X
Alexa Capital Insights
October 2024
The energy transition is messy. That's why flexibility is the key.
SIGN UP TO OUR QUARTERLY INSIGHTS*
The energy transition is messy. That’s why flexibility is key.
Is the battery energy storage system (BESS) boom-bust cycle here to stay? That is a question facing infrastructure investors in more developed BESS markets such as the UK. British BESS revenues have fallen by two-thirds in the last two years, according to research firm Modo Energy, with quarterly capacity additions more than halving in 2024 compared to 2023.
The problem comes after two decades of supply-side government incentives for renewable development (mainly wind and solar). These have helped decarbonise the grid but also risk creating sizeable wholesale market volatility as renewables drive down the average cost of electricity but struggle to cope with calm, overcast dunkelflaute periods when the wind is not blowing and the sun is not shining.
Batteries have been seen as the way to overcome much of the intermittency inherent in renewables integration. But the case of the UK market raises questions over whether this flexibility asset class can deliver defensible investors returns when revenue streams are largely merchant, especially given that the prevalent Li-Ion based storage technology has technical limitations in addressing extended discharge periods.
This is a serious issue for the estimated 16-gigawatt (GW) pipeline of UK BESS projects currently seeking capital, and competing for grid connection capacity. In that market alone, applications for relatively nearer term transmission grid connections by 2030 are over 200GW, including wind (32%), solar (22%, some with co-located storage) and stand-alone BESS (28%) – and these figures do not include over 100GW waiting to hook up to the distribution grid. Not surprisingly, there will be material fall-out, with a minority of this infrastructure able to get connected.
Notably, BESS developers are aggressively building project pipelines across multiple geographies – including in California, Texas, Australia, Poland, Germany, Italy, France and Spain, to name a few. For example, in May 2024 London-listed BESS infrastructure investor Gore Street stated that profits from Ireland and Texas had helped offset falling revenues from the British and German assets in its portfolio. Meanwhile, the challenge for infrastructure developers is what to do in places such as the UK. Is it worth waiting out the boom-and-bust cycle? Or are there other ways of looking at the current situation? And will other geographies face similar boom-bust cycles?
One perspective worth considering in the current context is that the flexibility BESS offers is only good up to a point. Batteries are ideal at dealing with hourly variability from renewables, but soon run out of capacity in the event of a dunkelflaute periods, when low sunlight and low wind persist over days at a time. For battery storage companies, this means there is a chance that the two to four hour storage capacity being planned for today may not be of much use four or five years from now.
Instead, as the market for short-duration storage becomes saturated, there will likely be a call for longer duration storage— six, eight, twelve hours, maybe more. It is hard to say. Other long duration energy storage technologies can play a role such as pumped hydro, but these installations are geography dependent. Notably, Germany recently announced a consultation in preparation for auctions for LDES which can provide up to 72-hour discharge duration with a minimum 1MW power rating. In the UK, the Department for Energy Security and Net Zero (DESNZ) has confirmed a new scheme aiming to stimulate investment in LDES in the form of a cap-and-floor mechanism with Ofgem set to open a first round to applicants in 2025.
Perhaps because of this, one trend we are seeing is a renewed interest in integrating gas peaker plants into wider flexibility portfolios. Data centres and broader industrial & commercial customers are increasingly demanding 24x7 green power, reliably despatched by suppliers and tailored to their consumption needs. Over recent decades renewables have driven down wholesale power prices, causing governments to reduce subsidies for incremental supply-side generation growth. But now there is a renewed focus on reliability of power.
With data centre demand expected to treble through the decade, even exceeding power demand of electric vehicles by 2030 [BNEF], there is a growing shift of customer demand-side fundamentals driving capital flows toward delivery platforms which can balance needs for resilent, competitively priced, low carbon power. Now scarce subsidies are shifting to incentivise dunkelflaute resiliency, whether through capacity mechanisms (as evidenced in the UK and Italy) or future LDES.
