No country for old men – is it becoming too hard to be an early mover in the UK battery energy storage market ?

This is of course great news for BESS developers who are about to enter the emerging storage markets across Europe and are full of zip and youthful enthusiasm. It is of course equally terrible news for BESS developers who entered the same markets in the last 5 years and are now facing the harsh reality that there is no financial compensation for being old in these markets. Storage differs massively from generation in this critical aspect, older BESS systems have to compete on exactly the same playing field as their younger cheaper peers without any compensatory reward. If we look at solar or wind, the prevailing orthodoxy from virtually all governments has been to encourage early adopters with subsidies or for later projects Contracts for Difference. These support mechanisms carry on for 15 – 20 years so the pioneers with old expensive technology have some form of advantage against new entrants with a cheaper version of the same thing. We see this phenomena very starkly with the UK Feed in Tariff (FiT) for electricity for wind and solar. The very early adopters were given FiT rates as high as GBP 250 per MWhr but quite quickly these were reduced for new entrants as technology prices came down. However and here’s the nub, the early adopters retained these exceptionally high subsidies for as long as 20 years and the consequences of this was that they were protected to some degree against falling technology prices. This makes old projects profitable and very valuable as they have a high degree of risk free income.

With BESS, none of this good stuff applies. Every day or even every 15 minutes, the grid place requests for ancillary services and all of the existing BESS operators have to go head to head on the same terms. The players in the two most revenue generating markets, ancillary services and arbitrage all compete on the same two playing fields and it’s a new competition every hour every day. There is no differences between the age of systems so our old GE BESS system which cost maybe USD 300 per KWhr in 2020 is now competing against a cheap and cheerful Chinese import costing less than USD 150 kWh. And as we see in the UK, this has been bad news for incumbents. The listed Gresham fund has 690 MW or 788 MWhr of BESS capacity and this represents 17% of the UK market. However their revenues fell 38% to GBP 38.7m in 2023 because of, amongst other things, market saturation and this took the fund from a GBP 217m profit in 2022 to an eye watering GBP 110m loss in 2023. The market cap of the group is now GBP 328m for those 690 MW and I am going to hazard a guess that they paid a lot more than that for those MWs originally. The market cap discount to net asset value is an eye watering 60%.

The pressure on all BESS incumbents is twofold, the threat of new entrants with cheaper technology and any reduction in demand. The UK has about  2 GW of BESS capacity already installed, and this is expected to grow to 12 GW of capacity by 2030 and 21 GW by 2050. There is over 95.6 GW of battery projects in the connection queue and this has grown by 2/3^rd in the last year which is genuinely surreal considering the total capacity of the grid is less than half of that. However annual revenues are declining from a peak of circa GBP 200k per MW in 2022 to maybe GBP 70k per MW in 2024 and dipped as low as 50k per MW in 2023.  

As the value of the ancillary market per MW markets declines due to saturation, the percentage of revenue BESS operators derived from wholesale arbitrage markets will inevitably increase. If we look at the ever helpful Gresham accounts, we see that 31.4% of their revenue in 2023 came from ancillary services, a decrease from 48.4% in 2022 and the amount of income from arbitrage rose from 10.6% to 25.2%. The overall arbitrage gap (i.e. the difference between the lowest and highest price in a 24 hour period) in the UK and European power markets has increased dramatically in the last few years as more low price solar and wind becomes available during the day. The duck curves referred to in our last blog are now appearing in Europe and intra day variations as high as EUR 200 per MW are not uncommon.

However, arbitrage is only once a day event at best and favours 1 hour systems rather than 2 hours ones as the first hour is typically more valuable. Arbitrage is also probably where value destruction by cheaper new entrants is going to be fiercest as the product is homogenous and the marginal cost of participating is virtually zero, so it is always going to be a daily price war. There’s also no disguising the fact that arbitrage markets have no absolute floor or peak and so for infrastructure funders, continuous daily price wars in bottomless merchant markets may seem a long way from the low risk world of project finance they are used to.

Furthermore, the peaks in the arbitrage cycle are directly linked to the wholesale gas price as peak price is usually set by the gas generators. This was fine when gas prices were very high. But they have calmed down massively in the last few months and as I write the wholesale gas price quoted on the TTF exchange is below the 2 year average and less than it was in 2011. As we know, low gas prices reduce electricity arbitrage spreads across the whole of Europe not just the UK.

The second risk for older BESS operators is whether the ‘problem’ of grid balancing which drives demand for ancillary services can be met from other sources. Unlike generation, BESS doesn’t add net electrons to the system, it either takes them out or puts them back but over the course of 24 hours the net effect is typically zero. BESS only solves a problem; for the grid of frequency imbalance, it doesn’t increase the overall amount of renewable generation. The risk for the BESS operators is that this problem can be solved by other emerging mechanisms such as demand side turn down, increased use of renewable turbine based generators such as bio mass and bio gas and even using domestic electric vehicle batteries as mini grid balancers.

As the European grids become more interconnected, other grid based solutions to frequency imbalances will also emerge. A great example of this occurred very recently in the UK on 12^th May 2024 when the sudden sunny weather coupled with windy conditions out to sea meant that the grid had to pay to fire up gas power stations to put more spinning inertia into the system. As it was a Sunday, demand was depressed so to create the headroom the UK grid were simultaneously reversing the interconnectors and paying our bewildered but no doubt grateful European grids GBP 500 MWh to absorb mainly wind and solar derived power from the UK system. This was revenue that could have gone to UK BESS operators, but I suspect their batteries were full quite quickly so our European friends benefited. This sort of thing will become more common over time as improvements in interconnectivity add to the existential threats to UK BESS operators. In effect, better interconnectors between countries enable domestic grid operators to export/import solutions to the problem of volatility rather than pay high prices to local BESS suppliers.

So, all in all, the long term outlook for BESS in the UK and elsewhere is unclear, particularly for early market entrants. Unlike being given your seat on a tube, there is no compensation in the BESS market for being old and I think its a fair bet that not many people who entered this sector 5 years ago assumed either quite such a precipitous decline in battery system prices or that it would open the door to quite so many competitors. Obviously demand for BESS will grow as spinning inertia declines,. But its far from obvious that the growth in demand for ancillary services, which pushes up revenues, will outstrip the counter force of growth in capacity (powered by ever cheaper technology costs) which obviously pushes them down.

The rapid decline in UK BESS revenue from 2022 to 2023 may have been a freak one off but may also be portentous of further shocks to come. I have no doubt that Gresham’s  GBP 100m loss in just 12 months from just 690 MW of installed BESS capacity may have had quite a few infrastructure funds pausing to suck a thoughtful tooth. Gresham are the dominant player in the UK market and probably one of most sophisticated BESS traders in the world.  If they can’t make money in the UK market then who can? There are always other renewables markets and suddenly UK BESS doesn’t seem as low risk as it may have first appeared. Add to this the fact that the ‘problem’ of declining revenue from ancillary services is seen by the Grid as positive not a negative. The Grid would dearly love to not be paying GB 70k per MW per annum for no net gain in electrons so are understandably actively exploring other solutions.

In conclusion two things I’ve learnt from getting old is not to draw conclusions or make predictions about pretty much anything. The world is more not less random than it first appears. Eventually battery prices will bottom out and some sort of equilibrium will emerge in both the ancillary and arbitrage markets but as the old adage says, markets can remain irrational a lot longer than you can stay solvent.