On 20 July 2021, the Department for Business, Energy & Industrial Strategy (“BEIS”) published a call for evidence on “Facilitating the Deployment of Large-Scale and Long-Duration Electricity Storage” (the “Call for Evidence”). The Call for Evidence considers the role that large-scale and long-duration energy storage (“LLES”) may play in the UK’s transition to net-zero and seeks stakeholder feedback in relation to the pipeline of LLES projects, existing challenges to deployment and what can be done to overcome these barriers.
BEIS notes that information gathered through the Call for Evidence will be used (amongst other things) to establish the need for LLES on the future power system, determine whether there is a case for intervention and identify the appropriate and cost effective mechanisms for intervention and any associated risks.
In this article we provide an overview of the key areas considered in the Call for Evidence and BEIS’ next steps.
The role of LLES in a net-zero power system
The Call for Evidence acknowledges that electricity storage can help in integrating high volumes of non-dispatchable generation, provide a range of flexibility services required to manage a low carbon energy system and deliver security of supply. The Call for Evidence notes that the UK has:
Despite a sizeable pipeline of storage projects, BEIS’ illustrative scenarios demonstrates that around 30GW of short duration storage and flexible demand may be needed by 2050 to support the government’s net zero targets.
BEIS is therefore considering the need for greater deployment of LLES i.e. facilities that would be able to store and discharge energy for over 4 hours (and up to much longer periods), and deliver power of at least 100MW when required. Currently, a range of technologies are capable of providing LLES, such as gravitational storage, redox flow batteries, compressed or liquid air storage or PHS (the latter being the most mature LLES technology). However, BEIS notes that, following engagement with stakeholders across the industry, it has become apparent that LLES faces market challenges (particularly in respect of obtaining financing) which are hindering deployment at scale.
Existing barriers to LLES deployment
The Call for Evidence identified several barriers that are hindering deployment of LLES at scale as follows:
High upfront capital costs and long lead times - LLES projects often have high upfront capital costs (particularly for less mature technologies) and for projects with lengthy engineering and construction timetables, this increases investment risk. It is estimated that as technologies mature this will in turn reduce costs, however, such maturity of the industry will be dependent on external factors such as the speed of technological innovation across this area.
Lack of track record - BEIS notes that clearly novel storage technologies face additional investment challenges when compared to more mature technologies due to the lack of track record for successful projects. With a lack of track record and deployment at scale, the increased risk reduces the pool of potential investors.
Revenue uncertainty - Electricity storage projects generate a revenue stream by stacking revenues via participation in different energy markets. However, these revenues tend to be contracted on a short-term, short-notice basis and whilst the Capacity Market is an exception to this, such revenues tend to make a small part of the overall revenue stack due to the clearing prices and de-rating factors applicable to storage. The longer delivery timeline associated with LLES projects means such projects would be unlikely to secure a T-4 Capacity Market agreement before construction works commence, impacting investability. This can be a deterrent for investors who seek greater visibility of long-term cash flows.
Market signals - The Call for Evidence notes that energy markets may not capture the full value of LLES projects as markets tend to value fast responding, short-duration storage. This has the effect of incentivising storage projects to cycle multiple times per day rather than hold stored energy over longer periods. In turn, this means there has been little to incentivise investment in LLES capacity and almost all new energy storage projects coming online are shorter duration.
Addressing the barriers to LLES deployment
The Call for Evidence considers the current routes to market available to LLES in GB and how these revenue streams contribute to the investability and bankability of storage assets. These include:
Floor price optimisation agreements - Whilst the optimisation offerings from certain market players have improved bankability of battery storage projects, providers of revenue floor contracts are limited.
New revenue streams - The Call for Evidence notes that a number of the markets that LLES projects participate in are currently undergoing reform which could provide opportunities to storage asset owners/operators. For example, ESO is trialling a new range of services, such as the Stability Pathfinder and Constraint Management Pathfinder projects, that energy storage assets are eligible to bid for. These services include multi-term revenue contracts, which may support financing for LLES.
New investment capital - The Government’s new national infrastructure bank will seek to invest in low-carbon projects, which could include LLES projects. Such financial support could in turn attract private investment to LLES projects.
