How long will fossil fuel-generated electricity remain a critical part of our electrical systems? That is the question for those seeking to predict the pace of the global energy transition. Electricity generated from wind and solar has grown dramatically over the past decade and is already cheaper in some cases on a per unit basis than coal-fired electricity or even electricity generated from natural gas. But fossil fuel-generated electricity may remain "in the mix" in many jurisdictions for decades to come. Partly this stickiness results from the long operating life of previously installed capacity, but it is also because fossil fuel-generated electricity can provide "on-demand" power in a way that wind and solar-generated power simply cannot – unless the wind is blowing or the sun is shining.
For jurisdictions that do not benefit from extensive hydroelectric power generation or a taste for nuclear power, there is a point beyond which intermittent sources like wind and solar cannot grow without threatening system stability. Solving this challenge would unlock the next phase of the energy transition by accelerating the phase-out of fossil fuel-generated electricity.
There are many partial answers to the intermittency challenge, but the game-changer in this space will be the massive expansion of industrial-scale and distributed energy storage to smooth the availability of intermittent energy sources like wind and solar. According to BloombergNEF, installed energy storage projects are expected to grow more than thirty times over the coming decade, exceeding a terawatt-hour of cumulative installed capacity by 2030. Many things will need to go right for energy storage to scale to this point, where it can accelerate the energy transition. Nascent technologies still need to mature. Regulators must work out how best to integrate energy storage into existing regulatory frameworks, provide appropriate incentives and remove roadblocks. And commercial teams will need to address new risks and develop new commercial structures to facilitate the financing and construction of energy storage projects.
This bulletin explores this changing landscape, first by briefly reviewing the range of evolving energy storage technologies, then considering key questions for energy regulators, and finally considering some of the commercial challenges that need to be addressed in energy storage projects and transactions.
Energy Storage – Something Old, Something New
The energy storage industry ranges from mature, well-established technologies to transformative technologies that fall decidedly early on the innovation and adoption curve. As a result, it may be a mistake to look at energy storage as a single industry. Different contexts demand different technological approaches. Some technologies are better suited to stand-alone energy storage projects, others to co-located projects (e.g. solar + storage) and still others may be more appropriate for "behind the meter" projects for industrial operations.
When considering the range of energy storage technologies available, it is worth thinking about the different jobs that energy storage can be called upon to perform. While one of the most critical jobs for energy storage is to address the variability of generation associated with wind and solar-powered electricity, this is not the only job. Energy storage can provide other valuable benefits as well, ranging from providing ancillary services (e.g. frequency response), enhancing system resiliency without the need for costly transmission upgrades, and addressing peak demand at a lower cost than constructing new generation.
Prominent energy storage technologies include the following:
- Pumped Hydro Storage
Pumped hydro is a mature technology, and is also the most widely-installed type of energy storage. In the typical pumped hydro project, water is pumped uphill using electrical pumps when energy demand is low. That water is stored in a reservoir until it is needed. When energy is needed, the stored water is released through turbines, generating electricity.
- Mechanical Storage
Mechanical storage takes a number of different forms. Some projects use cheap electricity to spin up flywheels, storing rotational energy until it is needed. Other types of mechanical storage rely on technologies such as compressed air, running electrical compressors while electricity is readily available and then releasing the compressed air through turbines when it is not.
- Battery Storage
Fewer than 10 years ago, it wasn't clear that large-scale batteries were going to play a vital role in decarbonization, but the technology has evolved to the point where battery electric storage is now the most promising path toward large-scale and ubiquitous energy storage.
Battery technology continues to evolve rapidly. Different lithium-ion battery chemistries are emerging that are more appropriate for stationary, utility-scale installations, while other more exotic battery chemistries are on the horizon. Emerging technologies, such as flow batteries, which pump liquid materials that interact across a membrane, also hold promise. Although flow batteries typically are less energy-dense than solid-state batteries, they can hold a charge for longer, with reduced risk of degradation over time.
Regulatory Issues in Energy Storage
As utilities in Canada consider battery and other energy storage projects, there are a number of key questions facing Canadian utility regulators. Resolving these issues will be critical for the widespread adoption of energy storage solutions, especially in light of the potential for growth in battery storage solutions:
- Regulatory Characterization
The first and most basic question is how to characterize energy storage facilities for regulatory purposes, which sometimes act as loads and at other times act as generators. This unique combination is hard to square with many existing tariffs and interconnection arrangements, resulting in a lack of clarity in their application and a potential need for updates to account for this emerging technology.
A number of regulators are taking steps to remove barriers to the participation of electric storage resources. For example, Federal Energy Regulatory Commission (FERC) issued Order 841, which is intended to remove barriers to the participation of electric storage resources. Specifically, FERC Order 841 requires regional transmission operators to revise their tariffs to establish a participation model consisting of market rules that, recognizing the physical and operational characteristics of electric storage resources, facilitates their participation in regional markets. And the Alberta Electric System Operator (AESO), which manages and operates the provincial power grid, has published an Energy Storage Roadmap, which sets out the AESO's plan to facilitate the reliable integration of energy storage technologies into AESO authoritative documents and the AESO grid and market systems.
