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Advances in battery storage technology are helping to meet supply and demand challenges in the UK electricity market, and in the process provide opportunities for investors.
A confluence of economic, environmental and social factors is transforming the UK energy market. With electricity supply and demand increasingly unpredictable, the storage flexibility provided by batteries is seen as a vital part of the solution, and infrastructure investors could be set to capitalize on this emerging theme.
According to the UK House of Commons Energy and Climate Change Committee, changing market dynamics “are shifting not only the way in which electricity and heat are generated, but also the way in which supply and demand are considered across the energy network”1.
In terms of supply, the contribution of renewables is increasing while thermal generation from coal and gas declines. All of the UK’s coal-fired power stations, which produced 22% of the country’s electricity in 2015, and the UK’s aging nuclear stations, which supplied around 21% in 2015, are to be closed by 20252,3.
Figure 1: Electricity total generation by source, 2008-2034
Source: Department for Business, Energy & Industrial Strategy: Updated Energy & Emissions Projections 2016. Note: Not adjusted for electricity used in pumping.
Supply and demand uncertainties
However, while an increasing dependence on renewables may be good for the environment, the intermittency of renewable generation technologies such as wind and solar may also bring greater variability and uncertainty in supply.
To complement the contribution from renewables and to minimize its intermittency, the grid needs other technologies to provide “base load” (i.e. predictable) capacity. For that reason the construction of a small number of new large nuclear power stations and CCGT (Combined Cycle Gas Turbine) plants are being incentivized by the UK government. This dependency is not without risk, however.
“As a rule of thumb, a new nuclear plant the size of Hinckley Point C (3,200MW) can replace approximately six large fossil-powered stations of 500MW4. However, should an unscheduled outage cause one of these large nuclear plants to go off line, it could take out a disproportionate chunk of capacity from the UK power market,” says Isaac Vaz*, Associate Director, Infrastructure Equity at Aviva Investors Infrastructure equity team.
Changing patterns of electricity consumption are also making demand harder to forecast. Residential rooftop solar panels and community wind turbines are driving this trend, and the growth of electric vehicle (EV) ownership is likely to prove increasingly important. There are currently more than 100,000 EVs on the road in the UK5 and EVs could account for the majority of new car registrations by 20276. EV owners can use the power from their car batteries to power their homes and feed into the grid.
Individuals, commercial and industrial companies are turning into both producers and consumers (so called “prosumers”), and lithium-ion batteries located in residential and commercial locations will only accelerate this transaction.
Several companies are already offering residential and commercial batteries, which can draw electricity from the grid when prices are low (normally during the night), store it and use the energy when prices are high (usually during the day from 4pm to 7pm).
Private companies are also likely to turn to batteries to meet some of their energy needs. As they and households begin generating their own energy, storing it and/or charging their batteries at non-peak times, it will likely become increasingly difficult for the UK National Grid to predict timing patterns for demand, particularly the periods when the electricity grid becomes particularly stressed.
However, as well as being a disruptor, batteries provide a potential solution to the changing nature of supply and demand. Advances in battery technology, leading to improvements in storage capacity, and, critically, the speed of response (measured in milliseconds), safety, reliability and lower costs, are boosting their appeal, according to BP7. The cost of batteries for EVs, the same type that are used on battery “parks”, has fallen from US$1,000 per kWh in 2010 to US$227 per kWh in 2016, according to consultancy firm McKinsey. The consultancy forecasts that EV battery pack prices will fall below $190/kWh by the end of the decade, and could decline below $100/kWh by 2030.8
“Batteries have a key role to play both in regulating electricity frequency and providing stand-by generation to offset supply and demand imbalances,” says Vaz.
To explain in simple terms, power generation and demand have to be matched as closely as possible to maintain electricity supplies at a safe frequency so that household electrical appliances function properly. This becomes more challenging as the contribution of renewables increases, since this prompts more volatile fluctuations in generation and therefore in frequency. By rapidly charging and discharging, batteries help the grid operator balance electricity supply and demand, as well as frequency, second-by-second.
Right time, right place
In the UK, the National Grid is warming up to the advantages of battery storage. In August 2016, for the first time, eight battery storage facilities won contracts with the National Grid in the country’s first “Enhanced Frequency Response” auction. The ability to control variations in frequency almost immediately should result in reduced costs of approximately £200 million (US$260 million**) and streamline services to make them as efficient as possible9.
