Q&A - Gresham House: Will declining BESS revenues bounce back?

Gresham House is an alternative asset manager, and a major investor in the battery energy storage systems (BESS) market in the UK. Through its Gresham House Energy Storage Fund (GRID), the company had 640MW of operational BESS capacity, as of 30 September 2023. The fund also has a pipeline of 1.2GW of projects under construction or development during that same period.

As of October 2023, the UK's battery energy storage sector had seen a 71% drop in profits, inspiratia previously reported. This sharp decrease followed a period of unprecedented growth driven by high energy prices, highlighting the sector's volatility.

inspiratia speaks to Peter Bolton, investment director within the Gresham House New Energy team, on whether BESS revenues are likely to bounce back in 2024.

How important is co-located battery storage to Gresham House's strategy?

Co-location is extremely important to our strategy. We launched the Secure Income Renewable Energy & Storage (SIRES) fund, which reached its first close in February 2023. The perfect project for the SIRES fund would be a co-located UK greenfield project. Its first project, which has recently begun construction, is exactly that.

But even in our more established GRID fund, that fund can do co-located investment as well, primarily in non-GB markets. We are quite excited about it as a form of project design that we think our investors will like, as a balance between stand-alone storage and stand-alone renewables. We believe in all three options, standalone storage, co-location, and stand-alone renewables, as they continue to be viable and attractive sectors for investors.

How does Gresham House decide on stand-alone BESS vs co-located projects?

From our perspective, it is more about which classification of investors we are representing. Traditionally, stand-alone storage has not had long-duration contracted revenues. So, it has been seen as more of a merchant play and, therefore, tends to be more suitable for people seeking a higher return. Whereas at the other end of the spectrum, renewables traditionally have had long-term subsidies from the government. Now, you also have the option of long-term corporate power purchase agreements, so you can get that very stable cash flow.

What co-location is doing is offering an interim, so you are getting a return premium compared to renewables, but you are getting a degree of contracted cash flows versus what you would normally get through standalone battery storage. The institutional investor base appreciates that balance.

On a project level, it is the developer at the time that decides the optimum project, and that will be determined by the grid connection and what is available. It will depend on the availability of both an import and an export capacity. If you can only get export capacity, then it is best for renewables on their own. If you can get import and export that then that lends itself either to standalone storage or collocation. If you want the project to be co-located, particularly if it is with solar, you need a lot of land around that connection as well.

How does the investment case differ for these different project classifications? 

For us, it is about fitting the risk-return profile, and as I mentioned - co-location sits nicely in the middle between stand-alone BESS and renewables. Probably the most exciting thing about it is the blend of cash flows on the revenue side that it generates. So you have the option of a predictable renewables generation that gives stable cash flow through long-term PPAs or Contracts for Difference. But then you blend it with a return that is driven by the battery revenue that often seems to be more merchant and has different components in the revenue stack like ancillary services, trading capacity, balancing mechanism, etc. So you get both a diversification and hedging effect, along with the return pick-up at the same time.

This is quite important as the risk-free rates that investors would consider have increased, and therefore, we want to maintain a premium above them. The blend of the cash flows from collocation allows us to do that. So that is kind of the thing that gets people most excited - the revenues.

But it is worth noting that there are usually cost advantages too. In co-located projects, you are able to share some of the equipment and the balance of plant capital expense when the project is in construction, particularly for DC coupled sites, as they share the inverter, so there are fewer physical boxes and expensive equipment on the site. If you have a single site, you can spread the cost of the operators, the people who are maintaining the site, across one project as well.

Grid connection is another important point. It takes a while to get projects through the development cycle to the point where they are grid-connected. There are some efficiencies with effectively having one project development process that is delivering two technology types that are essential to the energy transition. So there are efficiencies in planning, grid connection and securing the lease.

The UK's battery energy storage sector saw a significant decline in profits last year. What is driving this decline?

2021 - 2022 were very good years for battery revenues, while 2023 was lower performing. We have observed that within our portfolio of assets, as well as everyone in the market base. There are three drivers for this, as I see it.

Ancillary services revenues previously comprised a very large proportion of the revenue stack, but we have effectively reached the point of saturation, where the National Grid has been able to access the services it needs already, and therefore, the pricing of those services has come down. Everyone expected that to happen and expected that batteries would become less dependent on ancillary services and more dependent on trading.

Then on the trading side, that is dependent on power price volatility. We have not seen the level of power price volatility that was anticipated, which relates to the fact that the level of demand from consumers is depressed because power prices and gas prices have been high. With that reduced demand, you cannot get the kind of spikes in power prices.

The third point, one which we have been particularly vocal about, is the balancing mechanism. Essentially, National Grid is not utilising batteries to help it balance supply and demand and is instead prioritising other technologies like gas at a greater environmental cost and greater cost to consumers. National Grid ESO's trading system, along with its processes, needs updating to fully utilise the more efficient flexibility batteries offer. The good news is this is underway. The new system was launched in December, albeit with limited improvements to date until further issues are fixed through 2024, and further improvements are planned through 2024, including removing a time restriction on how long batteries can declare power for and being able to reserve battery capacity ahead of time to drive greater competition with gas.

While 2023 was not the best year for battery revenues, we believe that power price volatility will come back. We are also optimistic about the National Grid's promises to improve the balancing mechanism.

Do you expect things to improve throughout the year?

We are anticipating better revenues on our existing portfolio due to volatility returning and the balancing mechanism improving, bringing those revenues. We are also expecting to build out more duration on our existing sites. Our average at the moment is just over one hour across our 21 operating assets, and we want to bring that up. All our new assets, for example, will be two hours, so the average will increase, and that provides a solution that is better placed to capture value from wholesale trading. Looking at the battery storage market in general, we expect to see a lot more capacity built out. We have projects that are in late-stage construction and just waiting to be plugged in. So yes, we anticipate improvement in 2024.

How can developers navigate declining BESS profits?

Aside from adding more duration, we are also trying to identify new revenue streams that do not cause us to be dependent upon the National Grid or dependent upon short-term intraday volatility. Those would be more direct arrangements with larger counterparties over slightly longer durations. It is kind of an early idea, but there are avenues that we are exploring to use the battery in different ways to capture other forms of more predictable cash flow. The advantage for BESS has always been the different revenue streams. So, you are essentially stacking revenues on top of revenues and picking the best ones. I think we just need to keep finding those alternatives to provide diversification.

How critical will the US be as an investment region for Gresham House in the coming years?

We are excited about the California project, it is a big project – 160MW/ 600MWh battery, with co-located solar as well. That is a longer-duration battery than anything that we currently have in our UK portfolio. We are aiming to commission that battery project sometime between Q4 2025 and Q2 2026. So you can compare that to some of the projects you hear about in the UK with long-dated grid connection timetables.

That is another way to protect our investors by diversifying our portfolio. So, that is hopefully the first of many projects internationally. The US in particular is a very big and attractive market across all of Gresham House's strategies, not just in renewables and storage. We see the US as a growth market. The other interesting thing is the recent acquisition of Gresham House by transatlantic firm Searchlight - we would hope this will deliver the potential for more US activities across everything that Gresham House does.