Listen in as Gowling WLG chats with leading global infrastructure and renewables market analysts Inspiratia about the revenue landscape for UK battery storage.

The manner in which - and the related business models under which - income streams supporting UK battery storage project development can be accessed remains central to deployment.

The saturation of frequency response and uncertainty around the capacity market have brought merchant trading strategies into sharp focus, and many of the aggregators are now developing new propositions to access the balancing mechanism.

However, the long-term regulatory picture is one of uncertainty, which could threaten the industry's access to cheap capital that is likely required to deliver gigawatts of battery capacity.

To discuss the market landscape, Energy Partner Gus Wood sat down with Inspiratia, and Joe MacDonald, vice president of sales at UK aggregator Limejump, focussing on:

  • Revenue oversaturation and stacking - 01:10
  • Capacity market suspension in the context of wider energy policy uncertainty - 07:19
  • Ofgem's targeted charging review - 16:59
  • Merchant business models and investment landscape for batteries - 19:29


Hello and welcome to the second episode of Inspiratia, Battery Storage webcast series in partnership with the law firm Gowling WLG. I am Alex Blackburne, Inspiratia head of renewables and joining me for Episode two with Gowling Energy partner Gus Wood and Joe McDonald, Vice President of sales at UK Aggregator Limejump. The conversation took place in early February at Gowling's London Bridge offices at a time of significant uncertainty in the UK energy sector, in particular for distributed generation. This uncertainty came to a head at the end of 2018 when the EU ruled that the UK's capacity market was illegal on state aid grant. The capacity market is now suspended indefinitely. Gus and Joe shared their views on the implications on the capacity market situation and battery storage and also talked about a range of other policy developments including Ofgem's targeted charging review. We join the conversation with Joe reflecting on the firm's frequency response market or FFR which no sooner had it become investable for batteries became over supplied forcing the price crashing down.

Joe McDonald: Taking a look at price first of all we were winning contract for a round about £19 a Megawatt hour so that equates to around £160,000 a battery storage unit. That was in 2016 around February time. Today we are closer to £7 so we can already see certainly there has been some saturation in price. There is a link there, for example with the number of bids. Again if we look in 2016 you had about 15 active bids going in at one time for market contracts whereas in December 2018 again for the long term markets you had 400. So we are seeing that saturation. We have not seen a huge change in the available volume so it is more people bidding for the same amount of volume.

Alex Blackburne: To reflect on something that happened last year Limejump became the first aggregated to answer the balance in market with the virtual power plan of the batteries and demand response sites. How significant was that? How easy for the distributor generation to access the balancing?

Joe: I guess linking to the previous question we had to look to stack revenues especially if you brought a single saturated market and there was a view that the balance mechanism would be a perfect market for that. It was quite historic. It is the first time a non-transmission connected asset has entered into the balancing mechanism. Obviously the balancing mechanism itself is one of the most lucrative markets available. Traditionally obviously dominated by big power stations. So for us it was obviously a key target for us to complete what we would call a virtual power station because now we can access all of the same markets that a standard power station would. It is not super easy. You have to still be a fully-fledged supplier with a supplier licence. The lead is still three to four months. Once you become a supplier so you would add another six to nine months on top of that and there are technical challenges about certainly how you bring distributed assets into and replace what a traditional power station would have been so there is quite a lot of technical challenges we have to go through. I think generally from where we sit today even the combination of stacking is not quite where it neds to be so as of today you can now stack the balancing mechanism revenues for some hours and then in separate hours do frequency response. That was not even possible six months ago but in order to do so you have to have your contracts with the same party now so you cannot have a contract either director or with another supplier for the BM and then with a FFR you have to combine those. It is a little bit limited of choice for the customers and then on top of that you have certain restrictions for example on how you can bid because your single BMU needs to now bid as one single price into the market so we have now one from perhaps a model where lots of different customers under the Limejump umbrella are setting the prices they want to achieve going into an FFR market, they are now forced to almost collaborate on price and bid in to the National Grid which again a huge change and one that is a slight barrier for most investors who want to, obviously, have individual bids priced according to their needs.

