraint payments across the winter. Storage is being paid to ‘soak up’ excess wind output that would otherwise need to be curtailed given transmission constraints to flow power south from Scotland to demand centres in England.

The right hand panel shows average daily cycling performance across the 3 assets. There is a clear relationship here to duration (number of hours to discharge storage from full). The shorter duration of the battery (a little under 1.5 hours) results in much higher average cycling rates, versus longer duration pump storage (Dinorwig ~5 hours and Cruachan ~16 hours).

Historical versus future revenues

The Covid-19 shock across Mar-May 2020 is providing an interesting insight into the future. The sharp reduction in demand across the last 3 months has substantially increased the market share of intermittent wind & solar output in the UK energy mix.

The higher renewables share has pulled down the absolute level of power prices.  But it has also resulted in periods of significant price volatility that benefit flexible assets such as batteries. Battery returns (driven by price volatility) have stood up well across this period relative to assets more exposed to power price levels.

That said, there has been ongoing frustration amongst battery and engine owners as to National Grid’s relatively low utilisation of smaller scale flex assets in the BM.  Personnel, systems & processes at the System Operator have historically been focused on dispatch of large transmission connected CCGT & coal plants.

Grid appears to be facing challenges in adapting its capabilities to fully capture the benefits of newer sources of flexibility. But these BM dispatch issues are transitionary in nature and should be resolved across the next 1 to 2 years. That should pave the way for significantly higher battery BM returns going forward as intraday price shape and spot volatility rise in response to the UK’s changing capacity mix.