INSIGHTS

Risk vs. Revenue: a take on commercial battery arrangements

INSIGHTS

Risk vs. Revenue: a take on commercial battery arrangements

Octopus recently announced their new battery lease agreement (also called a tolling agreement) with Gresham House, whereby they will manage 900 MWh of Gresham House’s portfolio. This news got me thinking about the nature of commercial agreements offered to battery owners by route-to-market providers, or aggregators for short.

Let’s start with the tolling agreement – it’s essentially a rental agreement for the renter to do what they like with the battery, within warranty confines. My first question is about the motives of the battery owner. We invest in batteries either to profit from market price volatility, or to mitigate volatility, so Gresham, by investing in batteries, are buying volatility and value their portfolio according to the financial modelling that reflects that. To give up all the upside that granting a tolling agreement does, means that either a) the tolling value is considerably above the valuation of those assets that they have in their books, or b) they think there is a significant risk that volatility is going to decrease over the tolling term. And, of course, the opposite is the case for Octopus.

Tolling agreements therefore aren’t that prevalent because typically the buyer doesn’t want to risk a monthly committed payment at the level the toller wants or needs, which is unsurprising given how variable battery incomes are month to month. However, there is probably more scope for specific tolling agreements – for example, we would consider offering a call option through the winter at a strike price on a particular block – say block 5, for example. This is useful to some market players, like suppliers, and involves a far lower level of financial commitment.

The next level of commitment, and a greater level of risk sharing, is the floor. With a floor, the battery owner is guaranteed a minimum monthly revenue and a proportionate share of anything made above that level in the month. This means the storage owner is in a position to benefit from any upside should the month prove volatile, and the offtaker (the one buying the resources) is taking less risk in terms of guaranteeing payment, as payments will be less than under tolling agreements. Let’s not forget that in the purely merchant market that battery storage operates in, these guaranteed payments have material cashflow implications for the aggregator, a fact that asset owners need to think about when choosing a counterpart. So, the ratio of risk and reward changes here, tilting slightly from the aggregator to the owner.

A variation to this arrangement is the cap and floor, where the owner gets the first portion of the month’s income, the aggregator the next, and then above a certain level (the cap), the two parties share the upside on a proportional basis.

The last type of agreement in common use is the pure merchant revenue sharing arrangement. In this case, the owner stays completely exposed to market upside – and downside – possibilities, and relies on the aggregator to deliver the maximum revenue possible, for which they will earn a share of the rewards. Thus, there is considerable risk for the owner in the choice of aggregator, and whether said aggregator can deliver on their promises – whilst for the aggregator, this arrangement is in the nature of a free option, barring their operational costs specific to the asset. In this arrangement, the aggregator only earns a small percentage of the net revenues.

As more and more batteries come online, owners will weigh up the size of the opportunity against the risk in the various arrangements, and the beauty of them is that the levels and revenue share proportions can be played with and adjusted until a mutually acceptable arrangement is reached. The only real limitations are a) on the aggregator side, the arrangement has to be sufficient to meet the costs of integration (not inconsiderable) and operation, and b) on the owner side, the requirement for a minimum investment return.

1st August 2024

by Mark Meyrick

STORIES

Why are we here?

Hello and welcome to Ecotricity Smart Grid’s newest product launch - Ecolibrium.

Ecolibrium is, essentially, our Virtual Power Plant (VPP). We developed it to enable the batteries we’re developing to have a route to market. We didn’t want to use existing aggregators because – to be honest – we looked at what was on offer and didn’t think it was very good, in terms of contracts, transparency, risk-reward balance - but most importantly, in terms of ‘good’ optimisation.

What do I mean by ‘good’? I mean an optimiser that can assess all the revenue possibilities and consistently make decisions that create the best possible revenue outcomes alongside sympathetic battery utilisation.

We quickly realised that the models and platforms we were building had broader applications than just batteries – they could also be used to opportunistically turn down generating assets against revenue opportunities from the Balancing Mechanism or system imbalance price. And we have done this very successfully, as well as partaking in the Grid’s ‘pandemic scheme’, the Optional Downward Flexibility Mechanism, when demand crashed.

