Stacking the Deck: Unlocking BESS Revenue Streams
From Grid Stability to Profitability: The Business Case for BESS
Energy projects, particularly those involving capital-intensive ventures like LNG or renewables, often require substantial financing. While equity can be a source, debt is generally preferred due to its lower cost. However, securing debt for projects in illiquid markets can be challenging. To mitigate risks, lenders like banks often demand collateral, such as offtake agreements for LNG or government-backed Contracts-for Difference (CfDs) or Feed-in Tariffs (FiTs) for renewables. CfDs, in particular, provide a guaranteed revenue stream for renewable energy producers, making them an attractive option for lenders.
Battery Energy Storage Systems (BESS), unlike traditional energy generators, rely on multiple revenue streams like arbitrage, ancillary services, and capacity markets. This complex revenue structure can make securing project financing more difficult for BESS developers.
Like other commodities, power markets are volatile, making long-term price forecasting for battery projects a challenging endeavor. To incentivize battery deployment, some states have implemented auctions offering guaranteed prices per megawatt of installed BESS capacity through CfDs, or subsidies on BESS capital expenditures (CAPEX). Examples are the recent BESS tenders in Greece, Hungary and Italy. However, auctions might not be the most effective way to ensure efficient battery utilization.
An alternative approach is the tolling agreement, where a battery developer leases their system to a battery optimizer. Similar to a landlord or infrastructure owner, this model provides a stable revenue stream through a long-term contract, allowing the developer to utilize it for project financing. Please refer to my recent article:
Let's delve into BESS revenue streams. As previously discussed, BESS operate in various markets, generating income from diverse sources. Drawing from my experience with the German and European power markets, let's explore these revenue streams in detail:
Arbitrage: Arbitrage, a simple concept of buying low and selling high, is a key revenue stream for BESS. In Germany, arbitrage opportunities arise from price differences across the Day-Ahead (DA), Intra-Day (ID), and Continuous Intra-Day (CID) markets. While the day-ahead market typically employs marginal pricing, the continuous intra-day market often uses pay-as-bid pricing. Derivatives can also be used for hedging. However, liquidity constraints in some markets can limit arbitrage potential. The growing share of renewables has increased market volatility. While renewable energy sources offer lower operational costs compared to fossil fuels, the intermittent nature of renewables can introduce fluctuations in supply. In essence, there will be periods of surplus power with low prices, and other times with power scarcity and high prices, often referred to as 'Dunkelflaute.
Ancillary services: There is among many others, the Frequency containment reserve (FCR), automatic frequency restoration reserve (aFRR), manual frequency restoration reserve (mFRR), black start, reactive power and spinning reserve. While some are marketed through auctions, others are on auctioned on a regular basis and limited for BESS. Christian Schaefer runs a website tracking the FCR and aFRR market in Germany, see1. As more batteries join the grid, competition for FCR and aFRR services has increased, potentially resulting in market cannibalization.
Capacity market: Currently, Germany's capacity market doesn't explicitly accommodate BESS. However, there are discussions underway to explore ways to include them in future market designs. In contrast, Belgium has already implemented regulations allowing BESS to participate in its capacity market.
With so many revenue opportunities available, how can we maximize BESS profitability? Optimizing a battery isn't straightforward. Accurate bidding for day-ahead, intraday markets, and ancillary services is crucial, but miscalculations can lead to missed opportunities or penalties. Additionally, strategies like virtual trading and cycling, as explored in articles by Entrix2 and Flex Power3, can further enhance BESS revenue potential. To navigate this complex landscape effectively, BESS optimizers become indispensable.
Beyond traditional utilities and energy companies, a growing number of battery optimizer startups are emerging globally. In Germany, companies like Entrix, Enspired, Suena, Flex Power, and many more are leading the way. Even Tesla, known for its electric vehicles, has entered the market with its autobidder software.
BESS Project Evaluation
To model the project economics of a new BESS project, one approach is to analyze historical revenue data. While publicly listed BESS companies are limited, exploring financial reports of companies like Gorestreet Energy Storage Fund (GSF) can provide valuable insights, see FY report 20234 and 20245.
