The UK leads the world in offshore wind, and the sector notched up another success late last year when its largest project, Dogger Bank off northeast England, secured its final tranche of financing with nearly £3bn ($3.98bn) of senior debt and ancillary facilities from 28 banks.
As the ink dried on Dogger Bank’s financial close, one of the project’s main shareholders, Norwegian energy group Equinor, switched its focus from offshore wind to another sector with a key role to play in decarbonisation but less of a profile among investors—energy storage.
Equinor bought a stake in Noriker Power, a Gloucester-based developer of advanced battery storage systems, with an option to buy the whole company.
Equinor’s move comes as the need grows for a scale-up of energy storage and other flexibility technologies in the UK’s increasingly renewables-based energy system. Energy flexibility—the ability to shift the time or location of energy consumption or generation— gives the power system the ability to smooth out swings in supply and demand, which become more and more pronounced as variable renewables replace fossil fuel generation.
Substantial investment is needed in the full range of low-carbon flexibility technologies, global climate change consultancy the Carbon Trust says in a new report, Energy system flexibility: Opportunities for Investors, which is supported by Lloyds Bank. These technologies include pumped hydro, clean hydrogen production and storage, demand-side response, battery storage, thermal storage, smart-charging and electric-vehicle-to-grid, and international interconnectors. Investing in these low-carbon forms of flexibility reduces the energy system’s reliance on fossil-fuelled back-up generation and lowers the overall system cost of reaching net zero by 2050.
Great Britain’s energy regulator, Ofgem, and the Department for Business, Energy and Industrial Strategy (BEIS) say Great Britain may need as much as 30GW of low-carbon flexible capacity in 2030 and 60GW in 2050 to maintain energy security and cost-effectively integrate high levels of renewable generation and manage greater demand for electricity, according to a July 2021 policy paper titled Transitioning to a net zero energy system: Smart Systems and Flexibility Plan 2021. To put this into context, current low carbon flexibility capacity on the system is 10GW, with total power generation capacity at around 80GW.
No-regrets investment
Investing in a portfolio of technologies to deliver flexibility is a “no-regrets decision” as it can deliver net savings across the whole energy system of up to £16.7bn/yr, according to modelling undertaken for the recent Flexibility in Great Britain project by the Carbon Trust and Imperial College Consultants.
The savings come from the avoidance of capex and opex on gas-fired generation, reduced reliance on carbon-negative technologies and reduced need to reinforce power grids (although significant carbon capture capacity and grid reinforcement are still required). Failure to capture those savings will ultimately erode the financial benefits for consumers achieved by the impressive drop in the cost of renewables, the Carbon Trust says. “To capture these cost savings, the time to invest in flexibility is now, not after investments in network and generation capacity have been delivered,” it adds.
The need for investment in flexibility is perhaps best illustrated by projections from the electricity system operator, National Grid ESO, on the amount of variable renewable power capacity projected to come into the system as it decarbonises, says Steve Atkins, DSO transition manager at SSE Networks, UK utility SSE’s transmission and distribution arm. Across four scenarios outlined by National Grid ESO, deployment of solar by 2050 ranges from 30GW to 90GW, with installed wind power capacity at 95-160GW.
Similarly, deployment of electric vehicles and heat pumps is expected to increase significantly, increasing the total demand for electricity.
Managing both variable generation and demand requires system flexibility. “We need flexibility to make sure we can absorb that surplus renewable generation and utilise it when there is limited wind and sun,” says Atkins.
Batteries on a charge
Among low-carbon flexibility technologies, battery storage is one technology that has seen rapid progress in recent years. The growing scale of projects, reductions in capital costs and widening access to different flexibility and balancing markets to generate revenue have helped to drive investment.
The increased appetite for investment in the sector is highlighted by the emergence of pure-play energy storage funds in the UK, at least two of which have stock market listings.
The deployment of large-scale assets is gathering pace. In January, Canada-based renewables developer Amp Energy announced plans to install two of Europe’s largest grid-connected battery storage facilities in Hunterston and Kincardine in Scotland, each with a capacity of 400MW. Both facilities are due to start up in April 2024.
Singapore-based energy company Sembcorp Industries is deploying a 360MW battery storage system announced at the Wilton International industrial complex on Teesside in northeast England. The system is expected to supply short-duration storage of around two hours, capable of providing fast-response balancing services to the UK’s transmission system.
“Now, more than ever, flexible energy sources play an increasingly important role in maintaining secure and reliable energy supplies. With a growing reliance on renewables, the UK energy system needs to be flexible and able to respond quickly to changes,” said Andy Koss, Sembcorp’s CEO for the UK & Middle East, when announcing the project late last year.
