The key to net zero? Opportunities and challenges in the BESS industry

Widespread concern about the effects of climate change has led to a surge in industries that offer environmentally ‘clean’ solutions to domestic energy storage. In June 2019, the UK Parliament passed legislation that required the UK to be a ‘net zero’ emitter of greenhouse gases by 2050. This shift in governmental policy has accelerated the pace of advancements in the green energy industries.

What are BESS and why is there such an active market for them?

The basic principle of these technologies is that surplus electric charge can be stored using dedicated batteries, which is particularly useful for intermittent energy sources such as solar and wind. This stored energy can then be released at a later time, for example, when the demand on the grid is higher.

Historically, high cost and planning restrictions were a barrier to growth for the Battery Energy Storage Systems (BESS) industry. In recent years, however, the huge growth of the Electric Vehicle market has continually driven down the price of lithium-ion batteries, thereby increasing margins. By way of example, September 2020 saw a 184% increase in pure-electric registrations compared to the previous year and a demand for electric charging is being created that the UK domestic grid cannot currently supply. Planning restrictions have also changed in a significant way in the last year, opening up the market for larger scale BESS projects to a wider range of participants. With 1.8GW of battery storage systems installed in the UK as at January 2021, the aim is for 35GW by 2050.

Sources of BESS revenues

BESS projects can be particularly lucrative by obtaining ‘stacked’ revenue streams. These include, but are not limited to:

1. Capacity Markets – participants earn revenue for entering into commitments under a statutory contract called a ‘Capacity Agreement’ with the Government. These Capacity Agreements provide a back-up electricity supply to meet peak demand at times of system stress. These have a duration of up to 15 years.
2. Dynamic frequency response – extremely valuable source of income, however, contracts with the National Grid have a typical duration of two years. Under these contracts the operator responds to fluctuations in the demand on the National Grid by increasing or reducing its energy consumption. This is organised through the Dynamic Containment Service.
3. Offtake Agreements – these Agreements are with a consumer for a negotiated price. The contracts are called Power Purchase Agreements. These can be lucrative, however, the lender must consider the creditworthiness of the off-taker. These usually last for over 15 years.
4. Price Arbitrage in wholesale markets.

Opportunities and considerations for lenders

The wide range of potential revenue streams that can be achievable for a BESS project means that lenders have a number of potential ways to structure their facilities in a way that minimises risk. The most obvious being:

• borrowing base facilities: these facilities fluctuate with the value of the revenue under the various qualifying offtake agreements, thereby protecting the lender against borrowings being too high a percentage of revenues.
• asset finance facilities: traditional project finance structures looking at both projected revenue streams and also the value of underlying assets as sources of repayment in the event of an enforcement of the security.

However, matters for consideration for lenders include:

1. If adding BESS to a pre-existing generation project, you must ensure that the developer’s lease allows for this, and that all other grid connections, planning permissions, wayleaves and consents that are required are ascertainable and achievable.
2. The predictability and stability of the underlying assets need to be analysed carefully in BESS projects. Lenders need confidence in the performance of the battery over time and in the developer borrower’s proposed programme for replacements and upgrades. Usage patterns that maximise short term revenues may actually accelerate the degradation of the battery technology, requiring more frequent replacements, or invalidate the warranties.
3. Whether a developer will be able to extend their lease at the end of the term, and what the consequences are of a lease ending.
4. The types of revenue stream that it has and forms of security that it can take over and transferability of those assets (with the movability of the asset and the warranty protection on offer to be considered).
5. Decommissioning – responsibility for the cost and safe disposal of batteries, both during and at the end of the project. Also to be considered in the context of enforcing security and landowner requirements for bonds or other security for performance of the decommissioning and reinstatement obligations of the tenant entity.
6. The terms of any direct agreement required by the lender with the freehold landowner and whether the developer borrower’s lease provides that the landowner is obliged to enter into one.
7. Mainstream property due diligence considerations; like any other real estate finance project, the land interest should be analysed for title defects and saleability in the normal way.

Conclusion

In summary, the BESS market is going through huge growth due to the increase in demand forecasted over the next two decades. The need for investment and development combined with the range of potential income streams provides a wealth of opportunities for lenders, land owners, investors and developers but a full understanding of the underlying project, connection arrangements and contracts is key in deciding the feasibility and fundability of a project.

To the extent that you would like to discuss BESS, please contact: Gemma Goddard, Alex Schaafsma, or Jeremy Stanton.