Long duration electricity storage - a "balancing" act
On 9 January 2024, the UK government unveiled its proposed policy framework for supporting investment in Long Duration Electricity Storage (“LDES”) assets. LDES technologies, such as pumped hydro storage and long duration flow batteries, are designed to store energy for extended periods, helping to balance the supply and demand of electricity and support the integration of renewable energy sources. The proposed “cap and floor” mechanism is at the heart of this framework, aimed at providing financial stability for investors and affordability for consumers. The initial industry response has been cautiously optimistic, welcoming government support to develop the relevant technologies but warning against overengineering the policy framework to address “gaming” risk and also expressing disappointment at the exclusion of lithium-ion technologies.
Current estimates indicate that LDES could result in system savings of up to £24bn, representing a saving to consumers of 3.3% of total system costs. The potential savings are inversely related to low deployment of hydrogen and CCUS solutions as part of the energy transition (which are expected to play similar roles to LDES in terms of counteracting intermittency and providing low carbon energy generation alternatives). Given the uncertainty of deployment of CCUS and hydrogen technologies, the government views LDES technologies as serving a risk mitigation purpose as well, allowing LDES assets to act as an alternative to building new generation assets in order to maintain system stability.
The five key aspects of the government’s LDES proposal set out below provide insight into the government views on supporting a variety of technologies in this space whilst trying to achieve maximum systems benefits, protecting investor returns and ensuring consumers receive value for money.
1. “Cap and floor” mechanism
The government intends to take inspiration from the “cap and floor” mechanism used in the context of building interconnectors, with the aim of (i) providing guaranteed revenues for investors should returns from operating assets drop below the agreed floor and (ii) protecting consumers by providing a cap on the revenue that operators can earn, with some or all of the revenue earned over the agreed cap returned to the consumer. However, the government acknowledges LDES is inherently different to interconnectors (and potentially more susceptible to manipulation). Storage technology is subject to varying costs to buy the energy to charge the storage asset ahead of its discharge as opposed to interconnectors which are modelled on the basis of a simple rental charge for usage.
Under the current proposal, the floor would be set at a level that allows a project to recover its debt-related costs and the cap would be set at a level that incentivises the asset to continue operating to maximise the available storage in the future energy system and to gain a fair return on its equity investment, whilst protecting consumers from excessive cost. The government has suggested that the metric it will use for these purposes is “gross margin” i.e. the difference between revenues earned from dispatching energy and services of the asset and the costs of buying the energy to charge the asset.
The government approach acknowledges the need for private capital (and expertise) to help foster LDES solutions. However, there is also a concern about developers “gaming” the proposed solution in a way that either does not encourage the operation of an efficient storage solution or allows for public money to be exposed where a developer elects to stay below the floor level and take advantage of guaranteed revenues. At the end of the day, given the variable demand and supply aspects intrinsic to storage technologies, the eventual solution has to find the right balance between ensuring revenue certainty, systems operations and value for money for consumers. Developers need to be incentivised to contribute to efficient operations whilst the proposed solution needs to ensure sufficient transparency to oversee operations. The government may seek to revisit the proposed structure from time to time to effect market corrections, but it will need to be cognisant of developers fixed costs and debt related costs that will need to be guaranteed to ensure that the revenue certainty element is not detracted from.
2. Dual-stream approach
The government acknowledges that different technologies (or at the very least different categories of technologies) face slightly different challenges to deployment. In the context of established technologies such as pumped hydro storage, these may be that long build times result in the inability to access the capacity market and create revenue uncertainty for the project once the asset is deployed. For novel technologies the lack of a proven track record simply may mean lower investor appetite. In order to foster an environment that supports the development of both categories of technology, the government has proposed different eligibility requirements for Stream 1 (established technologies, including pumped hydro storage, liquid air electricity storage (“LAES”)) and Stream 2 (novel technologies, including compressed air electricity storage , LAES and flow batteries). This section of the government’s proposal is relatively light on detail, acknowledging that as technologies develop they may progress from Stream 2 to Stream 1. They key eligibility criteria pertain to technology readiness scores (TR 9 i.e. a marketable product in its final form that has been proven through successful operations for Stream 1 and TR 8 i.e. technology that has already been successfully deployed in a demonstration phase for Stream 2), minimum capacity (100MW for Stream 1 and 50 MW for Stream 2) and minimum durational capacity (6 hours for both Streams).
3. Other eligibility criteria
Locational requirements: Although projects throughout the UK will be considered, the government acknowledges the mammoth task of addressing transmission constraints in the UK and suggests that the marginal benefit of additional storage in constrained locations is likely to be low unless transmission systems can be upgraded. As such, the current view appears to be that locating more long duration storage in less constrained areas will be more beneficial to the system.
Duration and efficiency: The government has put its weight behind projects that demonstrate a minimum duration of 6 hours at a specified power capacity. The durational requirement is based on the understanding that longer duration storage options provide the greatest systems benefit as they can support prolonged energy shortfalls and excesses. The government has requested stakeholders to provide a view on whether minimum efficiency factor should also be included in the proposed scheme.
System benefits: The government has proposed that “systems benefits” of a particular LDES solution should be tested by an external third party with a view to testing whether the system will operate more flexibly at the least cost as a result of its deployment. Suggested “systems benefits” could include ancillary services, location based benefits, reduction of system costs, additional consumer benefits, local economy benefits, impact on constraint management and impact on energy security.
4. Delivery routes
The government proposes to use an administrative process that looks at a variety of factors to deliver the “cap and floor” mechanism described above rather than simply selecting the cheapest bids. This is because the government is keen to bring forward projects that bring the most system benefits rather than those that are the cheapest, plus this approach is more likely to ensure a range of LDES technologies can be supported.
5. Contract length
With the aim of supporting a wide range of technologies, the government has opted for a more flexible approach and instead of specifying a minimum contract term for the length of a “cap and floor” contract has instead proposed that contract length should be based on the project lifetime. Again, this approach complements the government’s desire to support a variety of technologies.
The initial proposal summarised above presents a considered market design led approach by the government. Each of the five parameters set out above indicate the government’s thinking on key risk areas (lack of revenue certainty, high upfront capital costs, long build times, system constraints) impacting LDES. The question really is whether it is enough to support capital intensive technologies required to implement effective LDES solutions and / or encourage nascent technologies in this sector. The consultation period closes on 9 March 2024.