Only about 1GW of battery storage is operational in the UK, highlighting the need to accelerate deployment. Most analysts put the total pipeline of assets in the planning system or under construction at about 16-20GW, with an acceleration in the number of proposed projects seen last year.
Virtuous circle
Tony Hable, director, infrastructure and project finance, at Lloyds Bank, says appetite among banks for financing battery storage is growing as the focus on ESG moves beyond traditional renewable power assets such as wind and solar farms.
“There has been a fundamental change in the mindset of banks with a renewed impetus to develop senior debt financing solutions that work for all involved, particular in sectors that have traditionally struggled with attracting bank-led finance (battery storage being a key example),” he says.
This mindset, combined with the maturing of the battery market and the emergence of larger-scale assets, is starting to bring finance to the sector. “Albeit there is a lot more we can do,” Hable adds.
Scaling up flexibility requires the creation of a virtuous circle—increasing the scale of projects to reduce costs, which then brings forward an even larger pipeline of projects, the Carbon Trust says.
Revenue streams
Several potential revenue streams are available to flexible storage assets, including price arbitrage via the wholesale power markets—buying power at lower prices and selling when prices rise (see Fig.1). Storage projects can also earn revenue through capacity markets, where the system operator tenders for contracts to provide power needed to keep the system balanced. Capacity markets are technology-agnostic, so they offer potential revenue to a range of flexibility tools including demand-side response, interconnectors and gas-fired generation, in addition to energy storage.
FIG.1: KEY REVENUE SOURCES FOR FLEXIBILITY
| Revenue source | Who can participate? | How do flexibility services participate? | Where to find out more | |
| Price arbitrage | Generating an income through buying energy when prices are low and selling when they are high | Typically, battery storage owners/operators | Through buying and selling energy to the wholesale market | – |
| Transmission level system services | A range of services procured by the system operator, National Grid ESO, to maintain system stability and security | Depends on the service provided | Through procurement processes led by National Grid ESO | National Grid ESO |
| Distribution network system services | A range of services procured by the distribution network operators (DNOs) to manage peak demand and constraints caused by faults | Depends on the service provided | Through procurement processes arranged by the DNO—several use the Piclo Flex platform as a marketplace | ENA |
| Balancing Mechanism | A tool used to balance supply and demand in daily half-hourly trading periods. It is an ad hoc market with no forward commitments | Applies to any business with flexible power that can provide a response within the timeframe. Minimum size is 1MW, but smaller assets can participate via an aggregator | Registered flexibility assets provide their bids/offers directly to National Grid ESO or via an aggregator to participate in each half hour of the Balancing Mechanism | National Grid ESO, Elexon |
| Capacity market | Market mechanism offering a payment for reliable sources of electricity to ensure there is sufficient generation or load management in the system to cope with network stress | It is a technology-agnostic mechanism open to: • New and existing generators • Interconnectors • Energy storage • Demand-side response (DSR) |
Capacity market contracts are issued via an auction, typically 1 or 4 years ahead of capacity need | BEIS |
| Corporate PPAs | Contract typically between an end-demand user and a generation and/or storage asset. The corporate typically pays a fixed or a floor price per kWh generated or exported. This acts as a hedge against volatile energy prices | For flexibility assets, corporate PPAs are typically applied to battery storage projects (either standalone or co-located with a renewable generator) | Corporate PPAs are agreed bilaterally. Storage PPAs are increasingly attractive to end-users who want to match their demand with low carbon energy in real time | – |
Corporate power-purchase agreements (PPAs) with end-users offer another attractive and stable revenue source for storage assets. Under PPAs, which are negotiated bilaterally, the buyer typically pays a fixed or floor price for the energy supplied from the storage asset, enabling the buyer to hedge against energy price volatility and giving the storage asset a stable revenue stream.
Storage PPAs are increasingly attractive to end-users who want to match their demand with low-carbon energy in real time. Bankable PPAs will typically have a robust investment grade counterparty, a length of contract that matches or exceeds the term of the debt on the project and a fixed price element upon which to “anchor” the debt, the Carbon Trust says.
Many investors are familiar with PPAs from the renewable generation sector, where they are increasingly being used by large companies to secure green power for operations at multiple sites. “From an investor perspective, there are three key factors which influence the decision on whether to finance a project and at what cost,” says Hannah Evans, a manager in the energy systems team at the Carbon Trust.
“Mechanisms that allow you to have certainty of the amount and the duration of revenue streams relative to the lifetime of the asset are really important,” Evans adds. In addition, understanding the credit rating of the counterparties providing that revenue certainty and assessing whether the technology being used is proven at the scale it is being deployed at also feed into a decision as to whether to invest and the level of investment, she says.
A Carbon Trust survey of energy and finance professionals found that, for almost all forms of flexibility—excluding interconnectors, which have a regulated income governed by Ofgem— the lack of long-term predictability of revenue streams is seen as a significant barrier to financing.
