Opportunity for energy storage in Australia’s Capacity Investment Scheme

In the first published instalment from Energy-Storage.news Premium’s conversation with Salim Mazouz, head of the policy and design branch office for the CIS at the government Department of Climate, Energy, the Environment and Water (DCEEW), we learned how the scope of the procurement scheme was devised, and its aim to mitigate a “high level of uncertainty” that persists for investors.

Our interview took place a few weeks after Mazouz gave a presentation on the Capacity Investment Scheme as a keynote speech at the Energy Storage Summit Australia 2024, hosted by our publisher Solar Media.

The government effectively underwrites revenues for successful projects against agreed revenue ‘floor’ and ‘ceiling’ prices, through 10–15-year Capacity Investment Scheme Agreements (CISAs).

At the same time, it is negotiating Renewable Energy Transformation Agreements (RETAs) with the states participating in the schemes to agree funding allocations.

As we heard previously from Salim Mazouz, the idea is to support project revenues that will remain robust in low-price environments. The more renewables come onto the system, and the more thermal plants retire, average electricity prices are expected to fall, which could impact revenues for renewable energy generators in particular when exposed to merchant risk.

Conversely, if renewables don’t come onto the system and coal plants aren’t retired fast enough, electricity prices stay high and Australian billpayers would lose out. The scheme was designed to mitigate risks for both scenarios, rather than “trying the second guess what the market needs,” Mazouz says.

He explains further that some inspiration was taken from procurements held in New South Wales (NSW) under the NSW Electricity Infrastructure Roadmap which set out the 20-year plan for state-owned EnergyCo to broker Long-Term Energy Service Agreements (LTESAs) for renewable capacity.

“What they were trying to do [in NSW] is get the risk adjusted rates of return into a space where people can do this commercially without really needing an actual top-up. When you’re pushing in less renewables that works. When you are pushing in more and more, and all prices start to drop, if the view of investors is that they’re not going to get sufficient money to cover their levelised cost of energy (LCOE), then you need some gap financing,” Mazouz says.

“Instead of trying to second guess what the market needs, we’ve designed a tender system whereby the market tells us what it needs through the cap and the floor, and the annual payment cap through the bidding process.”

Hybrid projects also eligible for Capacity Investment Scheme VRE tenders

The Capacity Investment Scheme will support 32GW of new renewable capacity, equivalent to about half the current generation capacity of the National Electricity Market (NEM) which covers Australia’s southern and eastern states.

While the majority of that, 23GW, will be variable renewable energy (VRE), 9GW will be dispatchable capacity backed with energy storage.

At the same time, VRE bids that include energy storage will also be accepted and the DCEEW branch office head says these hybrid or co-located projects can be competitive against standalone renewable energy bids. Those bids will be assessed in terms of benefits to the system as a whole, as well as in terms of cost.

“We’re not assessing projects just on the basis of dollars-per-megawatt-hour generated. If we did that we would end up with solar and nothing else, pretty much,” Salim Mazouz says.

“There are all sorts of other things we care about,” besides just lowest-cost generation, he says, such as reliability and the ability to deliver energy when needed, not just when it is generated.

So, during the day, prices that solar-generated power could fetch would be extremely low, resulting in the government needing to pay out big subsidies to projects with the same floor price as, say, a solar-plus-storage project that can shift capacity from a low-price dispatch period to a high-price one.

“When it comes to the cost, it’s not a simple proposition of what the floor price is. It’s what the floor, the ceiling, and the annuity cap are, against the expected dispatch-weighted prices, evaluated in a sort of stochastic environment about future prices,” Mazouz says.

“The other thing is that you’ve got other benefits from adding storage. One of the benefits you get is that the project enhances reliability more than if you just had a standalone VRE project.

“They’re enhanced by potentially reduced curtailment; they are enhanced by providing more reliability than otherwise would be the case. They’re the kinds of considerations that go into looking at what the benefit of a project is.”

Arbitrage and FCAS revenues factored in

One of the complexities of energy storage, which is also one of its greatest strengths, is the ability to capture revenues from different sources by stacking applications and contracts, often for a single battery asset as well as across portfolios.

As noted a few days ago from a report by the Australian Energy Market Operator (AEMO) which oversees the NEM, Australian battery storage assets are moving more towards an increasing share of revenues coming from arbitrage.

Until fairly recently, Frequency Control Ancillary Services (FCAS) had comprised the majority of the revenue stack.

This market is considered shallower than the arbitrage opportunity, especially as VRE growth drives more volatility in electricity pricing—the difference between peak and off-peak energy prices essentially—but both FCAS and arbitrage revenues will remain an important part of the typical revenue stack for large-scale battery energy storage system (BESS) assets.

In turn, forecasts for both of these merchant opportunities will be factored into DCEEW’s revenue calculations for selecting projects.

For energy storage, including hybrid renewables-plus-storage, the growth in VRE generation and the diminishing importance of thermal generation means greater arbitrage opportunities to capture volatility, even in an environment of lower average prices.

 “When it comes to energy storage, if you’ve got a low-priced environment but it’s all driven by solar and wind, you probably have huge arbitrage opportunities, compared to a world where you continue to have a lot of coal and potentially flexible gas that doesn’t allow the fluctuations to be as high as they would otherwise be,” Mazouz says.

“The arbitrage opportunity for storage is not necessarily directly related to the average price. It’s related to volatility, and the volatility of prices is more likely in a world where you have a lot of variable renewables, but you don’t have as many flexible thermal resources.”

Scheme inspired by, but different to, CfDs

Australian energy minister Chris Bowen announced that a tender scheme for dispatchable and variable renewables would be forthcoming in December 2022. From there, looking from the outside, it appears the Capacity Investment Scheme emerged very quickly, with pilot schemes rolled out mid-2023 and procurements now already underway.

The DCEEW’s CIS office had to move fast, Salim Mazouz says, noting that energy markets and policy design in Australia have been themselves subject to rapid change over the past few years. A proposed capacity market scheme was rejected in late 2022, which left a “huge gap,” he says, leading to the government’s decision to create the tenders instead.

 It was a lot of work, but the DCEEW was able to take some inspiration from other schemes around the world and Australia, including the New South Wales LTESAs, tenders in the Australian Capital Territory (ACT) and Victoria, and the UK’s Contracts for Difference (CfD) scheme.  

At the same time, applying a “traditional” CfD scheme where, Mazouz says, the floor and ceiling are essentially the same would not preserve market signals.

“When you’ve got a CfD, locational decisions, technology decisions, all of those are fully made by the offtaker, namely the government in that case. Whereas with our scheme, you actually have a number of incentives that retain the market incentives for locational decisions, technology choices and so forth,” Mazouz says.

The CIS is also technology-neutral by design and it was important not to proscribe solutions, especially when technologies are changing so fast, from the advances made within existing technology sets like lithium-ion (Li-ion) BESS or pumped hydro energy storage (PHES) to newer technologies like sodium-ion (Na-ion) or flow batteries, according to Salim Mazouz.

Rather than asking the market to deliver particular technologies, the scheme asks it to deliver specific services.

“Can you enhance reliability in this market? Can you provide arbitrage so that you’re buying when it’s low, and you’re selling when it’s high, which improves the economics of the VRE as well and enables higher penetrations of renewables, without having the reliability problems that you would otherwise get?”

Nonetheless, Mazouz says his personal view is that it’s likely lithium-ion will dominate energy storage bids over at least the next couple of iterations of Capacity Investment Scheme auctions, although the future beyond that is less certain.