Q&A - Harmony Energy Income Trust: Achieving a revenue sweet spot for batteries

Harmony Energy Income Trust (HEIT) is an investment company focusing on UK-based commercial-scale battery energy storage systems (BESS). Incorporated in 2021, the Trust has a portfolio that comprises 395.4MW / 790.8MWh across eight BESS projects, five of which are operational and three under construction.

inspiratia speaks to Max Slade, commercial director and general counsel at HEIT, about the development of the trust, the evolving management processes of the BESS market and how companies can best achieve a revenue sweet spot for their assets.

What is HEIT, and why was it founded?

We have been involved in the UK battery storage sector for almost eight years. In the early days, it was not easy to acquire funding. As a result, we needed to innovate through things like strategic joint ventures, which supported the build-out of our first BESS projects.

Within the energy storage sector, timing is critical, requiring the right combination of a positive regulatory environment, high revenues, a stable supply chain and low CapEx to enable the quick build-out of assets.

We saw HEIT as a terrific opportunity as it would allow individual retail and institutional investors to participate in this journey to build and own an extensive portfolio of long-duration batteries.

We have not wasted any time. In the two years since the IPO, we have completed the build of five projects with a combined capacity of 277.5 MW / 555 MWh, including two of the three largest batteries in Europe by MWh. This is the third-largest BESS portfolio in GB by MW, which is a brilliant achievement given the short timeframe.

It is a testament to the delivery team that we have been able to deliver these projects within the timeframe pledged in our prospectus as part of our IPO. 

We still have three more projects under construction (representing another 236 MWh). The target remains that by midway through 2024, we should have a fully operational portfolio of eight projects, representing a combined 394.5 MW / 791 MWh. This will be enough to power 1.2 million UK homes for 2 hours in a single discharge.

How does managing BESS differ from more traditional renewable energy infrastructure?

From a maintenance point of view, BESS are relatively simple as they are effectively modified EV batteries, wrapped in modules arranged into a container format in rows, with each number of units having its own transformer. It is relatively light touch and low cost compared to traditional forms of generation that involve many spinning turbines and moving parts.

However, when it comes to revenues, batteries are a lot more complicated than traditional generation. In a more conventional format, big, centralised power stations on the transmission network would sign long-term offtake agreements with big utilities, who pay an agreed strike price for whatever power the station generates. These power stations are, therefore, incentivised to be online and generating for as much time as possible.

With a BESS, you have less pressure to maintain constant operations. The warranted degradation profile of the BESS gives you a fixed number of "cycles", so you cannot operate all of the time. Instead, you use data analysis and trading algorithms to select the periods when the revenue is high enough to justify the activity. The other major difference is that a BESS has many more revenue strategies to choose from. This is what we call a fully-merchant strategy, meaning non-contracted. It requires minute-by-minute optimisation handled by AI and other algorithmic software. We outsource this function to a third-party "revenue optimiser" but direct the overarching strategy and monitor performance using our own proprietary software.

How do you achieve a revenue sweet spot for your BESS assets?

There are several types of revenues which can change on an hourly basis. For HEIT, the primary revenue strategy is "trading", which is essentially charging (i.e. buying power) at low prices when demand is low and then discharging (selling the power) at high prices when demand is high. What we are effectively doing is taking excess cheap green wind power from overnight periods when it is not needed, storing it and then putting it back onto the system later when wind penetration is lower, and pricing is high. At these times, BESS is displacing the lower efficiency, higher carbon gas-fired generation, which would otherwise be needed to fill the gap in demand created by low wind. 

The other principal revenue strategy is called "ancillary services". This involves signing short-term contracts with the National Grid, which uses you as a fast-response tool to keep the GB grid network stable on a minute-by-minute basis, guarding against network failures. The batteries charge/discharge upon demand act and with sub-second response times. Again, the more BESSs supplying this service, the less reliant we become on the traditional gas-fired generation plants. 

These two strategies are how BESS can and will enable the transition to a fully renewable power network.

What are the differentiation factors of your platform?