Gus Wood: But what Limejump has done around balancing mechanisms has been really exciting. I think one of the positive regulated changes we are going see coming through during the course of 2019 is around access to the balancing mechanism by distributed generation, a combination of what is often referred to as Project Tear which is an EU driven project but one that National Grid have taken up and will continue with regardless of continuing membership of the EU and which will introduce virtual lead parties a recognised class of BSC party and enable those people to bid in to the balancing mechanism in a way that was not previously available to distributed generators and this has been badged as one of those instances in which the National Grid is rebalancing the position between distributed generation and transmission connected generation in a way which equalises it in a sense of improving the position of distributed generation giving them access to a revenue stream that would not otherwise be available to them. So that is a positive in terms of regulatory change but it is not necessarily a guarantee of income it is just another means of accessing that income.

Joe: It comes with actually interesting nuance because a virtual lead party does not need to be a supplier and I think there is a slight shift already in the view that where we are seeing market entry for normal suppliers being scrutinised at the domestic level, obviously suppliers going bust, virtually parties do not need to meet all of the strict regulations that a supplier would. There is quite a lot of blurred lines between the reconciliation between your supplier who will invoice you and then your aggregator or third party or perhaps even another supplier who does not have to disclose who they are to your current supplier for example or current PPA provider. That virtually party is going to be very interesting on things like reconciliation, what kind of penalties can be charged against them, even things like credit checking and making sure that they are facing the right kind of penalty should they fail to perform on the BM. Simply said a supplier today, if they do not meet the requirements of the balancing mechanism they can have their entire supply licence revoked. That is a huge penalty, one that will keep you on the straight and narrow. If you do not have one, what is the worst you can face? So it is quite an interesting dynamic about bringing these to smaller and wider access but it is quite a positive thing, more liquidity in that market is going to be far greater for everyone.

Alex: Moving on to another revenue stream that has been a critical part of the battery markets and via the capacity market. Obviously it was only in the last couple of months that is has been suspended indefinitely I guess at this point.  My understanding is that a lot of investors, asset owners use the capacity market as a peg to hang their debt financing on. Obviously if that is their strategy... just interested in both their views on how significant the news was before Christmas about the suspension and what you think will happen.

Also as a secondary question just what the impact will be on batteries in the short term?

Gus: Sure. It was definitely a shock to everyone in the industry. The challenge had been ongoing for a number of years but obviously the outcome was not known and when it came through I think it was a surprise.
What it means in legal terms because the 15 year customer market contract were not available to demand site response and because the courts found that the EU Commission did not give sufficient consideration to whether that was an appropriate distinction to be made then on the back of that the scheme was held to be illegal state aid so it is as you say suspended pending outcomes. Currently the Commission are appealing that decision. Unfortunately it does create a huge amount of uncertainty in the market as to whether ultimately it will found to be illegal and therefore a different scheme would need to be creates or whether the Commission will be successful and the appeal overturned so in the short term it is very frustrating and confusing for everyone involved.

Having said that from the perspective of batteries the de-rating factors that apply to batteries most recently made it a relatively unattractive proposition for batteries anyway so in the case of batteries you might say that it is not a problem; the lack of the capacity market. I am sure that Joe will comment on this further but an economic view might be that there is a need for that capacity and it needs to be rewarded in some way so that reward in the absence of the capacity market there will be higher prices or higher payments under other types of balancing service such that the economic case remains broadly the same and it is just coming through a different stream. Where that does make a difference though is around the nature of that whereas the capacity market was a long term revenue stream if you were even to access it. The other alternatives where that economic benefit might come through in spot power voices that they are not long term and therefore that presents a difficult position for different funders depending on their risk appetite.

