Investors will benefit keeping an open mind when looking at the structuring of arrangements for the optimisation of flexible assets. Some of the key themes covered in the discussion are set out below.
As flexible assets become more important to the UK's electricity grid and technological change in this area accelerates at a rapid pace, there is much uncertainty around the right route to market, the place of flexible assets in portfolios, and how optimisation contracts should be structured to attract investment and deliver maximum return on investment.
The two schools of thought – short or long term contracts?
The speed at which the market is evolving and the pace of technological change makes it hard to know how best to structure commercial arrangements. Given the nascent nature of the market there is no standardised approach (and, indeed, there is doubt whether a market-wide standardised approach will ever develop).
Many investment committees remain tied to a need for revenue certainty in some form, which stems from years of investment in subsidy-backed renewables. The market uncertainty is a significant concern for some investors and they therefore favour longer term contracts, often with price floors, to provide that certainty.
The opposing view is that longer-term contracts tie you to one optimiser/market solution and do not allow you to capitalise on market changes. This group are willing to take merchant and change risk in order to stay abreast of new products and to ensure they are linked to the best market aggregators.
Floor prices – good or bad?
Revenue stacking is now an accepted part of the landscape for battery assets but the stack composition is steadily evolving. Predictions are that wholesale and capacity market trading will exceed ancillary services revenue in the future.
A segment of the market is reliant on floor prices to unlock investment. However, as the floors currently being offered are well below merchant returns, some investors consider these to be an expensive form of insurance and prefer to proceed without. This latter community consider that, where a floor is included, the floor revenue just goes towards servicing the debt and you end up with a similar merchant profile but at higher cost. Parallels were drawn between the merchant profile here and the position where an investment committee takes merchant risk on renewable obligation certificate-subsidised renewable projects with high debt levels.
The potential benefit of diverse portfolios, which include flexible assets as well as renewable generation, is that they provide a natural hedge that captures some volatility, which is attractive to some investors. Others however have a pure battery play and are not interested in a portfolio position – much is driven by the attitude or goals of any overarching fund.
As renewable subsidies fall away and there are less regulated revenue bases, floors may become more prevalent but the general feeling was that, at the moment, they can assist in getting projects developed but at the cost of equity returns. Investors should remember batteries are a different asset class and that investing on a merchant basis may be where you can unlock most value.
Modelling by Aurora Energy Research shows there is value in batteries year on year even in a volatile market. The question is what is needed to get investors and then debt providers comfortable? 573MW of battery storage was awarded a contract in the recent 2021 T-4 Capacity Market auction; these contracts can provide some revenue certainty to investors.
What level of oversight should asset owners and investors have?
It is recognised that the aggregator market is very competitive and aggregators utilise advanced artificial intelligence and data technologies that are growing more complex. Again there was a divergence of views as to the extent that asset owners should oversee strategy and direction for their asset leaving aggregators flexibility in day to day management. Some saw leaving flexibility to aggregators as crucial to ensuring the most is made of their skill set and software, others were concerned about the degree of value leakage if optimisers were not held to close scrutiny. A useful tool to balance some of this tension is to include flexibility in the contract to allow for market changes and new products, along with transparency in the services and the prices being provided to ensure strong performance.
There are no answers, only questions
Given the market is nascent and rapidly evolving there is no set "right" way to bring battery optimisation to market. In this climate, each asset owner and investor should take the time to challenge and understand the underlying assumptions, trading approach and risk allocation. This understanding and clarity is the key to gaining a competitive advantage. That will then drive the approach to the relationship with the optimiser and papering of the commercial agreements. To get the most out of flex assets, asset owners and investors will need to retain a flexible mindset.