- Regulatory Incentives
Government incentives and mandates to develop energy storage, including the provision of funding and energy storage mandates for public utilities, could have a significant impact on the development of energy storage.
A number of US jurisdictions, in particular, have put in place ambitious energy storage targets. California's targets are among the most expansive. The California Public Utilities Commission has issued an order requiring three investor owned utilities to procure 500 MW of energy storage. That mandate built on a previous standard requiring utilities to procure 1,325 MW of storage by 2020. On the other side of the continent, New York state has set a target of 1,500 MW of energy storage by 2025, and 3,000 MW by 2030. Some states are now also requiring utilities to include energy storage in their integrated resource plans.
- Effects on the Grid and Capital Project Requirements
In addition to ensuring adequate on-peak resources and reducing or eliminating the need for peaking facilities, energy storage can reduce costs to public utilities by deferring or avoiding the need for costly transmission and distribution upgrades, resulting in potential cost benefits to customers. Energy storage may also have a role to play in supporting grid resilience, an issue that has received increased attention in recent years as a result of large outages caused by weather events. Energy storage may have the potential to reduce the impact of power outages in these instances, provided it is energized and available close to the demand.
- Load Defection from Behind-the-Meter Storage
At the same time, energy storage at the consumer level could result in significant changes to household usage patterns that may affect the economics of public utilities – and in extreme cases threaten their viability. Declining costs for solar power combined with behind-the-meter energy storage could mean that grid-connected solar-plus-battery systems will be economic for many customers. One result of that development may be lower GHG emissions, but another would be a significant decline in energy sales for public utilities. If households become more energy independent, the presently enjoyed benefits of resource sharing provided by public utilities could be eliminated.
- Vehicle-to-Grid Charging
Electric vehicles (EVs) have received a great deal of attention in recent years. In a regulatory context, most of the attention is related to the expectation that EVs will significantly increase electricity demand. But EVs may also provide opportunities for energy storage through vehicle-to-grid charging. EV batteries could be used as storage of off-peak energy for the grid, and then used to provide energy when the EV is not in use. Vehicle-to-grid charging represents an interesting example of some of the scale effects of energy storage that may be challenging for energy regulators. Though it would have only a limited impact in early stages of adoption, when implemented broadly vehicle-to-grid charging has the potential to have a significant impact given the anticipated scale of EV adoption and its distributed nature near load centres. This could in turn impact on the economic viability of centralized storage technologies with higher capital costs.
Transactional Considerations Relating to Energy Storage
As commercial teams work to develop and bring battery storage projects online there are a number of key issues driving project and deal risk that must be managed to ensure a successful transaction. Unique aspects of storage technologies and the novelty of the commercial arrangements mean traditional lending and contract models must be adapted.
- Merchant Models and Revenue Stacking
Depending on the market, merchant Front-of-the-Meter storage (those relied on by utilities, not individual customers) typically has multiple revenue sources from grid balancing services and wholesale market arbitrage, rather than a single long-term power purchase agreement or electricity supply contract of the type seen in Behind-the-Meter projects or renewable energy generation. This reduces the certainty of contracted revenue, making due diligence and cash flow modelling more complex. These factors initially inhibited senior debt funding of projects, although the battery project finance market is now opening up rapidly as the revenue stacks are better understood and the regulatory landscape evolves.
- Revenue Optimization
A complex revenue stack puts more emphasis on revenue optimization and the terms of the revenue optimization agreement. Revenue optimizers are responsible for managing the storage and offer a range of services including market access, optimization of market selection, submission of bid and offer pricing into a range of markets and the physical dispatch of the storage. For batteries, it is important that they not be incentivized to operate the battery in a way that negatively impacts its long-term degradation profile through cycling loss. In some cases, the equipment supplier will also be appointed as a revenue optimizer, ensuring that it is incentivized to manage the charging and discharging profile of the battery within the qualifying parameters of the performance warranty.
- Debt Covenants
Revenue stacking also necessitates more flexibility for permitted uses of the asset in debt covenants than would typically be seen in infrastructure project finance facilities. This may complicate the negotiation of standard form infrastructure debt documentation that has not been adapted for battery energy storage systems (BESS) projects.
- Concentration of Value in Batteries
The costs and risk of a BESS project are concentrated on the batteries themselves, with the limited balance of plant and civil work. The duration and scope of the warranties for the batteries (covering both system availability and retained energy percentages over the expected operational lifecycle of the project) are therefore crucial value points for any battery storage transaction.
- Supply Chain Issues
Many of the components for lithium-ion battery systems are manufactured in Asia, with a long supply chain to Europe and North America. Supply contract lead times, therefore, need to be carefully negotiated and factored into project timetables, with liquidated damages or delay in start-up insurance put in place to mitigate any construction or commissioning delay caused by supply chain issues.
Energy storage holds much promise in unlocking the next phase of the energy transition and solving the intermittency challenge. Emerging technologies and new commercial paradigms generate their own challenges though, as regulatory frameworks evolve and commercial structures adapt. Regulators and governments can play an important role in facilitating and supporting energy storage as a solution, but project and commercial teams have a role to play as well in resolving emerging issues. With the focus on the energy storage market right now, we expect a period of rapid change on the regulatory and commercial fronts. We're certainly charged up about it!
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