New innovation competition - BEIS launched its Longer Duration Energy Storage Demonstration competition as part of their Net Zero Innovation Portfolio. Designed to encourage the commercialisation of energy storage projects, the competition is split into two funding mechanisms. The first stream is a grant competition and the second is through the Small Business Research Initiative rules. The competition is due to close on 13 August 2021, more information can be found here.
Mechanisms for de-risking LLES
The Call for Evidence goes on to identify three possible mechanisms for de-risking LLES and bringing forward investment as set out below:
Regulated Asset Base (“RAB”)
The RAB model is employed by Ofgem as part of the “RIIO” framework and is widely used in other sectors. For this model, Ofgem would approve expenditure and determine a reasonable return on investment. The revenue entitlement is set at a level that is intended to ensure investability whilst protecting consumers – reducing the project’s perceived risk and increasing investor confidence. As a result, the RAB model has attracted significant investment in energy networks. However, the model’s effectiveness is limited. Incentive schemes may be set up under the RAB regime, but this would not match the level of market exposure gained through the Cap & Floor mechanism.
Cap & Floor Mechanism
The Cap & Floor mechanism was developed to support investment in electricity interconnectors. The mechanism provides a minimum revenue allowance (subject to a minimum availability threshold) which reduces projects’ exposure to uncertain future capacity revenues. Where the revenue falls below the ‘floor’, it is topped up by consumers. Conversely, if revenues exceed the ‘cap’, consumers receive the excess. The cap and floor levels are calculated based on project costs including financing costs (at the floor) and a return to equity (at the cap).
The Call for Evidence notes that a variation of the current approach for LLES could be to set a floor for the relevant project, without a cap which may incentivise investors and developers to optimise the asset, or allow profits above an agreed cap to be shared between investors and consumers.
The Call for Evidence identified a Cap & Floor regime as being effective for LLES technologies because it:
Retains merchant exposure – developers are incentivised to optimise the storage in order to generate the highest value;
Retains developer-led approach – users can enjoy the upside of projects in exchange for having de-risked the downside; and
Keeps consumer cost low – a subsidy will not necessarily be paid out, depending on the project’s economics.
Contract for Difference (CfD) Regime
The Call for Evidence notes that greater price stabilisation and revenue certainty can be delivered through the CfD regime. Under the CfD regime, where the market price for electricity falls below the generator’s awarded strike price, top up payments are made to the generator to close the difference. However, the Call for Evidence goes on to deem the CfD regime unsuitable for the purposes of de-risking LLES.
The Call for Evidence notes that BEIS’ overall objective is to incentivise LLES to respond to varying price signals and provide flexibility when it is needed. A RAB and CfD model would be less likely to incentivise developers to operate storage assets in this way, for example, the core incentive under the CfD is to maximise output. As a result, BEIS considers that the economics of the Cap & Floor regime is a more favourable approach to meeting the demands of the LLES market.
Alongside the Call for Evidence, BEIS and Ofgem also published an updated Smart Systems and Flexibility Plan 2021 (our commentary on which can be found here), which sets out the government’s roadmap to transforming the UK energy system into a smarter and more flexible one, capable of integrating high volumes of low-carbon energy and utilising technologies such as energy storage in order to effectively deliver on the UK’s net-zero by 2050 ambitions.
Whilst the Call for Evidence recognises the value LLES can deliver to the energy system, it is clear that this must be balanced against quantifying what types of assets will be most valuable to the future net-zero energy system. Market intervention, while on the one hand can be invaluable, on the other carries its own risks and complexities. Whilst implementing a particular project revenue model (such as the Cap & Floor framework) might combat bankability and financing challenges facing LLES developers, without addressing the issues relating to market signals, this may not be enough to deliver LLES projects at the scale and pace required to support the transition to net-zero.
Stakeholders in the LLES sector have been raising the challenges such projects face for years. It is positive that the Call for Evidence indicates a way forward at long last – but it should be noted that process to delivering on such proposals means that it will be some time yet before we see LLES projects being developed under such support mechanisms.
The deadline for responses to the Call for Evidence is on 28 September 2021.