Based on the revenues, I conducted a quick valuation. The results, as outlined in the accompanying Excel sheet, are promising and demonstrate the project's strong economic potential for FY 2023, a period marked by elevated energy prices due to the Russia-Ukraine war. Despite the initial promise, a comparison of FY 2023 and FY 2024 revenues reveals the potential volatility of BESS income, see my excel sheet (tab 1)6.
Third-party providers like Modo Energy and BESS Analytics offer valuable data resources for the UK BESS industry. While Germany's BESS market may be less transparent than the UK's, relying solely on historical data can be misleading. The recent Ukraine-Russia war and the growing integration of renewables and electrification are significantly altering the power market landscape both on supply and demand side. These factors underscore the limitations of backtesting and the need for forward-looking analysis. No bank would provide any project financing based on historic revenues.
How can we model future BESS revenue streams?Forecasting:
Coming from an oil and gas background, I've encountered the challenges of price forecasting, particularly in the volatile oil market, see also recent article in Forbes7. Predicting power prices, especially at the granular level of day-ahead, intraday, and continuous intraday markets, is even more complex since often needed on an hourly or even 15min basis. Accurately forecasting these prices, including supply, demand, and ancillary services, requires a high degree of skill, expertise, and perhaps a touch of intuition - like gazing into a crystal ball. Given the inherent uncertainties in energy markets, it's essential to approach such forecasts with caution and consider the potential limitations.
Optimisation:
Once you've gathered granular price forecasts for the next 20 years, you can input them into an optimization algorithm. This algorithm, combined with your BESS's trading strategy and technical specifications (MW, MWh, cycling rates), will generate daily, monthly, and yearly revenue projections. These projected revenues can then be used to assess the project's overall economics.
What companies offer forecasting and optimization solutions for battery energy storage systems?When seeking forecasting and optimization services for BESS, energy consulting firms like Aurora, Enervis, Barringa, and Afrys can provide valuable expertise. They offer detailed market analysis, forecasting, and backtesting services, plus optimisation. However, BESS optimisation is not the bread-and-butter of energy consulting shops, as it involves specialized algorithm development. Thus, once you have forecasted pricing data, consider working with multiple battery optimizers to compare their revenue projections and benchmarking capabilities. This approach can help you identify the most effective optimization strategies for your specific BESS project.
Ultimately, the question is: Is this project bankable? To secure financing, you'll need to present a compelling business case to lenders. While project developers often maintain a positive outlook, banks tend to adopt a more cautious approach. Additionally, banks may conduct their own in-house analysis or require information about the chosen optimizer and their ability to maximize BESS revenues. To address these concerns, consider conducting a deterministic scenario analysis using high, medium, and low-case scenarios. Alternatively, a probabilistic approach can provide a more nuanced assessment, as discussed in a previous article.
However, this raises additional complexities, basically another pandora box….
Bottom-up ApproachFinally, using a bottom-up approach, I calculated that a BESS project would need to generate approximately 80 kEUR/MW per year to achieve a 10% internal rate of return (IRR), based on certain assumptions outlined in tab 2 of my Excel sheet.
Secondly, I explored the arbitrage potential of a BESS system. For a 2-hour system cycling twice daily, a daily spread of 70 to 90 EUR/MWh would be required to achieve a 10% IRR. However, with declining capital expenditures and longer duration BESS, this spread could decrease to below €50 per megawatt-hour in the future. While unexpected outages of power plants or interconnectors can occasionally lead to significant spreads exceeding €1,000 per megawatt-hour, ancillary services remain a crucial revenue stream for BESS. Moreover, a daily spread (min/max) of 70 to 90 EUR/MWh was not uncommon in the German DAM in 2024.
Disclaimer:
Image generated with Leonardo.ai8 and Gemini9 asked for some advice.
Please note that according to GoldmanSachs “Battery prices are forecast to fall”, see second chart in a recent publication10. However, the price in US$/MWh does not include other development, EPCIC, etc. costs.
Footnotes
Parts of the website are in German: FCR is basically PRL, aFRR is SRL. Many other good stuff on the website: https://www.regelleistung-online.de/