Data centre loads and domestic content policy define US battery storage market’s future, law firm says

This policy is expected to significantly affect Chinese companies or those with over 20% Chinese ownership, beginning at the end of this year.

As seen in Troutman Pepper Locke’s report and noted by other analysts, such as BloombergNEF’s Isshu Kikuma, the US is expected to see a significant amount of load growth over the next decade, primarily from the rapid development of data centres.

Industry discussion has seen data centre development as a potential lifeline for continued BESS project development.

Morrison highlights how companies are responding to the FEOC restrictions, as well as the pros and cons of integrating BESS with data centres.

The impacts of FEOC restrictions

“Battery storage emerged relatively unscathed from this budget reconciliation process, at least in the near and medium terms,” Morrison says.

“If you look at where the industry is now compared to where it was before the Inflation Reduction Act (IRA) was passed, when there were no tax credits for battery storage except to the extent paired with solar-plus-storage, the industry is much better off, for sure.”

Morrison hopes to see the industry grow, but acknowledges the current confusion companies are experiencing in maintaining eligibility requirements and navigating FEOC restrictions.

“There are developers that are closely held, and that’s the end of the discussion. Others are owned by hundreds of LPs, which is more complex. And then there are those who have publicly issued debt, multiple tranches of publicly issued debt over time. Going back and trying to figure out who it was sold to at the time of the issuance is just a Herculean task.”

John Leonti, a partner at Troutman, who contributed to the report with Morrison, notes, “The most prepared in the sector have acted nimbly to restructure supply chains, and key stakeholders are strengthening their close working relationships to share risk and collaboratively revise strategies.”

Morrison says a large focus has been placed on avoiding the need to restructure arrangements to allocate risk in the first place.

This is complicated because if a taxpayer, potentially including a tax equity investor, is the “wrong type” of entity, it could lead to a disallowance.

Morrison clarifies that when an FEOC holds too much of a taxpayer’s debt, it can lead to disallowance. Consequently, some companies are considering including representations and covenants to shift the risk to the party best able to manage it.

He says, “Our primary focus has been on negotiating risk allocation with suppliers and service contractors. This includes crafting contracts that may activate certain control categories, such as representations and covenants confirming that the counterpart is not, and will not become, a specified foreign entity.”

Morrison continues, “We’ve also dedicated significant effort to designing contracts that avoid triggering these categories, especially for clients with a more cautious approach. This involves removing affirmative licenses to prevent falling under licensing restrictions and adjusting clauses to ensure they are well within safe boundaries, providing greater certainty that these categories are not met.”

Additionally, the Troutman Pepper Locke partner notes that many companies have not previously needed to monitor debts and ownership details at this level of detail. Consequently, many are now “scrambling” to gather this information.

Hope in data centre development?

In a recent discussion with ESN Premium, Jason Abiecunas, business development manager at FlexGen, said:

“There is the potential that the data centre market is one of our larger market segments. It’s a significant driver of economic growth. It’s a significant driver of the next major wave of industrialisation. We see it as enduring, and we see it as significant.”

Morrison says that, perhaps crucially, to its relative sparing in the OBBBA, the storage industry has separated itself from the renewable energy industry, a “logical” decision, he notes.

The industry’s focus on providing energy security over being a renewable energy source has already had a bit of a ripple effect, with solar developers taking note of the messaging and others adapting it further.

BESS projects can help data centre developers manage power fluctuations and quality; the pairing makes logical sense. However, BESS being tied to data centre development is not necessarily a sure thing.

Morrison says, “I think people have not totally figured out yet what role battery storage is going to play with data centres. There are some intuitive use cases, particularly around pairing storage with intermittent generation, which is so important to a lot of the hyperscalers. But we’ve not seen that deployed at the same scale as we have other technologies for purposes of behind-the-meter delivery to data centres. So, that’s still early days.”

He continues, pointing out the risk as well: “The risk is that the load does not actually pan out the way people think it will, or that if it does, people are so focused on reliability that they just disregard non-conventional generation technologies altogether. So, there is a risk of either that boat not coming into port or missing that boat if other technologies gain an advantage that can’t be overcome.”

There are multiple unknowns for BESS and data centre development. As Thomas Cornell, CEO and President of Prevalon Energy, recently pointed out in a discussion with ESN Premium:

“I think everybody’s been following the existing process, but now the question is, are they going to declare an emergency?”

Cornell continued, “Then, the data centres are going to move to the front of the line, or some of these gas assets are being moved to the front. Especially now, the government has really hampered wind and solar. Most of the queues, if you look at them over the next five years, are flooded with wind and solar energy, mainly solar projects, and then gas is beyond that.”

“Now, you take solar out of the mix, and you cannot build gas generation fast enough. What are people left to do?”

In a situation like the one Cornell described, developers would find themselves in an even tougher spot, and have limited opportunities to pivot into other industries or niches.

Morrison explains, “If you’re just a general energy investor, then you probably just pivot to natural gas or data centres at that point. If you’re a battery storage developer, I think you’re focusing more on opportunities that are not as vulnerable to interconnection queue delays.”

“We have already seen a good bit of that in PJM and ISO New England, where existing interconnects are repurposed for ancillary services or what have you, and then focus on behind-the-meter applications,” he continues.

While a large number of projects are thought to be secure through Safe Harbouring, and onshoring the supply chain presents a potentially longer-term opportunity, creating domestic BESS products and adhering to FEOC restrictions remain a near-term issue that could become more significant.

Morrison says, “I think between the FEOC rules, the 45X credits and the domestic content bonus under the Inflation Reduction Act, what we’re seeing at the federal level is a unified market signal from both parties that domestic manufacturing is important, and it’s something that the federal government is investing in, regardless of who’s in power.”

“If you’re in the business of building the only thing that the two political parties can agree on, that’s a good business to be in, for sure.”