Risk and reward
While securing fixed revenue can mitigate the risks for investors in flexibility technologies, there is also a need to improve returns on assets to make the sector more attractive.
One way to improve returns is by bundling together, or aggregating, opportunities. The transaction cost associated with investing in individual small-scale flexibility projects is high relative to their potential return, making them less attractive to investors. Aggregating opportunities can be a more attractive proposition for investors and can bring down overall costs.
Co-locating flexibility technologies with generation assets or demand sources can also help, especially with reducing upfront costs such as grid connections. “Considering flexibility as part of a wider project investment rather than in isolation can really help demonstrate the value of that flexibility to the co-located assets,” says Evans.
Pricing in the cost of carbon is also crucial to demonstrating the value and attractiveness of all low-carbon flexibility assets. This is especially important given emissions prices in most traded compliance markets are now hitting record levels, with prices in Europe driven up by recent increased reliance on coal-fired generation because of surging natural gas prices.
Implied carbon costs will become increasingly important in evaluating flexibility projects as energy system operators and other users of the technology start to be more transparent about the carbon footprints of all elements of the system.
The Carbon Trust highlighted well-recognised concerns in the industry about apparent market distortions caused by the exemption from the UK emissions trading scheme of gas-fired engines with a capacity of less than 20MW. This means their carbon emissions are effectively free of cost, potentially handing them a competitive advantage in tenders for flexibility services. Recent capacity market tenders in the UK awarded small gas assets contracts for 615MW, compared with 327MW for demand-side response and 114MW for battery storage. The gas-engine exemption is under review by the UK government.
Early movers
While the battery storage market is starting to mature, other parts of the flexibility sector are in their infancy, making it challenging to prove the technology at scale and therefore to secure financing.
Green hydrogen, which converts renewable power and water to storable molecules via electrolysis, offering a powerful low-carbon flexibility tool, has made significant strides over the last 12 months, with dozens of projects announced. Several dedicated clean hydrogen investment funds have also emerged.
But relatively few projects have reached FID as uncertainty over support mechanisms, and the need for more bankable offtake agreements, makes it difficult to manage risk.
The UK government recently consulted on the design of a contract-for-difference (CfD) for low-carbon hydrogen production, including production from electrolysis and natural gas coupled with carbon capture. The government hopes the CfD model can help to drive investment in flexibility on the scale it has done for offshore wind and other renewable technologies. So far, the inability to de-risk a lot of proposed hydrogen projects means the financing that has materialised has tended to be mostly equity-based rather than debt-based. A successful CfD offering could change that for hydrogen and for other less mature flexibility technologies.
“Energy flexibility is a real opportunity for business, but there is a need for the financial sector to take a lead role in supporting the flexible solutions, both through the early development stage and as it scales up,” says Jonas Persson, head of sustainability and ESG finance at Lloyds Bank.
“We have seen this work amazingly well for our domestic offshore wind sector, where the UK government supported through CfDs. This wonderfully simple but very effective mechanism has provided certainty of revenue streams. And to note, banks love this certainty,” says Persson.
For hydrogen and other flexibility technologies, there is a pressing need for investment in the enabling infrastructure as well as the main assets. Domestic demand-side response requires smart meters. Electric-vehicle-to-grid and smart-charging need a charging network.
Investing in these forms of enabling infrastructure is crucial to many forms of flexibility, the Carbon Trust says. “From a financing perspective, the smart meter rollout is an example of where a clear requirement for installation (from government) and the ability to invest at scale (in a wide-scale rollout programme) has delivered bankable opportunities for the private sector to raise finance,” it says.
Communicating the opportunity
Mobilising the investment needed in all flexibility technologies and their enabling infrastructure will require lots of communication between the energy and finance sectors, and with the government and Ofgem, the Carbon Trust’s report says.
“Realising this opportunity will require stakeholders from the finance sector, industry and the UK government to work together to ensure the value of flexibility is recognised and rewarded at a project level, and that appropriate financing sources are readily available,” the Carbon Trust says. It calls on the finance sector to provide leadership in communicating flexibility related opportunities available to the industry and to support their realisation.
Novel financing structures may be needed if the risk of investment remains too high for some forms of debt financing. Blended finance structures, using government-backed funding to leverage private investment, could bridge the investment gap and may open up new sources of finance and reduce overall cost, the Carbon Trust says.
“Banks and finance providers need to show their willingness to be involved, and the way to do that is quite simply through communication,” says Hable from Lloyds Bank. “The onus should be on banks and finance providers to be speaking to their clients and prospective clients to understand what it is they are trying to do. We absolutely cannot underestimate the effectiveness of two-way communication in emerging sectors.”
To read the Energy System Flexibility: Opportunities for Investors report and watch the webinar, click here.
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