We outline the key factors for borrowers and lenders to consider when financing battery storage projects, based on our experience working on one of the first UK battery storage project financings.
1. Complex revenue streams
Battery storage projects rely on more complex “stacked” revenue streams than traditional energy generation projects. These might include availability payments, services payments, capacity payments, performance payments as well more usual payments for power (including arbitrage) and avoided costs.
At present, the typical revenue stack for an ‘in-front of the meter’ grid scale battery involves some combination of frequency response, capacity market payments, triad revenue and, to a lesser extent, payments for power. Each of these revenue streams presents challenges for project financing:
- Dynamic frequency response is usually the most valuable service, but contracts with National Grid have a maximum duration of four years (in respect of Enhanced Frequency Response) or 24 months (in respect of Firm Frequency Response).
- Capacity agreements have a duration of up to 15 years, but are typically a relatively thin slice of the overall revenue.
- Triad payments, while significant, are not guaranteed and changes to industry rules mean that they will reduce significantly by 2022.
We have been working on some innovative debt structures to mitigate the risks inherent within these revenue streams.
Borrowers and lenders need to ensure that the revenue streams in the financial model are compatible. This requires a careful analysis of delivery requirements and periods, performance obligations and penalties, as well as potential mitigants such as any asset substitution rights.
Where the provision of multiple services is permitted contractually and technically, further consideration must also be given to the demands of delivering those services and the compatibility of those demands with the project construction contracts and any warranty provided by the battery manufacturer.
2. The role of aggregators
Aggregators play an important role in the balancing and ancillary services markets, particularly in relation to frequency response. Contracting through aggregators brings challenges, but can also have significant advantages including:
- the ability to leverage established relationships, principally with National Grid
- the potential to increase revenue and reliability through aggregating batteries with other assets
- use of sophisticated control systems to prioritise dispatch to capture maximum revenues.
The key challenge for project finance is the credit and performance risk of interposing into the structure an aggregator, which might not have a significant balance sheet. Careful consideration needs to be given to insolvency risk, the aggregator’s technology and IP, and even its customer base (in cases where a battery is aggregated with third party assets).
Where an aggregator installs equipment and controls the dispatch of a battery, there is an interface risk and any agreement with an aggregator must work with the construction and operation and maintenance contracts, as well as any warranty provided by the battery manufacturer.
While it is not possible to eliminate counterparty risk entirely, a number of structures are possible. We have developed agreements and structures to mitigate the risks from a financing perspective.
3. Construction issues
Given the arrangements underpinning the commercial viability of battery storage projects, specialist legal and technical input is important in any financing to ensure that the construction and operational contracts and revenue contracts are, where possible, 'back-to-back'. For example:
- any pre- or post-completion testing requirements under the installation contract must be at least as onerous as testing requirements under the revenue contracts
- the installation and maintenance contracts will need to allow the National Grid and/or any aggregator to access the site to carry out inspections, monitoring, testing, etc.
- the intended use of the battery must not invalidate the warranty.
For more details on the construction aspects of battery storage please see our article Battery storage: getting your construction and operation contracts right
4. Industry and regulatory change
The battery storage market is developing against a background of rapid and significant industry and regulatory change. Proposals which will or might have an impact on battery projects include:
- Capacity Market changes to the de-rating of batteries and strengthening of satisfactory performance obligations
- BEIS’ Smart Systems and Flexibility Plan
- National Grid’s Product Simplification Consultation
- Ofgem's Targeted Charging Review
- Proposals to allow wider access to the Balancing Mechanism
- Proposals for mandatory half hourly settlement of domestic and small business customers.
Lenders and borrowers need to ensure that they are aware of the large number of proposed changes which may affect battery projects and the impact of those changes on anticipated revenues. Legal documentation needs to be flexible so as to accommodate future changes in the landscape.
5. Co-location of battery storage
If a battery storage system is to be co-located on an existing renewables site, it is necessary to consider and review how the proposed battery storage system interacts with the existing land rights, grid connection, subsidy and offtake arrangements.
Where existing project financing is in place for the renewables site, these arrangements need to be assessed for their compatibility with those existing arrangements.
In particular, the installation of a battery storage system will still lead to a temporary suspension of subsidy payments while Ofgem assesses the new metering solution (which it currently does on a case by case basis).
In an encouraging development, Ofgem recently announced that it has re-accredited a solar farm which is co-located with a battery under the Renewables Obligation and the industry’s expectation is that any suspension periods will shorten significantly as a result, but the potential for cash-flow and covenant issues under any existing project financing has not yet gone away.