Adding a portfolio of distributed flexible gas-fired peaking plants (or incremental CCGT capacity) to a hybrid BESS portfolio enables vertically integrated suppliers to pass on low-cost renewable generated electricity to end customers, ‘firming up’ intermittent low carbon supply to achieve the ‘resiliency premium’ for which major industrial and commercial groups are prepared to pay. In effect, in a hybrid portfolio, flexible gas-fired generation may only operate less than 10% of any annual period, with ‘turn up’ only when the power system is under stress (like an insurance policy), and with carbon offsets integrated during those infrequent periods. Conscientious integrated supply platforms may plan to ultimately reduce peaker emissions by using carbon capture and storage, switching to low-carbon synfuels, or green hydrogen over time.
Or they can simply choose to sweat the assets (and the grid connection) until replacement technologies such as LDES becomes economically viable. And when peakers are no longer needed those grid connections can be repurposed for other opportunities.
Either way, the point is that a gas peaker can deliver flexibility—and value—beyond what is possible by adding more batteries to an already congested grid. They can be viewed as an ‘accelerator’ to integrate more intermittent energy. This value is increasingly being recognised by electricity system operators, which are offering long-term capacity incentive contracts and similar support mechanisms to keep conventional power on the grid and keep the lights on – even if only operating at very low levels of utilisation to meet system resilience needs, as an insurance policy.
What this highlights is that investors in grid-constrained markets might do well to focus on flexible portfolio plays rather than sticking to a single technology. After all, what is important now is not so much whether a project is BESS or another technology, but rather the location and size of the grid connection it will be using. In the UK for example, the amount of clean energy queueing for connection is growing at a rate of around 20 GW a month, according to UK transmission system operator National Grid.
But at the start of 2023 government ministers were told that power plant developers already faced a wait of up to 15 years for a grid connection. As the grid becomes increasingly congested, connection offers are being constrained to restrict exports, affecting the bankability of projects. There is a real danger that the grid will lack the flexibility it needs to absorb the quadrupling of offshore wind that the UK government wants to see by 2030 on the supply side, not to mention the requirements for power from hyperscaler data centres and economic growth on the demand side.
Hence, investors should look at their grid connection as a strategic asset that can be adapted to suit current market demands, which are increasingly placing a premium on flexibility and energy security as well as low emissions.
Big Tech and data centres illustrate a significant part of the underlying shift in grid dynamics, with drivers moving from supply-side government targets for renewable nameplate capacity (measured in MW peak) to demand-side industrial, commercial and residential customer requirements for round-the-clock clean energy (measured in MWh). If the demand is for round-the-clock, round-the-year supplies then adding another battery into the mix might not always be the best option.
Instead, infrastructure investors might prefer to keep an open mind about their technology mixes, adjusting them to track emerging requirements for flexibility. For example, in the ‘island grid’ markets of the UK and Ireland, we see this flexibility portfolio approach emerging in a new breed of infrastructure players, including I Squared Capital’s Conrad Energy (UK) and Energia (Ireland), Vitol’s VPI , EQT’s Statera, CFP Energy’s Brook Green Supply, Brookfield and Oaktree’s Hartree, Vision Ridge Partners’ Earthrise Energy (US), to name a few.
These are groups with increasingly vertically integrated flexibility, trading and supply capabilities, plus some ‘direct wire’ into industrial customers. Many are integrating flexible storage and/or peaking capacity to cover daily physical shortages in supply and deliver on their 24x7 green promises.
The emergence of new flexibility-focused players highlights a difference on power utility service provision. The 20th Century model integrated customers and carbon-intensive baseload generation. Aggressive government incentives for renewable development over the past 20 years created an ‘unbundling’ of energy supply with the upstream generation value chain – spawning an array of independent power producers (IPPs) thriving on subsidies. With subsidies falling away, we’re seeing a return to customer demand-centric integrated power utilities – where flexibilityis the most value-added service as cheap (intermittent) renewable generated energy is pervasive. Now the value-add is delivering low carbon power when customers demand it. So the supplier of the future must leverage FlexGen, tap carbon trading markets during dunkelflaute periods, support digital demand-side incentives, making margins on the volatility. And manage their grid connection assets through this messy energy transition decade.
In a world driven by customer demand for 24x7 low carbon power, the Energy Supply Platform 2.0 needs flexibility at its core. Surprisingly, distributed gas-fired generation can be used as a ‘renewable power accelerator’, firming up more intermittent green electrons than almost any other form of flexible power. Just use the gas sparingly, during a few of the more stressed hours of the year.