So here we are – with architecture and a platform suitable for not only our assets, but for anybody’s asset or battery. Indeed we’ve been running a co-located solar-battery site in South Wales for the last 2 years as we’ve been developing our models and platform.

I’m genuinely excited by this development, which has been painstakingly created over the last 4 years. We have some really smart and engaged people who understand the energy and tech space, we have an insightful revenue estimation model where clients can get a realistic revenue estimation for their assets. And last but not least, we are very transparent – so our clients always know exactly what’s going on with their assets and why, through their portal account on our website.

What is Flexible Energy and Why Do We Need It?

The National Grid Electricity System Operator (ESO) is tasked with balancing the supply and demand of electricity on the grid every second of the year to keep it close to 230 volts and 50 Hz. Energy flexibility refers to the ability to adjust generation or demand to maintain this balance. To be compliant with Net Zero targets, the methods of achieving this balance are evolving.

Changes in Generation

If we look back to 2008, Britain’s electricity generation was dominated by power plants running on fossil fuels, which accounted for three quarters of the fuel mix. While these traditional generators are dispatchable and can turn up and down to match the demands on the grid, they are also carbon intensive. Fortunately, there’s been a shift towards renewables, and last year saw more than half of Britain’s fuel mix come from zero-carbon sources. However, there is still more that must be done, and flexibility is key to unlocking the full decarbonisation of the grid.

Last year saw a significant milestone of wind and solar generation accounting for over a third of Britain’s energy. This shift towards renewables is changing the energy landscape as they’re intermittent sources of energy. As more and more renewable projects come to fruition, there will be greater variability in generation driving the need for flexibility - and the way in which the grid is operated must adapt to make the most use of these resources.

Increasing Demand

With the electrification of heat and transport, electricity demand is expected to rise. This will require increased system capacity and upgrades to transmission and distribution networks. However, this rise in demand also opens new opportunities for flexibility.

Types of flexibility

Energy Storage

One key source of flexibility is the conversion of electricity to other forms of energy which can be stored. Examples of energy storage include compressed air as elastic potential energy, pumped hydro as gravitational potential energy, flywheels as kinetic energy and BESS (battery energy storage systems) as chemical potential energy. These methods of storing energy vary in terms of the capacity of energy that can be stored, their power, efficiency, ramp rates and duration.

With decreasing costs and increasing energy density, BESS assets are rapidly being deployed across Britain. They offer high efficiencies and are instantly available compared to more traditional power stations, making them ideal for load shifting (from high generation to low generation moments) and frequency response services. Storage assets are the most versatile form of flexibility as they can be utilised to both increase or decrease demand and supply.

Supply Side Flexibility

During periods of high demand, the traditional form of flexibility is the use of gas peaking power plants which increase the supply when called upon. However, the supply side of flexibility also includes renewables such as wind and solar. They may be entered into the Balancing Mechanism so that they can be turned down when generation is greater than the demand for power or if there are network constraints. Additionally, wind and solar sites may be co-located with a BESS asset which unlocks further flexibility.

Demand Side Flexibility

Electricity demand follows typical profiles which follow daily, weekly and seasonal patterns. Demand side response alters this profile to shift load from peak to off-peak periods. Certain industrial processes are well suited to this load shifting and in recent years a more distributed domestic approach is beginning to emerge. Time-of-use tariffs are one such example whereby EVs, domestic batteries and heat storage can have smart controls to allow flexibility in this space.

Interconnectors

Interconnectors are the sub-sea cables that link up Britain’s electricity system with neighbouring countries. The flow of electricity is dictated by the markets, meaning it will flow from systems with low prices where there is high supply/low demand to systems of high prices where there is a low supply/high demand. In a similar way to the Balancing Mechanism, the ESO is also able to utilise in the very short term the flexibility of interconnectors to ensure the system is balanced.

What We’re Doing

Here at Ecotricity Smart Grid, our team of energy, software and data experts have developed Ecolibrium. As the name suggests, this is our service which helps the ESO to keep the system in balance. We act as a route-to-market for energy storage and fossil-free generators. Ecolibrium connects to these assets and dispatches them according to the best-suited market or service at any given time.