Joe: Yes I think that I would reiterate that. What we saw is that de-rating factor which effectively brought them down to close to a third of the original value and that capacity market as a stack value only represented at the time maybe 10-12% of the total revenue stack. The de-rating factor was the thing that took the wind out the sales of batteries in the capacity market. Therefore in an economic basis it did not make a huge difference it being suspended but it undoubtedly has impacted investment. When you have got something that is a government backed subsidy, in the midst of everything else we are probably going to discuss today when that is suddenly suspended out of the blue effectively when it was not deemed a high risk by anyone including National Grid that throws up a lot of uncertainty for investors so new projects when they were being looked at for the market we saw projects simply being pulled, not because the economics do not stack up because there was just no faith that there is future revenue streams that are predictable for these assets so that was quite interesting. Absolutely for our current battery portfolio's and perhaps for those that are going to arrive in the next couple of years value distribution is very likely. Somehow they will have to spend the money to ensure that there is a reinforcement of the grid in their spare capacity in reserve. Whether that will be a reconstruction of the capacity market which I think we might touch on or simply it is put into other revenue streams like the balancing mechanism. We are pretty certain that batteries who were hugely successful in the outcome of the capacity market anyway will likely have a better scenario when this comes back around but as I said in the meantime it just creates a lot more uncertainty unfortunately for investment.

That regulatory uncertainty there is a really important point because the energy market has been beset by regulatory change in recent years and whereas perhaps levy exemption certificates and climate change levy that was perhaps seen as a one-off it was all sorts of tax and it was an anomaly that was not going to happen again. What we have seen in recent years is there has been a lot of change around the charging frameworks so the changes to the trial benefit related to [charging by National Grid that was a significant detriment to all distributed generation projects and something that participants attempted to change and had no success challenging and therefore there is a general perception and really a perception that is hard to refute that there is scope for more changes and ongoing changes around the benefits that you might otherwise use as part of your justification for a dispute generation project because a lot of those income streams do not hang off primary legislation they hang off the way that industry codes work and so the frequency and significant to the changes that are being made, have been made and continue to be muted for those charging regimes, presents a significant barrier to funding in this specific project.

Alex: What do we think that will happen to the CM? You have said that it is current under appeal and until then payments have been deferred as far as I am aware. Is it fit for purpose under its current structure?  Do you think that payment will be successful and if not what will the market get in terms of the support structure?

Gus: It is interesting there is an indication from the government that pretty certain that this is going to come back because it is in the price cap and they have kept it in the price cap. Ultimately there is almost an objective element that it is not necessary fit for purpose otherwise it would not have been in this position. The question is was it fit for purpose and considered in fairness in 2014 when the concept was created or has it subsequently been found to have lots of holes in. I think what we have seen is ultimately it was created to be technology agnostic and therefore provide a fair game to build reserve capacity in the UK. It was effectively the parameters for the capacity market definitely suited the likes of transmission connected gas, CCGT and we know that there is an inclination from the government to build that and what happened is we are a lot smaller distributed generation that and cut the price down lower and then subsequently what we have had is we have had a series penalties against those distribution generation assets like batteries where we have the reductions without any view of what the benefits of their uniqueness, for example speed of response rather than being able to hold for two hours and then even that was based on National Grid's stress event scenario analysis which came out, no-one had nearly any time to provide any feedback to it and will put it under scrutiny and we said not we need one to two hour assets. So I think from our perspective what we would like to see from the CM is not too dissimilar from what we have seen from other government subsidies, we have actively subsidised certain types of technology in order to get them built. Previously we have do it with wind, we have done it with solar, we done it with arrow, with digestion, with gas, all of these different technology types. We do not see a problem in doing a bottom up analysis of what reserve capacity we actually need and therefore treating those independently for both their flaws and their uniqueness rather than try to create this kind of general approach which frankly just favours larger transmission gas.

Alex: I would like to move on to the type of charging review and the Ofgem published their consultation on its review decision and draft impact assessment before Christmas. Maybe Gus I could put to you what the headline takes away from that and how could it change the landscape for battery storage.