When we came to market in 2021, it was important for us to show investors that we were doing something slightly different and that we were generating more value.

We did this in two ways. Firstly, through our acquisition model. HEIT acquires projects at "shovel-ready" status, which essentially means "ready to build". Certain material binary risks, such as planning permission, have been covered, but construction has yet to commence.

On top of that, we also ensure that the seller has undergone a high-level procurement process so that the key supply and construction terms are already agreed upon, minimising the contracting timetable between the point of acquisition and the point that CapEx is fully locked down.

By acquiring projects at this point, we are protecting investors from early-stage binary risks whilst enabling them to benefit from value uplifts as the projects move through the construction phase into operations.

The second differentiator is that all HEIT's projects are 2-hour duration projects. That is unusual, with the average BESS project being a 1.2-hour duration. Although still a relatively small proportion of GB BESS projects, two-hour duration BESS generate higher revenues than their shorter-duration peers. Every BESS is limited to the number of MW it can produce at any moment. Still, a longer duration BESS has more MWh, meaning it can produce the maximum MW for longer. When trading, it pays to have more MWh because you can trade more volume, and a two-hour duration battery has double the amount of MWh as a one-hour battery. In short, doubling the MWh provides the opportunity for double the revenue.

Independent commentators have projected that by 2030, a two-hour duration battery is forecast to make 90% more revenue per year than a one-hour battery. The primary driver for this is an increasing reliance on trading revenues amongst the BESS fleet and less activity in ancillary services. That is a strong endorsement of HEIT's strategy and portfolio, with it well positioned to outperform over the short to medium term. Indeed, September and October have already seen a widening of wholesale market trading spreads as GB prepares for winter, with strong revenue performance for HEIT's portfolio.

Grid connections are provided in perpetuity. What are the strengths and weaknesses of this model?

A grid connection is a vital cornerstone of any power infrastructure project and the priority agreement which any developer must secure.

Once secured, you have perpetual rights to do what you want with it. We get questions from investors: what happens if someone invents a "better" storage technology or chemistry? Well, as long as you have a grid connection, you can upgrade your technology accordingly. We do not see technology obsolescence as a near-term threat, of course. Lithium-ion remains the dominant solution, and HEIT benefits from warranties to support the business case for at least 15 years.

What happens when the cells in the BESS reach degradation?

When you build a BESS, the supplier sells you a warranty curve, guaranteeing you a certain number of cycles over 10, 15 and 20 years. A cycle is an aggregate full discharge of the battery from 100% to 0%, but it is rare for a BESS to perform a full cycle in one burst. What normally happens is that the battery charges and discharges multiple times a day, and the state of charge moves between 20-80%.

The more one cycles the battery, the more revenue is earned, but the shorter the lifespan becomes. HEIT models a 15-year life cycle, assuming 1.3 cycles per day. In reality, we are cycling less than this, so the battery's useful life should be somewhere between 15-20 years. At that point, we will have reserved enough revenue to enable us to swap out degraded batteries with new ones, taking advantage of the modular design.

You focus on a diversified BESS portfolio. Can you walk me through the funding process?

We have used a combination of debt and equity. HEIT enjoys a right of first refusal over the BESS pipeline developed by Harmony Energy Limited (HEIT's second-largest shareholder). Harmony Energy Limited is a private developer with a 2.5GW GB pipeline at various stages of development – this company takes the "binary" risks I mentioned earlier – and develops the projects to the "shovel-ready" stage. At that point, HEIT procures external legal, technical and valuation due diligence before resolving to acquire the projects in accordance with template SPA terms, paying Harmony Energy Limited a developer premium consisting of cash and shares.

Although HEIT is free to acquire projects from third parties, the right of first refusal structure is designed to ensure ongoing alignment between Harmony Energy Limited and HEIT's other shareholders. This alignment is critical for HEIT and ensures it acquires and operates high-quality assets, which can be delivered through construction into operations as fast as possible.

The process relies on strong governance, and HEIT benefits from an independent, talented and experienced non-exec board of directors who safeguard shareholder interests.