Critical Questions for Battery Storage Investments
In 2017, a series of tweets were exchanged between the Premier of South Australia, Elon Musk, CEO of Tesla and Mike Cannon-Brooks, CEO of Atlassian, in a conversation which led to the 100-day build of what was then the largest battery in the world – a powerpack system with 100 MW of capacity.
The battery solved a system reliability problem at a time when major issues surrounded the use of batteries in Australia’s National Electricity Market. Few markets within the NEM recognized and rewarded the granularity of response required by batteries in the energy system. It is no understatement to say that the arrival of the Tesla giant battery brought with it a fundamentally new understanding within industry of the role batteries can and could play in the NEM. Let’s explore why.
Why do batteries make sense in the NEM?
An honest discussion of the NEM would have to acknowledge the fact that it has never been structured to either acknowledge or reward the benefit that batteries can provide. This, in turn, has made it difficult for the sort of project development that tends to accompany new opportunities in the market. Ideally, projects do not get developed via Twitter, as they did with the South Australian battery, but when they do, and credit where credit is due, they are a gift to markets. As George Eliot once wrote, “what lamp is there but knowledge”. The timing of this particular exchange of knowledge could not have been better given the underlying changes in generation mix in Australia’s eastern seaboard.
Batteries make more sense in our energy system because this energy system is changing quickly. The increasing penetration of variable renewable generation, forecast closure of large synchronous generation, increased participation by demand-side response assets, and uptake of behind-the-meter assets are all compounding towards an increased requirement for flexible dispatchable assets, and while it is hard to bank projects right now, the market is emerging quickly for firming assets. At the moment, we’re seeing this need met via investment in pumped hydro and new flexible gas generation assets. However, the realisation of proposed gas assets is likely to be dependent on the competitiveness of future east coast gas prices. The real question is how companies and developers should assess the opportunities for investing in battery storage.
Why location rules in battery investment
The first, and most significant factor, that will guide investment in batteries is the same one that rules real estate – location, location, location. Placing a battery where volatility will be greatest will throw up the deepest opportunities to fill that gap for a price. We’ve seen with price volatility increasing in a number of parts of the NEM over the last few years, together with increasing incidences of negative prices over the last 12 months. As price volatility increases, new opportunities for battery storage assets arise around the ability to earn revenue via wholesale price, load and generation marginal loss factors (MLF) arbitrage.
The second crux question is what to build – which technology, size and brand? Putting technology and brand aside, investors are faced with sizing decisions almost immediately – whether to go big or small, or more specifically to build several small batteries to stack to one larger one. There are a range of arguments for and against of both. There is no doubt that a single large battery asset requires lower operational, trading and contractual complexity. It also avoids duplication of asset connection costs. Multiple sites, in contrast, provide diversification of risk across future MLF outcomes and would deal with locational marginal price risk under, for example, a COGATI framework.
The third key question to be answered surrounds how to operate the battery asset. This means determining how best to encourage a stacking of various revenue sources, including an optimal apportioning of the storage capacity between merchant and contracted revenues, and then how best to apportion the share of battery capacity to serve specific revenue streams within that. A merchant commercial model will increase the operating and trading complexity, cashflow risk and exposure to new entrant competition from a battery asset. Merchant exposure also provides increased flexibility to allow pivoting of the commercial strategy at pace and the ability to access potential new future revenues, if and when these arise as the market develops. In contrast, a contracted commercial model to provide services to a third-party off-taker does reduce operating and trading complexity, provides the cashflow certainty which can see projects more easily banked and approved during the development stage, and potentially locks down a customer and takes them out of the game – a sure fire way to discourage and block new entrants. The reality however is this degree of certainty brings with it costs – contracting a specific share of battery capacity for periods of a day may restrict access by the asset to lucrative periods of high price volatility.
The Timing Challenge - Not Too Early and Not Too Late?
The last, and most important, question is when to invest – or, more specifically, how best to navigate the need to make money with the reality that you may need invest to get ahead of the competition. In a world where location is everything, there is always first mover advantage. Battery storage development which arbitrages volatility leads to erosion of overall wholesale and ancillary market revenues for other battery players, as well as the capture of finite contracted revenues for services such as network constraint alleviation and retail price hedging. You wait, you lose – a tough situation when the numbers don’t add up in the short-term and the long-term present value relies on future markets.
While these are being quickly developed – there are no less than seven rule change submissions currently being considered which deal with system security and the role that storage can play – they are, as mum and dad used to say, “around the next corner”. The Technology Roadmap, COGATI and the list of rule changes are hard to bet on, but they do show direction and momentum. The AEMC’s decision to defer 5 minute settlement – but only by 3 months – illustrates the push and pull dynamic facing the industry.
This is, of course, the rub with storage. On fundamentals, it makes sense. Volatility is rising, with short enough intervals for batteries to make a real difference. The technology is proven and costs are declining over time. But finding the right opportunities is key, and assessing them dispassionately is the way to stay safe. What’s your storage strategy?