The attraction was further underlined when several battery storage facilities, which store energy during period of excess supply and release it back onto the market when supply is needed, won contracts with National Grid in its auction of subsidies for back-up capacity in December 201610.
This development has come at an opportune time for infrastructure investors, according to Vaz. Government subsidies for renewable electricity projects in the UK are being phased out as the sector and its underlying technologies become more mature. “Consequently, infrastructure investors should be more creative if they are to find good investment opportunities in this new energy market,” says Vaz.
Commercial and industrial investment opportunities
The advantages of battery storage for commercial business are creating opportunities for investment in battery infrastructure. “Imagine a major grocery retailer that consumes a large amount of electricity to power its fridges and freezers and the lighting in its stores and warehouses, and pays high network charges from consuming from the grid at peak times,” says Vaz11. “It could make considerable cost savings by storing energy (imported from the grid) overnight when rates are low, and releasing that energy (from the battery) during the day when it is needed. By not consuming from the grid during peak times, the retailer can also avoid payments of some network charges, which are an increasing percentage of its utility bills.”
However, the retailer may not wish to use its balance sheet to finance the batteries and it may not have the expertise to operate them. Infrastructure investors could step forward and offer to finance the batteries in return for a long-term revenue stream from the retailer, adds Vaz.
Moreover, since the commercial and industrial clients already have a grid connection, and the batteries are constantly connected to the national network, they can earn extra income, both by helping the National Grid to balance supply and demand and by regulating frequency. The flexibility of a battery to generate multiple revenue streams is generally referred to as “revenue stacking”.
Revenue streams for energy storage assets will largely represent regulated and/or contracted availability payments based on the services the technology provides.
Figure 2: Revenue stacking and battery storage
Source: Aviva Investors, May 2017
Risk and reward
Investing in batteries is not without challenges, however. National Grid only awards short-term contracts (for up to two years for frequency regulation and four years for enhanced frequency regulation), rather than the typical 15- to 20-year contracts seen in the renewable energy sector. “So, while investors might get a 15-year contract from a commercial and industrial client, they must bid every two years for a new contract from the National Grid and that is one of the main investment risks,” says Vaz.
Investors also need access to the National Grid and Distribution networks. “There are only a limited number of new grid connections being offered by grid operators,” explains Vaz. “With no grid connection a battery project won’t be able to realize its potential, even if batteries prices fall further.”
Despite these concerns, the House of Commons Energy and Climate Change Committee recognizes there “is immense opportunity for the UK to harness the potential of the storage industry and become a world leader in this technology”.
The experience of the United States, where an entire industry has developed on the West Coast, suggests the challenges around battery storage deployment are not insurmountable, so long as there is state support and legislative incentives.
As the committee acknowledges, by breaking down some of the regulatory barriers faced by the storage industry and providing a signal to the market on its importance, the government could help to unlock further investment.
* Investment professionals are members of AIA/AIC's Participating Affiliate, Aviva Investors Global Services Limited ("AIGSL").
** Based on GBP/USD exchange rate as of August 8, 2017
1 The energy revolution and future challenges for UK energy and climate change policy, House of Commons Energy and Climate Change Committee, October 13, 2016
2 Coal Generation in Great Britain, Department for Business Energy & Industrial Strategy, November 2016
3 World Nuclear Association: Nuclear Power in the United Kingdom, May 2017
4 Brexit and the failure of the Conservative Party to gain an overall majority in the June 2017 election has cast some doubt on whether the government’s decision to progress with Hinckley Point C, which is being built by EDF of France, is sustainable.
5 Society of Motor Manufacturers & Traders, EV Registrations, June 5, 2017
6 Go Ultra Low, (government and industry-backed campaign), July 2016
7 BP Technology Outlook
8 Electrifying insights: How automakers can drive electrified vehicle sales and profitability, McKinsey, January 2017
9 National Grid brings forward new technology with Enhanced Frequency Response contracts, National Grid Press Release, August 2016
10 Daily Telegraph, New batteries to help Britain keep the lights on, August 26, 2016
11 Network charges are a cost-recovery mechanism charged to consumers and suppliers for the costs incurred by the electricity transmission and distribution networks operators to balance electricity supply and demand whilst maintaining its frequency stable.
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