Legal Briefing

Energy storage – the answer to the UK’s power trilemma?

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Projects, energy and natural resources | 13 June 2016

Unsurprisingly, one of the hot topics of the moment is energy storage. As anyone connected with the energy industry is aware, the prospects for decarbonising our electricity system at the same time as ensuring secure and affordable energy seem to be reaching further into the future.

Addressing the so-called ‘trilemma’ of decarbonisation, security of supply and affordability has been at the heart of government policy for years. Meeting two of the objectives is easy enough but achieving all three is proving more of a challenge.

The essential problem is that renewables (or at least the established technologies) decarbonise supply and are affordable but not secure. Nuclear decarbonises supply and is secure but less affordable. Gas-fired power is affordable and secure, and if it replaces coal, it reduces CO2 emissions. But if it replaces nuclear, it increases CO2 emissions. The added problem is that renewable generation is variable and nuclear is not despatchable (it needs to operate on a constant basis) and therefore nuclear is unable to provide additional power at times when renewable generation is low.

The challenge

If nuclear could provide all our electricity supply safely, we would be able to rely solely on nuclear – this was the dream back in the 1950s when it was forecast that the cost of producing power would be so cheap it wouldn’t be worth metering. It is clearly not going to do that – £92.50 per MWh is the agreed price for Hinkley Point, somewhere between two and three times the current market price. Even at these prices, nuclear could not provide all our power – it will be at least 2025 before Hinkley Point is generating. The only conclusion we can draw is that renewable generation is required if we are to decarbonise our power supply.

The second conclusion is that despatchable technologies must be used to complement the deployment of renewables. It is true that we can make more use of technologies to match demand to the availability of supply. Nonetheless, there will always be times when additional power is needed. The UK government’s answer to the need for more despatchable supply appears to be the deployment of new gas-fired power stations.

Technologically, gas-fired power is despatchable but, as we noted above, if it replaces nuclear, it has the effect of increasing CO2 emissions. Since the UK, particularly Scotland, has several nuclear facilities reaching the end of their lives (EDF recently extended the lives of its nuclear plants to 2030 but this cannot continue indefinitely), the use of gas-fired power stations is not an ideal solution.

The third and unavoidable conclusion is that the only way we can decarbonise our power supply is if we can develop low-carbon technologies that are despatchable. Biomass combined heat and power could be one, but it cannot alone provide the solution. Tidal, hydro possibly, but again they do not have the potential capacity to provide a total solution. Carbon capture was once all the rage but the UK government has withdrawn support and it does not look as if it will be a viable technology for some time, if ever. All of which leaves energy storage as the only technology we currently know of that could potentially be deployed at scale, and could be low carbon and despatchable.

Potential deployment

Reports on storage are released at an ever increasing frequency. We will mention only two. Firstly, the Carbon Trust released a report this year stating that energy storage could save up to £2.4bn per year by 2030. The second report was also released this year by the National Infrastructure Commission. It is called Smart Power and contained this statement: ‘Crucially, storage technology will not need subsidies to be attractive to investors – businesses are already queuing up to invest.’

A rosy picture indeed, and one which would answer the prayers of policymakers worldwide. Can it really be the case? If, by investing in storage solutions, investors are able to unlock and capture those forecasted savings of £2.4bn per annum, a large amount of storage could indeed be deployed and paid for by private investors. So why isn’t this happening now? The Smart Power report did identify the current regulatory regime as a barrier to investment.

It must be correct that the current regulatory structure is not conducive to the deployment of storage projects. The policy questions are two – how to change it and will that be sufficient to unlock investment? We will come back to the first question later, but first we will address the second point, given that it is such a startling conclusion from the Smart Power report.

The economics of storage

Storage takes many forms and can be deployed at many different points over the network. However, the issue we are looking at in this article is how to ensure that supply and demand are always in balance. Two possible storage deployments that can address this requirement are storage on the generation side of the meter and a stand-alone storage project that draws electricity from the network to store.

Let’s look first at the economics of the first type of scheme. In Scotland, that would most likely be a storage project located at a windfarm. The question then is whether the deployment of storage could improve the project economics. Storage would potentially allow the windfarm to delay export to a time when demand, and therefore the price, is high, thereby obtaining a better price for its power. The primary difficulty for an investor is forecasting the amount of the additional revenue – will it increase sufficiently to provide a return on the investment in the storage facility? The nature of price volatility means that the additional revenue is inherently unpredictable.

