Volatility brings shift towards longer-duration batteries

Greater scarcity and higher, more volatile prices in power markets are bringing a shift towards longer-duration battery storage, according to a new report from LCP.

The consultancy highlighted the growing importance of revenue stacking as frequency response markets become saturated and wholesale, balancing and capacity markets more lucrative.

“Until now, the vast majority of battery storage capacity has been allocated to providing frequency response,” the report explained. “Battery storage’s fast response times and ability to be on standby to provide flexibility in both directions without incurring significant cost mean they are ideally suited to these markets.”

However, LCP said frequency response markets are “relatively shallow and we expect that they will become saturated this year.”

In October 2020, National Grid Electricity System Operator launched Dynamic Containment – the successor to its sub-second Enhanced Frequency Response trial and the first in its planned suite of three new frequency response services. The service was initially undersubscribed, with prices remaining at the cap of £17/MW/hr throughout most of 2021.

However, following revisions to the volume requirements and the introduction of shorter-duration four-hour contracts, which allowed batteries to move between markets within the same day, the price dropped below the cap for the first time in November.

LCP said the market has remained valuable, with prices averaging £13/MW/hr, but is expected to become oversupplied this year as more batteries come online. Although the ESO is set to launch its Dynamic Regulation and Dynamic Moderation services in March and April 2022 respectively, the report said the volume requirements will “typically be small in the near term.”

Meanwhile, other energy markets have been moving in the opposite direction, with skyrocketing gas prices, low wind output and tighter margins due to the closure or mothballing of coal, nuclear and gas plants, leading to day-ahead prices of over £1,800/MWh and balancing prices of more than £4,000/MWh in the second half of 2021.

LCP said the ten most expensive days in the Balancing Mechanism all fell within a few months, with annual balancing costs rising by £860 million. At the same time, network constraints meant wind power was curtailed on more than half of days, wasting 2.3TWh of electricity that could have been stored for later, reducing the upward pressure on household energy bills.

“While the news was poor reading for consumers, these events provided a clear signal of how battery storage is able to capitalise on volatile market conditions at times of system stress,” the report stated.

Charts provided by LCP showed the monthly average for intraday price spreads peaking at around £550/MWh in the Balancing Mechanism and almost £350/MWh on the day-ahead market in the autumn of 2021.

The consultancy said it expects spreads to fall from these levels in the coming years as gas prices return to more normal levels and more competition enters the market but said they are indicative of the long-term trend as the power sector continues to decarbonise.

“Above all, the changing nature of the system means that valuing market volatility is not just a cherry on top of an asset’s ‘fixed’ revenue streams but is a core piece of the puzzle, and understanding how ‘bankable’ volatility is, and how sensitive it might be to different market forces, is crucial,” the report said.

Those fixed revenue streams include the Capacity Market, which recently saw record clearing prices in both the year-ahead (T-1) and four-year-ahead (T-4) auctions of £75/kW and £30.59/kW per year respectively.

LCP noted the price volatility in the T-1 auction, which is partly used to “plug the gap” when more capacity is needed than was expected at the corresponding T-4 auction and cleared at just £1/kW last year: “Uncertainty in the energy market may mean we continue to see volatile prices at these T-1 auctions.”

However, the firm said prices in the T-4 auctions are likely to remain “relatively healthy” as older plants close and are replaced by non-firm capacity such as wind, solar and interconnection, whilst demand increases due to the electrification of transport and heat.

LCP said these trends are bringing a shift towards batteries with a duration of two hours or more: “These have a greater ability to capitalise on volatile intraday price spreads and benefit from being less heavily de-rated in the Capacity Market than shorter duration batteries.”

The consultancy modelled the revenues that could be generated by a 50MW battery with a one-hour and two-hour duration operating in both wholesale and balancing markets over recent years. It found revenues for the two-hour battery would average £60/kW per year compared to £34/kW per year for the one-hour battery.

Whilst not quite double, LCP said the two-hour battery also benefitted from significantly lower cycling rates, reducing the degradation and extending the life of the asset.

The report said this emerging shift was reflected in the recent Capacity Market auctions, with 3.3GW (1.03GW) of battery storage securing contracts in the T-4 auction, including 1.6GW (0.65GW de-rated) of two-hour storage.

LCP highlighted the risk from price cannibalisation, particularly in the Balancing Mechanism, which is “relatively shallow” when compared to wholesale markets.

Analysis of historical data covering 2018 and 2021 indicated 4GW of one-hour batteries would have been able to cover 50% of net imbalance volumes in the Balancing Mechanism, but 10GW would only have been able to cover 70%. The report said the amount of storage capacity needed to saturate the balancing market therefore appears to be “much less” than the current pipeline of battery capacity of around 20GW.

It likewise warned that in the Capacity Market de-rating factors for limited duration storage are likely to continue falling as more enters the market and they become more likely to become the cause of stress events when they run out of charge.

Commenting on the report, LCP partner Chris Matson said: “To date, batteries have primarily focused on supporting the energy system through the frequency response markets but in the coming years we are likely to see a change as these markets become oversubscribed.

“We have begun to see new strategies adopted to maximise returns not only from frequency but also from wholesale and balancing markets which offer a great opportunity for investors to stack their revenues.”

He continued: “The frequency response market will still be an important revenue source for shorter duration systems, but asset owners will increasingly be looking towards the lucrative opportunities in wholesale and balancing due to the current market conditions.

“For investors, as well as considering the right strategy that works across both one and two-hour durations, they will also need to consider where they are building the assets. Co-location alongside generation such as solar PV could offer long-term savings as investors make the best use of connection capacity and spread the cost over a larger revenue base.”