Next Generation Energy Briefing: opportunities from UK’s changing grid

Amid fierce competition for traditional infrastructure and renewables assets, and with the UK's electricity system undergoing widespread changes, investors are increasingly looking at grid-balancing technologies for opportunities – a trend at the centre of inspiratia's Next Generation Energy Infrastructure briefing with the Foresight Group last week

The UK electricity sector is at a critical juncture. As the share of renewables has grown, replacing ageing fossil-based generation, their intermittence is now challenging the system's integrity, which brings with it opportunities for grid-stabilising technologies.

As a result, battery storage, demand-side response, smart meters, peaking capacity and interconnectors – vital components of what is commonly called the smart grid – are becoming increasingly talked about by investors in both the traditional infrastructure and renewables markets.

But while the demand for such technologies is great and the pipeline potentially large, they often come with complicated revenue streams – sometimes uncontracted – and sit within an uncertain long-term policy landscape.

Batteries excite

This system change provided the backdrop for inspiratia's latest briefing – hosted by the Foresight Group at the Shard last Friday [16 September] – in which an esteemed panel of experts discussed the next generation of energy infrastructure opportunities.

At the top of the agenda was battery storage, which just three weeks earlier had made headlines as part of National Grid's enhanced frequency response (EFR) tender. In total, the organisation handed out four-year contracts to eight storage projects, totalling 201MW.

But it is the price of these contracts that garnered most attention, with the winners offering between £7 and £11.97 per MW per EFR hour – significantly below initial anticipations.

The inspiratia panel pointed towards some of the successful bidders' low cost of capital as one driver behind the eventual price, adding that others may have simply wanted to be among the first-movers. Either way, the winners will have made some aggressive assumptions on revenues post-year four.

Richard Thompson, a director at Foresight, made the point that in other recent auction processes – such as the contracts for difference or capacity market – similarly low prices had led to projects being economically unviable and ultimately not getting built.

"There is a possibility that not all of the projects that got through the EFR tender will get built because the returns are so low, and if that is the case, National Grid will need to look at how they procured those tenders," he said.

As an example, Foresight put in support letters for some bidders, but the EFR process hadn't required groups to show committed financing. If it had, the eventual tariff may well have been much higher.

Revenue complexities

A key challenge for battery storage is around the several revenue streams on offer – some of which are tricky to forecast and can at times be mutually exclusive.

According to Andy Kelly, principal consultant at Poyry Management Consulting, the trick is to design a system that targets certain areas. "If you're looking at very short response times, you're not worrying too much about the amount of energy you can store or how long you can provide for," he said.

David Kemp, a director at M&G Investments, said the revenue complexities made it difficult to see batteries as investable assets on a standalone basis, but added they had potential when combined with other solutions, such as demand-side response or energy efficiency. He admitted, also, that the current market conditions meant it was "a bit early for debt" in the sector.

However James Knight, a director at advisory boutique Augusta & Co, offered a perspective that countered this view. A German battery project he was involved with had just secured 15-year debt, he said, despite only having a year's revenue visibility.

In the German system, projects bid to provide frequency response on a weekly basis, but can get one-year contracts with a trader who takes the volume risk in return for around 20-25% of the revenues.

Interconnector development

While batteries, and their sub-second response times, help plug very short-term electricity supply gaps, they are solving only one problem when it comes to balancing the UK grid.

Interconnectors are another solution, helping to bring down electricity prices and supporting the UK's decarbonisation efforts. With four projects already in operation, totalling 4GW, capacity could be anywhere up to 23GW by 2030, according to estimates.

But doubt has been cast on the next wave of interconnectors by the UK's vote to leave the European Union in June. While a number of projects may already have the green light, there are uncertainties around electricity trading that come from a potential exit from the internal energy market (IEM).

More broadly, the currency fluctuations brought on by Brexit have led to a general nervousness about investing cross-currency, according to James Knight of Augusta. Clearly this could have a real impact on the UK's development of interconnectors.

However, Knight argued that the rationale for such projects outweighed their potential obstacles. He said, "The harmonisation and the ability to capture the [price] arbitrage between these markets is so great that even relative uncertainty around regulation and currency is not great enough yet, to my mind, to stop this happening."

Offering a contrary view, Pavel Miller, head of wholesale policy at SSE, said there is currently too much uncertainty around interconnectors. If the UK leaves the IEM, it's not clear at all what the rules will be regarding the use of interconnectors, he added.

Demand-side response

While the investment opportunities in battery storage and interconnectors are clear, they are often less tangible in the demand-side response sector.

Demand-side response is all about changing usage patterns, and helping electricity generators to balance their power grids. The sector made headlines earlier this month [September 2016], when Octopus Capital struck a deal to invest in Reactive Technologies, whose product allows users to remotely control how and when individual electrical assets consume electricity.

Meanwhile, there have also been a couple of big transactions involving smart meters – a democratised version of demand-side response. Specifically, Infracapital-backed Calvin Capital has now concluded two smart meter roll-out partnerships with big six energy companies – British Gas and more recently SSE.

The UK government requires all energy suppliers to install smart meters for each of its customers by 2020 – totalling around 53 million homes – so the pipeline is clearly sizable.

However, despite having invested in smart meters for four years, Foresight doesn't see the broader demand-side response sector as an investable asset class. "As an investment opportunity, we feel it's more of a technology play, and less suited to an infrastructure investor like us," said Richard Thompson.

More broadly, Augusta's James Knight commented that it had always been difficult to attract investor interest to the energy efficiency sector, where even the smallest deals are often very complex.

Secure infrastructure-type revenue streams were different propositions to investors deploying capital in order to lower a certain cost and then finding a way of sharing that saving with a counterparty, he said.

Policy hurdles

Policy-makers are increasingly looking at demand-side measures to stabilise the grid, and clearly play a crucial role in introducing the necessary incentives or price signals that will enable the sector to grow.

For SSE's Pavel Miller, a key challenge for the government is around the way it approaches subsidies. In the past the focus was sustainability, but this appears to have shifted towards affordability. He asked, "How do we measure the cost of these different investments? What would the alternatives be if we are going to need new infrastructure?"

Meanwhile, on batteries specifically, there are regulatory issues around who can own storage assets, and the fact such projects are currently classed as generators, according to Poyry's Andy Kelly. M&G's David Kemp added that "double charging" was also a problem – whereby battery operators have to pay levies when both charging and discharging their projects.

Ultimately, though, despite the clear obstacles, the panellists agreed that there is a large volume of capital looking for a limited number of investable opportunities in traditional markets.

With this increasing competition putting pressure on returns, the natural consequence is therefore for that pool of capital to seek diversification, and certain components of the smart grid have some of the fundamentals that infrastructure investors desire.

Panel:

• Richard Thompson, Director, Foresight Group
• James Knight, Partner, Augusta & Co
• Pavel Miller, Head of Wholesale Policy, SSE
• Andy Kelly, Principal Consultant, Poyry Management Consulting
• David Kemp, Director, Project and Infrastructure Finance, M&G Investments

Partner: Foresight Group

Date: Friday, 16 September, 2016