This description of the additional revenues could not be realised where the windfarm operator is entering into a long-term, fixed-price Power Purchase Agreement (PPA) to sell its power, a common technique for independent developers, since the price to the generator would always be the same. Many PPAs, however, pay a market rate for power subject to a floor price. The PPA provider hedges its risk based partly on weather forecasts that effectively determine likely output. If you introduce a person or an algorithm to change the time at which the power is exported, it will add a new uncertainty into the hedging strategy. Of course, the storage facility ought to reduce a windfarm’s exposure to balancing risk, but it is far from clear how a PPA provider can value the reduction in that exposure, at least at present.

If the windfarm has a Contract for Difference (CfD), the generator will ultimately receive close to the agreed strike price for every MW of power exported, which means there is no incentive to store power to increase the market price of the power, since all that will do is reduce the amount of the CfD payment. In short, the very purpose of introducing the CfD was to remove price risk for investors. In storage, the primary commercial case is the ability to delay export to secure a higher power price, which requires investors to have exposure to price risk! In other words, a CfD will deter investment in storage facilities at CfD plants.

The second source of revenue for storage projects is their ability to provide system services – usually called ancillary services. These generally relate to maintaining the quality of power on the system and are procured by the system operator – currently National Grid. In the case of pumped storage facilities they also provide back-up power services. However, all these services are currently procured on short-term contracts, which are valuable to existing capacity but will not by themselves support investment in new capacity, since developers cannot be sure their contracts would be renewed.

Support mechanisms for energy storage

Clearly there are quite a few barriers to deployment of storage projects at present. Ultimately, it comes down to the Secretary of State for Energy and Climate Change Amber Rudd’s comment back in November 2015 that no new generating plant is built without some form of support. Why should storage facilities be any different? They are after all, as yet, unproven technologies with uncertain economics. We are of the view therefore that some form of support will be required if storage projects are to be deployed at scale on the GB system.

What form could this support take? There is one that already exists – the capacity market. However, in its current form, it is not encouraging the deployment of new generating capacity, other than new small-scale diesel generation capacity. Not a single new-build energy storage project won a capacity market contract in the latest auction at the end of 2015. So it is not working for energy storage. If there is any consolation for storage, it is clear that the capacity market as currently designed is not encouraging new-build gas-fired power plants either, and therefore a restructuring of the capacity market is needed if it is to encourage any new generation capacity to be built.

While the government is keen to redesign the capacity market to promote the construction of new gas-fired power stations, the renewables industry may want to push for the redesign to also promote the installation of new storage facilities. It is worth remembering that the capacity market is operated under a state aid decision from the EU Commission. This decision states that the design of the capacity auction should give low-carbon generators a ‘preference’. It is clear from the results of the first two auctions that any preference is not sufficient to bridge the gap to fossil fuel technologies. So we should ask the question should the new design features of the capacity auction embed more credible preferences for low-carbon technologies in order to promote the development and deployment of despatchable low-carbon power?

It is possible that standalone storage projects could become viable in a redesigned capacity market. However, the capacity market cannot currently be used to promote storage being deployed generation side. Projects that have a CfD or Renewables Obligation support are excluded from participating in the auction under the no-double-subsidy principle. This would seem to be short-sighted in relation to storage. If CfD plants were able to compete in the auction, no facilities would receive two subsidies – the primary generation technology would have CfD support and the storage technology would have capacity market support.

Could there be a new CfD for storage projects? CfDs are reserved for low-carbon technologies and that would not be guaranteed if the storage project was drawing power from the grid. Could a new component be added to a CfD entitling any low-carbon project that also deployed storage to benefit from an additional revenue stream? It would require state aid clearance, and would require a review of the operation of the CfD auction, but it might be possible within the current EU guidelines on energy and environment since it would promote additional export (if not generation) of low-carbon power.

Finally, longer-term contracts for ancillary services, with a minimum take-up obligation, would help support investment. The difficulty is that a minimum take-up obligation would expose National Grid to the risk that it would not require the contracted level of service, a risk that would increase if contracts were extended to ten or 15 years. It is difficult to see how National Grid could accept such an exposure.

Conclusion

So where does all this leave storage? It is one of the most promising technologies capable of complementing the deployment of renewables, which itself is an essential technology if our power system is to be decarbonised. It is difficult to see how storage can be deployed at scale without some form of support. The types of support that could be designed include a redesigned capacity market, a CfD add-on component for storage, as well as long-term ancillary service contracts. None of these will be easy to deliver, but finding a means is key to designing the power system of the future.