The opportunities for energy storage in the US continue to grow and grow, but moving away from contracted revenue structures to merchant risk projects will be a challenge, especially for lenders.
Louise Pesce, a project finance banker to the power sector with MUFG — one of the world’s biggest banks — said that her team has seen a “huge uptick” in the last four years in both standalone battery storage and hybrid (storage paired with generation).
Seeking to finance projects with bank debt or private placements, Pesce’s activities include supporting clients “as needs grow ever larger,” with increasing size and scope of battery projects they are involved with.
Speaking at a session at last week’s Solar and Storage Finance USA conference hosted by our publisher Solar Media, Pesce said that one of the challenges, but also opportunities, is that in the US, regional markets are very divergent in terms of their needs, and technologies are not standardised either.
Other panellists in the session took up the theme on both fronts: Andrew Mazze, a senior director of the infrastructure investment team at John Hancock Life Insurance, said with five years’ experience in standalone energy storage, two of the US’ biggest markets for storage, California and Texas’s ERCOT, have wildly differing technological requirements and market structures.
One example of this is that California’s market is underpinned by long-term off-taker contracts, primarily for Resource Adequacy (RA). RA is the means directed by market operator CAISO that load-serving entities such as utilities in the state ensure they have adequate capacity to serve their customers, especially at peak times.
As such, the longer the duration of the batteries used, the stronger the value proposition and lithium-ion battery systems with four-hour duration are increasingly common and now present the majority of projects going online in California.
Whereas in Texas, an equally talked-about state for energy storage, the opportunity is essentially energy arbitrage with some additional revenue streams stacked on top. Therefore, there is a declining value to each hour an energy storage facility can run, Mazze said.
The first hour of energy arbitrage is that much more valuable, given the market construct than the fourth hour, so Mazze said the additional capital cost for four hours of storage doesn’t pencil out in Texas.
“I don’t need four hours to maximise the value of the battery [in Texas], you can get 90% of the value with much less capital cost, with a one or two-hour battery [system].”
“In CAISO you see four hours being more advantageous due to regulatory benefits, being able to sign RA contracts and dispersion of revenue outcomes across four hours is better, more compressed, so you can get a better return profile for a longer duration battery.”
Merchant revenues: Attractive to sponsors, less so for lenders
All of the panellists were in agreement that one of the fundamental truths of the energy storage business is that it isn’t the same as working in solar and wind, where the business models are fairly straightforward. In renewables generation you generate power to earn revenues, but in energy storage, for each project and each territory the available revenue streams can be very different.
According to John Hancock’s Andrew Mazze, the energy storage space has evolved quickly and investment has “poured in” at speed. Whereas investors originally thought it would be like solar or wind, energy storage is more akin to a gas peaking asset in some ways — paid for what it does for the grid.
As more people realise the value of energy storage is in that role of adding flexibility and reliability to the grid, Mazze said there will be an “adjustment” in the investment landscape and business models: from underwriting long-term contracts such as for RA with value adders, there will gradually be market saturation that leads to a shift to “truly merchant projects”.
Lance Jordan, senior vice president for energy and infrastructure investments at Pacolet Milliken, a family-owned investment group said that a few years ago, battery storage was a “proof of concept investment” where the market was broadly investigating whether it would primarily be used in combination with solar, or if it would be a separate asset class.
Pacolet Milliken had found, Jordan said, that battery storage can be a separate asset class with a strong future ahead, whether it be on a contracted basis or merchant.
However, while merchant revenues may represent an upside versus contracted revenues — especially as market regulations across the US adapt to recognise the many different applications battery systems can provide — lenders are likely to be more comfortable with financing projects where the returns are visible over the long-term.
“Lenders like revenue certainty, so contractual revenue is great,” Louise Pesce of MUFG said.
The project sponsor meanwhile may not see that as the best return on their investment from an equity perspective, she continued. While merchant therefore may present an opportunity to make more money, it “doesn’t give the lender much certainty”.
Forecasting of revenues from merchant projects looks like it might be fairly accurate over a one to five-year timeframe, but it’s harder to do over the 15 or 20-year expected lifetime of a battery asset, which means that “it is going to be challenging to do large-scale merchant battery financing,” Pesce said.
That said, from MUFG’s experience of financing thermal power plants, Pesce added there had been a trend seen that once an initial contract for RA in California runs out, there is an appetite for brokering merchant contracts.
Investment director Lance Jordan countered that “it does seem like merchant batteries are emerging with a deeper market than people thought a few years ago,” especially in light of events like Texas’ Winter Storm in February. But, he said, there is a need to bolster merchant project business models with contracted revenues where possible.
Industry building momentum as track records develop
Nonetheless, as more battery asset operators and owners start to build up their operating track records, the rest of the market will be able to see from successes — and losses — how the merchant models can play out. As more use cases for storage are put to the test in the real world, the markets will have a deeper understanding of the characteristics of storage, Jordan said.
One thing was certain: battery storage is growing fast in the US, whether hybrid or standalone. Gigio Sakota, director of energy markets at solar developer 8minute Solar Energy said that “it’s almost rare that we’ll develop a solar project and the off-taker won’t ask about adding storage”.
Sakota noted that a few years ago in a previous role he had managed what was then the largest battery system in the world. At 10MW, it was only a few weeks before someone else had a bigger one and in today’s market it is not uncommon to talk about projects with dozens or even hundreds of megawatts output.
It’s not just that almost every client now asks 8minute about storage, Sakota said, but from what used to be a “little bit” of storage, it’s routine for customers to consider a 1:1 solar-to-storage ratio and enquiries focus on longer duration storage too, “not just three to four hours, but also asking about five to eight hours”.