10 minute read 19 May 2020
Offshore worker standing on helipad with wind turbines behind him in sunset

Why battery storage must be at the heart of the low-carbon transition

By

Ben Warren

EY Global Power & Utilities Corporate Finance Leader

Adviser on procurement, regulatory policy and mergers and acquisitions across the entire energy, waste and water value chains.

10 minute read 19 May 2020

Utilities and developers are ramping up investment in large-scale batteries for storage – but will capacity be there when it is needed? 

This article is part of the 55th edition of the Renewable Energy Country Attractiveness Index (RECAI)

The growing reliance on energy sources such as wind and solar to decarbonize electricity grids brings with it a particular challenge: the need to match demand with intermittent supply.

Around the world, utilities, regulators and investors are pursuing an “all of the above” approach to building up the flexible capacity needed to meet demand: encouraging distributed solar and behind-the-meter batteries; looking to electric vehicle fleets as a source of flexible demand and supply; and encouraging investment in demand-side response technologies that can power down non-essential equipment at times of high system load or power up standby generation when grid prices peak.

A critical piece of the flexibility jigsaw, however, will be utility-scale storage. Energy storage at the multi-megawatt scale is needed to meet residual demand peaks, give incremental energy output, shift energy across time and locations, and provide real-time grid balancing.

Approaching a cliff edge

At the moment, electricity systems are reasonably well able to manage volatility in the energy market introduced by the current level of deployment of renewables. As we move toward zero-carbon electricity systems, a cliff edge is approaching where we will need very large volumes of storage capacity to manage that intermittency.

The challenge is that there are not sufficient economic signals today to incentivize investment in the volume of energy storage we will need in the future.

While there are a number of long-standing storage technologies, such as pumped hydro, and some emerging technologies, such as compressed air or stacked concrete blocks, the majority of investment to date has been directed toward large-scale lithium-ion batteries, such as those found in electric vehicles, mobile phones and laptops.

Uptake of the technology has been driven by dramatic cost reductions. Bloomberg New Energy Finance calculates that the cost of lithium-ion batteries fell by 85% between 2010 and 2018, and costs are expected to fall a further 50% by 2030. This will underpin growth in capacity from 9GW/17GWh in 2018 to 1,095GW/2,850GWh by 2040 – a 122-fold increase. This growth will require investment of US$662b.

While there are a number of long-standing storage technologies, such as pumped hydro, and some emerging technologies, such as compressed air or stacked concrete blocks, the majority of investment to date has been directed toward large-scale lithium-ion batteries, such as those found in electric vehicles, mobile phones and laptops.

In the near term, the COVID-19 pandemic and any subsequent recession will crimp that growth, according to research by Wood Mackenzie. It is now forecasting the installation of 12.6GWh of battery storage this year, down from a pre-COVID-19 forecast of 15.6GWh. This would still make 2020 a record year for energy storage growth, however, and the company still expects to see a 13-fold increase in capacity, to 230GWh by 2025. 

Maximizing the value of batteries’ ancillary services

But the successful development of the volume of utility-scale storage needed will be challenging. It will require the right market conditions and, particularly, for the various functions that each individual battery can perform to be incentivized, valued and monetized properly. The functions that battery storage performs fall under four main categories.

Batteries can offer ancillary services, such as regulating the frequency and voltage of power grids. These services used to be provided by thermal power plants and can’t be supplied by renewable energy capacity. Providing these services can be lucrative; the UK’s frequency-response market helped to incentivize the significant growth of batteries in 2018, when 460MW of battery storage was commissioned.

However, these markets tend to be shallow, notes Richard Braakenburg, Managing Director, Investments, at Switzerland-based investment manager SUSI Partners, which manages a €252m energy-storage fund. “They can be quite quickly saturated and subject to price cannibalization,” as was seen in Germany’s frequency reserve market, the PJM Interconnection, and in the UK.

“The challenge is to build up a revenue model that provides for access to deeper and more liquid markets, and has some form of downside protection,” Braakenburg says.  

