Financing the Energy transition – Funding battery storage projects

With storing electricity vital to the UK's efforts to hit net zero, we assess the obstacles and opportunities

The ability to store electricity that is produced by renewable energy projects is crucial to maximising efficient energy use and securing the UK's energy supply in the face of global upheaval, as well as accelerating the transition to net zero.  Energy is generated intermittently by wind or solar projects, for example, depending on the weather or the time of day, and does not always correlate with demand.  Energy can be stored in a number of ways, depending on the source, but the most common is in chemical batteries.  In this briefing, we look at some of the considerations for financing battery storage projects.

While financing the storage of electricity has often been carried out on a low-leveraged, corporate or portfolio basis, as the size of battery projects increases, we are now seeing more typical SPV non-recourse project finance structures, with a full security package. Given the current constraints on grid connections, we are also seeing some projects being co-located and financed alongside other energy generation projects, such as solar. Battery storage project financings tend to have finance documents which mirror those seen in a renewables project financing, though they raise a number of additional issues, particularly in relation to structuring repayment profiles around their complex revenue streams.

Key concerns for lenders

Uncertainty and complexity of revenue streams 

The available government subsidies for battery storage in the UK do not currently form a sufficiently significant and stable revenue stream to ensure battery storage project financings are fundable on the basis of capacity market or ancillary services alone.

The income stream for a battery storage project is therefore usually more complex than on renewables projects, which often benefit from the existing Contracts for Difference regime. Battery storage revenues are typically derived from a combination (or "stack") of revenue streams, including from wholesale market revenues, revenues from supplying services to National Grid Electricity System Operator (which may be under long-term contracts) and capacity market revenues (which can be for up to 15 years). These may be managed via an optimisation agreement with an energy aggregator or offtaker, who will take a management fee for maximising the available revenue, and potentially offer a floor price for the revenue generated.

Financing arrangements can mitigate the risks associated with this complex stack in several ways:

• Where battery projects are co-located with renewables projects (which is becoming increasingly prevalent), the more stable income streams of the renewables project (given CfD support, for example) can be used to increase the confidence in the overall project's revenue streams and improve the bankability of the project.
• Battery storage financing structures usually involve a greater proportion of equity funding than would be typically seen on a renewables project and a shorter tenor of facility.
• Cash sweep mechanisms are often seen, to ensure that free cash is used to repay debt.
• The creditworthiness and experience of aggregators and offtakers will also be of interest to the lenders.
• And finally, different financing structures can be used to address the specifics of deals. For example, borrowing base or portfolio facilities may address fluctuating cashflows between projects and differing stages of development.

Asset manufacture and stability

Battery manufacture involves a complex supply chain, and the performance of the technology used is crucial to the viability of the energy storage project.  Adequate manufacturer's warranties will be a key part of the financing package, and lenders may wish to explore direct recourse against manufacturers via collateral warranties if the assets are an important part of the package. The use of the battery within the ambit of those warranties will also be important and will need to be balanced against contractual obligations to deliver energy under the various revenue-generating agreements described above.

Co-location

Where the battery is co-located with a renewables project, how will the battery storage project interact with the existing arrangements?  This is particularly important in relation to:

• the real estate (such as leases and planning permissions);
• grid connections, where additional capacity is often required;
• the development and continued smooth operation of the renewables project;
• available subsidies and interactions with Ofgem; and
• the renewables project's financing and other contractual obligations.

Regulatory issues

Battery energy storage is considered generation for regulatory purposes and requires a licence from Ofgem under the UK Electricity Act 1989 unless an exemption applies (for example, being a smaller capacity).

Grid connections are in short supply: as we accelerate towards net zero, with the huge accompanying increase in demand for electricity, the pace of accommodating connection requests to the grid cannot keep up.

The UK Government has recognised the crucial importance of renewables in generating electricity in its Energy Security Plan, and has announced a raft of measures aimed at improving networks and grid connections, which will hopefully remove some of the hurdles to developing and financing battery storage projects. It will be interesting to see these develop in the course of 2023 and beyond.

We have considerable experience in both battery manufacturing and in financing battery storage projects, as well as in the myriad of regulations that affects these markets. If you have any points you would like to discuss, please do get in touch with one of the team below.

For more information on financing the energy transition, read our previous article on the role of smart meters here.