Gus: I think there is a number of limbs to the government proposals but today we are talking more about reach the market perhaps stand-alone projects so the more significant change from the prospective of those projects would be the changes around PERSEUS and there are some two headline issues really. The first is that currently suppliers are changed for their demand customers on a net basis so they are charged for their demand net of their distributed generation whereas the proposal is that that will cease to be the case and suppliers will be charged on the basis of their gross demand ignoring generation. So that removes an income stream that distributed generators which we have previously had through selling that avoided PERSEUS benefit. Secondly, the double whammy it is a government minded position is to introduce a PERSEUS charge for distributed generation. Whereas at the moment only transmission connected generators pay PERSEUS that would actually be a charge for distributed generators and that charge National Grid would charge that to the PPA offtaker so the offtaker would likely pass that charge through to the distributing generators. So that is a double hit for Walter Street Generators including peakers and batteries.

Joe: I would actually agree that when we look at the larger scale projects what it basically means is there is very little benefit of having a distributed generation battery project. Why not just make it big and transmission connected. We know actually larger sites benefits from an economy of scale and now considering there is going to be zero trial benefit there is very little likely any embedded benefit. You could even have, as we have mentioned the PERSEUS charge I think it has sort of blurred that line and effectively benefits those that are transmission connected anyway.

Alex: I think one of the things that has come out of this conversation is that there is a lot of uncertainty with these kind of markets and maybe just to finish off a two pronged question, one is that there is this many kind of battery asset earners who are pursuing a merchant business model, I would be interested in your views on that. Maybe as a secondary question, what does it mean all this uncertainty for investment in battery storage in the UK?

Gus: I think it would be impossible to divorce yourself entirely from these regulatory changes because the nature of energy is that a lot of the available income in revenue is via these regulated scheme so it is not possible to divorce yourself from those. I think what we are seeing though is people who are willing to make investment decision on a macro-economic basis of there needs to be capacity and batteries can provide capacity and therefore we will build batteries and seek, without any particular plan of necessarily which pots the income will come through but with a general entrepreneurial approach of there will be income and we will be flexible and fleet afoot and follow the best opportunities and that I think is a valid approach for many investors.
I am not sure what I have seen a kind of step back from what kind of UK plc perspective and energy policy generally.  That does not sound necessarily the most sensible way for the capacity question to be answered. I echo what Joe said that we do need a more joined up approach and policy to deliver capacity in a coherent and cost effective manner and rightly or wrongly a lot of the current changes proposed to charging, whilst everyone would agree there is sense in that in reviewing and changing the current system I think a lot of people would also feel that the changes have been pre-determined, a sort of pre-disposal against distributed generation and a lot of the outcomes seem to be stronger than perhaps those involved in distributed generation will expect.

Joe: I think from Limejump's perspective we have seen without a doubt is less investment opportunity there is no doubt and we have had a very quick burst of projects across say two years and that has definitely slowed down. There is no doubt that is linked to saturation but also uncertainty but it is definitely not all doom and gloom at all. I think exactly correct that if you take more than infrastructure kind of financing view on this that it is needed over 10/15 years there is a need for capacity therefore if we build there will be markets and as long as we stay nimble enough and smart enough and look at stacking the revenues and fully understanding those markets and that merchant risk which yes is a massive move away from quite easy frankly fit long term investment decisions that most investors were used to making but those that are able to take up that challenge are still finding there are still movement advantages, there is money to be made and there are project that are being build but I think if you are talking about getting to gigawatts there is no doubt that right now where we are it is just a little bit too much of that uncertainty. I do not think we are going to see that solved via a new rock will fit subsidy scheme which suddenly makes from the government everyone wants to buy and build batteries but it could well be sitting on the suppliers. If the suppliers can get comfortable enough with the market and have a big enough balance sheet they can help with underwriting with things like tolling contracts which remove a lot of that need to understand and asses the merchant risk which frankly a trading division should do every single day and often do so we would still need some level of certainty back in order to do that but it could be by the means of how you actually really to start to scale storage in the UK but it is, yes it is definitely an interesting time and very very important to keep up to date with all of these changes.

That was Gowling WLG's Gus Wood and Limejump's Joe McDonald talking about routes to market battery storage in the UK.

You can listen back to episode one of this series which looked at behind the need to battery storage on the Inspiratia website.

See you next time for the third instalment in the series.

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