Some of that protection can be found by installing batteries alongside renewable energy plants, allowing the project to store generation when demand is low, and dispatch it at times of higher prices. Such hybrid projects can improve the economics of both the battery and the generating capacity.

“Combining renewables generation with energy storage means that each component balances out the weaknesses of the other,” says Toddington Harper, CEO of Gridserve, a developer, builder, owner and operator of solar and battery hybrid systems. 

The challenge developers face is that there is not sufficient clarity of revenues … there is really no visibility of what the market will support beyond the next five years.
Barney Wharton
Director of Future Energy Systems, RenewableUK

Batteries can be also used in place of expensive peaking plants, providing short-run capacity at times of high demand. Last year, for example, utility Southern California Edison announced that it was to replace a 262MW gas peaker plant with a portfolio of 192MW of lithium-ion battery projects. They can also be used to defer or avoid expensive upgrades of transmission and distribution capacity, at locations where the grid is constrained.

Finally, batteries can provide bulk energy services – allowing traders to arbitrage between periods of high and low power prices, and, ultimately, managing the longer-term shifting of supply from renewables from periods of high supply and low demand to times when demand is high.

In most advanced markets, batteries are being deployed that can deliver against one or more of these objectives.

Economic incentives to develop storage are lacking

In most markets, however, development is taking place on an ad hoc, opportunistic basis. This makes it difficult for the owners of individual batteries to be compensated for all the services that each battery can deliver.

Currently, no market is sophisticated enough to incentivize properly, on an economic basis, the development of storage when and where it is needed. Regulatory regimes are not sophisticated and open enough to enable a battery owner to pull and push the levers of operating a battery in a way that enables them to fully optimize the value of their assets. 

Although there is a clear market price now for some of the services batteries can provide – such as grid balancing, fast frequency response and short-term capacity provision – other elements of their value are not evident, or at least not given an economic value.

A starting point for regulators is to set out how much storage will be required in an energy market to create the necessary system stability, and by when. That required deployment curve will be driven by factors including the retirement of thermal power generation and the penetration of new renewables. Some US states have started on this process; seven US states have set out targets that add up to 7.6GW by 2030, according to the Energy Storage Association.

“The long-term market for batteries is something that investors are still trying to get their heads around,” says Barney Wharton, Director of Future Energy Systems at trade association RenewableUK. “The challenge that developers face is that there is not sufficient clarity of revenues – while they see opportunities today, there is really no visibility of what the market will support beyond the next five years.” 

Regulators also have to be clear about which of the functions, above, specific battery-storage assets will be required to meet.

The difficulty here is that, although there is a clear market price now for some of the services batteries can provide – such as grid balancing, fast frequency response and short-term capacity provision – other elements of their value are not evident, or at least not given an economic value.

It’s a bit like the smartphone. Manufacturers knew that people would pay to make calls on them, but they had no idea of the actual value they could generate once an entire ecosystem of apps and new business models had emerged.

Struggling to determine where the value lies

To try to address some of this uncertainty, governments should look to set up infrastructure storage programs on a public-private-partnership basis. Such partnerships would allow grid operators to use the infrastructure procured to meet their needs in future, rather than asking developers to develop assets on spec.

Another element that would support battery rollout is “priced locational signals,” says Mark Simon, CEO of Eelpower, a developer, owner and operator of battery storage systems. “We need two things from grid operators: to be told where the pressure points are, and to be appropriately incentivized to put batteries there.” Such targeted charging can relieve pressure on electricity grids that, in the past, would have been alleviated by transmission operators putting in additional power lines “at enormous cost. Now, we can put in a battery that can balance that part of the grid second by second.”

Utilities and power traders are finding novel ways of generating value from batteries in existing markets. For example, utilities are turning to batteries to trade in very short-term balancing markets.

Others, however, argue that the best thing for the market would be for regulators to simply level the playing field and step away. “Constant change in the market is difficult,” says Harper, at Gridserve, noting that, in the UK, the regulator Ofgem “constantly reviews and often implements new regulatory approaches, which means developers and investors are forced to constantly review, and sometimes reinvent, business models, and this often leads to delays in delivering projects.”

“The advantage we have now is that batteries are low-cost and renewables are low-cost,” he continues. “If you combine the two, you should be able to outcompete more carbon-intense alternatives … We can get to net zero by 2050, provided we can keep delivering, and provided market distortions are removed.”

Certainly, utilities and power traders are finding novel ways of generating value from batteries in existing markets. For example, utilities are turning to batteries to trade in very short-term balancing markets.

“The 15-minute window before delivery is the area where batteries can arbitrage power prices, selling power at times of high pricing, but also getting paid to take power at times of high supply and negative pricing. That’s where we’re seeing the emergence of sophisticated, software-driven platforms that look to optimize battery assets,” says Grant Brennan, a senior manager at Ernst & Young LLP in the UK. 

Harnessing the advantages of scale

This is where Braakenburg, at SUSI Partners, sees the opportunity for utility-scale batteries. Participating in very short-term merchant power markets gives batteries access to “gigawatt, as opposed to megawatt, hours of liquidity,” with transparent pricing compared with the “black-box processes for determining capacity or frequency response market prices,” long-term pricing history, and multiple offtakers, including utilities, power traders and, increasingly, oil and gas companies diversifying into power markets.

Simon, at Eelpower, sees portfolios of batteries being aggregated and operated to give grid-level balancing services. “There is a great opportunity for aggregators to bring together large platforms of batteries that they own, manage and optimize, lending those batteries into the marketplace to deliver the balancing services necessary,” he says.

The risk here, however, is that the market does not build capacity at the rate needed to match longer-term need. “The problem with market forces [alone] driving the battery storage market is that it’s currently an inch at a time,” says Brennan, at EY.

He adds that this is the dilemma faced by the growing number of established renewable energy investment funds that are eyeing investments in the market, partly as a hedge against the future cannibalization of power prices that might be caused by growing volumes of low-operating cost renewables coming to market: “However, the question is, when is that power-price inflexion point? When will the economics stack up enough for them to make the returns they will need to justify the investment?”

Every country is different regarding the battery business model. With solar, 90% of the things you learn in Germany, you can apply to the Netherlands. With batteries, it’s more like 50%.
Sebastian Gerhard
Director, Batteries, Vattenfall

Regulators could play a pivotal role

Regulatory tweaks could help spur faster growth, argues Sebastian Gerhard, Director, Batteries, at Sweden-based power and heat utility Vattenfall. One of the most significant would be to incentivize – or mandate – data centers to use batteries rather than diesel generating sets to provide back-up power. Doing so would reduce these data centers’ annual carbon emissions by at least 50%, Gerhard says.

“The problem is that reliability is key for them; they are very used to using diesel gensets, and no-one wants to take the first step,” he adds. “But data centers are growing dramatically, with 20GW of new-build data centers in Europe over the next five years. You could easily require them to use batteries and reduce their carbon footprints.”

Given that these data centers need back-up capacity at least equal to their total usage (some also factor in significant redundancy), this would create a substantial additional market for batteries.

International players such as Vattenfall face additional challenges in working with different regulatory regimes that share far fewer characteristics than other clean-energy schemes. “Every country is different regarding the battery business model,” Gerhard says. “With solar, 90% of the things you learn in Germany, for example, you can apply to the Netherlands. With batteries, it’s more like 50%.” 

He concedes that regulators, too, have to learn quickly. “Power-market regulators used to be able to take five to 10 years to make progress. With batteries, it needs to come much faster. “Governments are getting quicker, and they are working more closely with industry – but, with batteries, we’re still on the edge of innovation.”

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Summary

Investment in large-scale batteries for storage is on the rise as electricity grids decarbonize. Successful development of the volume of utility-scale storage needed will be challenging, however, and will require the right market conditions. Particularly, it will need the various functions that each individual battery can perform to be incentivized, valued and monetized properly.

About this article

By

Ben Warren

EY Global Power & Utilities Corporate Finance Leader

Adviser on procurement, regulatory policy and mergers and acquisitions across the entire energy, waste and water value chains.